Episode 19 - ESG Reporting: Where to next?

In this podcast Daniel Roach, Senior Technical Lead at Company Matters, discusses the latest developments in ESG reporting.

In this podcast Daniel Roach, Senior Technical Lead at Company Matters, discusses the latest developments in ESG reporting. The conversation covers both voluntary and mandatory ESG requirements, looking particularly at the new ISSB standards, the TNFD and the proposed changes to the UK Corporate Governance Code. Daniel discusses increasing investor pressure on companies in relation to ESG, why ESG matters to governance professionals, and how to decide which ESG standards to report against. He argues that understanding your stakeholders will help you identify the correct ESG focus for your business and that good ESG reporting is honest and transparent.

*This episode was recorded before the withdrawal of the ESG proposals within the consultation on the UK Code


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Transcript

RJ

Today I'm speaking to Daniel Roach, Senior Technical Lead at Company Matters, which is a part of Link Group. We're going to be discussing the rapidly evolving area of ESG reporting. It's great to be speaking to you today, Daniel. Perhaps you could start off our discussion by telling us a little bit about your background, and why you think environment, social and governance (ESG) matters to our audience of company secretaries and governance professionals.

DR

It's great to be with you too Rachael and great to be on this podcast. In terms of my background, I studied history all the way through to PhD level, but then needed a real job and needed to earn some money and fell into the Co Sec (company secretarial) profession, as I suppose a lot of people do. And I'm happily there still 10 and a half years later.

In terms of ESG and why it matters to company secretaries and governance professionals. I think it matters for a whole host of reasons. It matters because we're humans and the environment matters to us. It matters because we're working for companies that care about ESG matters. It matters because we're supposed to be advising boards on ESG, and that's a complicated area. So our minds are heavily focused on trying to understand it as best we can [to be able to] advise as best we can.

I think it matters too because we know through a whole host of studies that boards and companies are talking about ESG all the time. I think we want to make sure as best we can as company secretaries that they're having good conversations and the right conversations about the right things. I think that's a little bit of why it matters uniquely to us.

RJ

That's interesting. I suppose one of the areas that's driving that focus from boards on ESG is an increased investor focus on ESG matters. What do you think is driving that focus?

DR

That's a really interesting question and there's lots of different ways you can answer it. One of the useful things that's out there – and there’s so much out there ­– is Schroders do an annual sustainability survey. What's interesting about that is you can see how the responses to that survey – in terms of why people invest in sustainable funds and sustainable investments – you can see how they’ve changed over time.

In 2020, the biggest block of respondents said, we invest in sustainable funds because of the likelihood of higher returns. It's been interesting, since then, that that has gone from being the biggest reason to the smallest one. In the last couple of years, and in the last survey, [respondents say] it is just the wider environmental impact [that] is driving investor focus on ESG matters. Then after that, societal principles: we should care about this, because we should care about society and the environment.

I think that's where we are now. It's unavoidable even if you're a director, or a company, or an individual who's not that bothered; you can't avoid it anymore because the amount of pressure from investors and regulators is such that you've got to tackle this.

RJ

That's an interesting shift that it's moving up the agenda and it's becoming about more than just returns, like you said. What are some of the challenges facing company secretaries and governance professionals on ESG?

DR

It's great, isn't it, as someone in the industry who loves governance to have lots of focus on governance, but the downside of that is [that] this is an incredibly complex area, where there's lots of governance, and there's lots of regulation, and it's quite technical. There's mandatory [requirements] and there's voluntary [requirements], and there's this framework, and there's that framework.

I think one challenge is just trying to get our heads around it and trying to watch it as it moves. I think, as well as being technical, our role is highly practical. We are advising boards; we're advising management about these things. I think the practical challenge of getting buy-in from boards, and getting time in board meetings, and getting the right things in front of the board, and getting boards comfortable with some of this stuff; I think that's a real challenge.

With new regulation comes uncertainty [about] how that is going to be applied. Also, from boards, [there’s] a degree of discomfort in terms of where they stand or what their appetite is like. Or, if you think about something like the new diversity requirements, boards are having to think about those things and think about the future and how they're going to move towards those things.

I think those are some of the challenges. There's obviously two conversations around to have or not to have an ESG committee and the merits of that. Those are some of the things that come to my mind.

RJ

That's interesting thinking about having an ESG committee. It makes me think about the what the UK Corporate Governance Code says about ESG and the proposed changes to it. I think some of those reference giving ESG reporting to the audit committee.

DR

It's interesting what the Code might say and what's happening in the industry as well. I think something like 52 per cent of the FTSE 100 has got an ESG committee by that name, or another name. It's fewer into the FTSE 350. But lots of companies, regardless of what's going to happen with the Code; they have ESG committees, or a committee like that by another name.

It's interesting that [in relation to] the current consultation on the Code, in the actual narrative around that they (the Financial Reporting Council (FRC)) talk about how they had considered mandating a Sustainability committee, as it's called in the consultation document, but decided against it because, to quote them, ‘companies are building experience in different ways and the issues relating to sustainability and ESG might be dealt with by risk committees, people committees, management teams, or external experts.’ Then they say, which I think is maybe the nub of the issue, ‘the audit committee has experience in setting policies and frameworks, which could be adapted to ESG metrics, and as such, it is best positioned to oversee ESG disclosures, controls, processes, and assurance.’

RJ

You mentioned a little bit earlier about lots of different requirements around ESG. Some voluntary, some mandatory, and there's quite a few new things coming up. What future ESG reporting developments do you think companies need to be aware of?

DR

I think there are three in my mind. One is the ISSB sustainability standards. The second is TNFD: The Taskforce on Nature-related Financial Disclosures. The third is this consultation on the Code.

I think in terms of ISSB, we've obviously got two standards that have come out, which will really feed sustainability into the financial statements and into the notes in the back end of an annual report, and into financial reporting and the risks and opportunities around that.

Those two standards will form the basis of UK sustainability disclosure standards. There’s two consultations that have been announced by the FRC and the Financial Conduct Authority (FCA) on those things. I think aspirationally, the UK standards would come out 12 months after the launch of the ISSB standards. But I think, as with all these things, it'll probably take a bit longer than maybe originally envisaged.

The second is TNFD. When I say TNFD, I do still find a mixture of responses, which tend to be, ‘I've never heard of that,’ or, ‘I've already heard about TCFD (Task Force on Climate-Related Financial Disclosures).’ The final TNFD recommendations were published very recently. There's some traction and there's some press around it, but there still seems to be quite a lack of awareness. But this is TCFD for nature. It's very self-consciously trying to mimic TCFD, in the sense that the four pillars of TCFD are identical in TNFD. So they're trying to make it easily ‘integratable’ into TCFD. The ISSB and the GRI (Global Reporting Initiative), to use another acronym, those people have been knowledge partners in the actual consultation around TNFD. So hopefully, it'll be a bit more integrated and a bit easier to come in.

How it (TNFD) comes into the UK corporate governance regime is TBC. Some investors have begun to ask for it to be mandatory in the same way that TCFD is. At the moment, it obviously isn't. TCFD took years from implementation to actually coming into UK regulation as mandatory. It may well be similar. We're already beginning to see some of the FTSE early adopt and begin to integrate some TNFD reporting into their TCFD reporting. It's really putting nature under the spotlight in the same way as climate generally.

The third thing is the UK Code consultation, which is getting a lot of airtime. One of the reasons why there's been a consultation on the Code is because of ESG. There's three areas which touch on ESG. One is remuneration and the need for there to be stronger links between remuneration policies and corporate performance with ESG objectives and executive remuneration being tied to those objectives.

The second is the role of the audit committee. The proposed new wording stipulates that the audit committee will have responsibility for monitoring the integrity of narrative reporting, including sustainability matters: it's very clear there. And [on] the assurance side of things, too. In the way the audit committee engages with the auditor now around the financial disclosures, so too going forward, I think it'll become much more increasingly common for the audit committee to think particularly about the assurance around the ESG metrics and disclosures in an annual report.

The third bit is around diversity beyond gender and ethnicity; diversity of all types, particularly at board and executive management level. Those are the three areas that the new Code consultation is touching on. The idea is that that Code will apply to accounting years commencing on or after 1 January 2025. So there'll be a year probably from the time that the new Code is finalised to implementation. Those are the three things that I see coming down the track.

RJ

I think it's interesting [that] the Taskforce on Nature-related Financial Disclosures doesn't quite have as much traction at the moment. Do you think that's because this area of nature and biodiversity loss and understanding its relationship with climate change is a bit of a newer theme that companies and boards and governance professionals are still getting to grips with?

DR

I think it doesn't have traction yet because it's so fresh and I think you can get acronym indigestion – for want of a better phrase! I think that's a reality, too, that boards are getting confused. There's a lot to grapple with and it's difficult to work out how these things all interlink. I think the hope for ISSB is that things begin to be standardised and incorporated. I think people who are doing good TCFD reporting and good ESG reporting at the moment are already reporting on nature, you can see that in the best practice that's out there. Now, what's happening, of course, is that some of the bigger companies who are on the front foot have signed up to TNFD and have been part of the consultation. The disclosures will get better and fuller and aligned with TNFD, but I think they'll already be doing quite a bit of it.

RJ

How should companies go about determining which voluntary ESG reporting frameworks they should adopt?

DR

I think that's a good question. I think, at the heart of that, it's important to know who you are as a company and who your investors are, and who your stakeholders are, and what matters to them in terms of what frameworks matter to them, what information matters to them. The best companies will have accessible corporate reporting and interfaces with their stakeholders and the users of their annual report, but they'll also have web pages which link to all sorts of different fields and much more exhaustive information so that people can access those sorts of things. If you want 5000 bits of data, you can go and get that. If you're the average man on the street, you don't need that level of information. I think helping the user distinguish [is important].

I also think there is just a reality that you can't do everything around voluntary reporting. And so to choose what you will do, and be good at that, is a good thing. And to show how what you're doing interlinks with, say, the UN Sustainable Development Goals. That's useful, helpful, and I think there’s a humility in it as well, just acknowledging we're going to do this; we can't do everything.

RJ

Yeah, I suppose it's that materiality of understanding what is relevant to your business and your customers, and where you can make a difference. Because like you said, you can't do everything. But if your business is in a particular sector that has an impact on the environment, or can positively impact society, then it makes sense that that's where you would focus.

You mentioned different groups of people needing different information. When we think about the AGM and voting at that time, what approach are the proxy voting bodies taking towards ESG matters?

DR

I think the overall statement would be that they're backing up the regulatory changes. They're adding teeth to them, I suppose. Whether that's TCFD, or the listing rule requirement the diversity statement, they're backing up those things. They are recommending that companies vote against the chair of a committee or board if the TCFD reporting isn't up to scratch. If companies aren't meeting their diversity targets, again they will recommend voting against. There's no place to hide, I think, in a way, because this is such a priority for investors. This is such a priority for proxy voting bodies.

RJ

We've seen in the past the weight that investors can give to perhaps an activist who has a resolution relating to an environmental or social issue. If an investor gets behind it, a big investor, then it can really affect the company and in some cases be passed. Thinking about getting the best information to your stakeholders, what does best practice ESG reporting look like?

DR

I think you sort of nodded to it there really in terms of stakeholders and investors. Thinking from that angle, from the beginning. [Asking] ‘who are our stakeholders?’ ‘What matters to them inside and outside the organisation?’ Good ESG reporting isn't just facts and figures. It isn't just numbers; it isn't just data. It's actually telling the story of the company, where it's coming from in terms of ESG reporting and climate reporting, and where it wants to go. I think the best ESG reporting comes from companies who have worked out who they are and where they want to go and are being transparent about that. Not just aspirational; not just pretending they've got it all sorted. But they've done a materiality assessment, they've worked out what's important for their employees, for stakeholders inside the organisation, for people outside the organisation, for the regulators, for investors, for the environment, for their communities, for all of those different groups of people.

Then they say, as a result of that exercise, we've worked out that these five things, or whatever it is, are our most important priorities, and so we're going to work on those things. And so next year in our annual report, you should expect us to report on those things. And on those five things, this is how we're doing at the moment. We're kind of on track with this one, we're slightly behind on this one, and we're ahead on this one. And with the one that we're behind on, we're behind because of this reason, and this is what we're going to do about it.

There's a real transparency there and an accountability to the user of the report about how that company is doing. It's also clearly understandable; best reporting is intelligible, and it's understandable, and you can look at it and get it quite quickly; you don't need a PhD to understand it.

At the same time, [at] the other end of the spectrum, the best reporting is technical, and it is comprehensive, but it's integrated. It's applied, you can see, as I said, where their priorities around ESG matters interlink with the UN Sustainable Development Goals, where they link in with TCFD, what they're doing around TNFD etc. But it's still user friendly, you can see it, you can understand it, and they even explain why those metrics matter to them, and how they're doing. In that sense, it's very applied, it's not generic, it's not trying to be all things to all people. It's just trying to do a few things well.

RJ

So, when governance professionals are trying to assess those different areas, and which are important to their company and their stakeholders, what are some of those key ESG questions they would be asking themselves and thinking about in terms of their company and their stakeholders?

DR

I think starting from the stakeholder perspective, specifically, I think there is a question of, if we know who our stakeholders are (and hopefully companies do because of their Section 172 (of the Companies Act) reporting, which they've been doing for a while), how do we assess their views on ESG matters? How do we assess what's important to them?

If we are assessing what's important to them, how well are we doing at that? How are we integrating their views into the way we're collecting data and what data we're collecting around ESG matters? How are we integrating that information into decision making within our organisation, and at board level? How are we integrating that into our corporate reporting?

Then there are a whole host of other questions for a board around ESG matters. How well aware are we of not just the regulation at the moment but what's coming down the track? How are those things going to impact us as a company? Do we have the right governance structures in place within our organisation to cope with what’s coming down the track and what is [in place] at the moment? Do we have the right committees in place? Do we have the right expertise on those different committees, and at board level? Do we have the right skill sets and the ESG experience at board level and committee level to be able to deal with this sort of stuff? Do we have a clear understanding of how our ESG goals are integrated into our overall company goals?

Questions like that become quite important. Can we articulate that to stakeholders? I think that's important. Because if you can't articulate it, do you really know it? Do you actually believe it? Lots of questions, but those are some.

RJ

I suppose sometimes that's when it goes back to looking at what you are doing already and how it relates [to ESG] because that would help you articulate it, because those are the things that you know about. Rather than trying to pick something that you don't know so well, because you think it's what you’re meant to do.

DR

Yeah and, you know, organisations and companies, large organisations and companies, have lots of people who are doing lots of things. So there's both, there'll be both structured, top-down initiatives, led by an organisation, initiated at board level, but there'll also be lots of grassroots things going on. Sometimes it is just a case of pulling that together and saying this is what we're doing.

RJ

You mentioned a little bit about requirements around diversity reporting, which would probably fall under the ‘S’ in ESG. What do you think best practice thinking and reporting on that ‘S’ looks like? Is it diversity? Is it any other areas?

DR

I think all the scrutiny at the moment is on the ‘E’ in ESG. It might be an exaggeration; I suppose diversity is the other. If it's climate under the ‘E’, then it's diversity under the ‘S’. But I think, [in terms of] best practice around ‘S’, the social side of things. Often, I think we find and see that social disclosures are dispersed across an annual report and initiatives too in an organisation, therefore, might be dispersed as well.

I think the best companies can pull together those disclosures around ‘S’. The best companies have clearly thought about what their ‘S’ is. They've said, for us, the ‘S’ in ESG is these 1234 things, and this is why they matter to us. This is why they're the most important things. I think as well as diversity, I think culture too remains [an area of focus] under the ‘S’ and the best companies that I've seen in terms of reporting are able to not just say qualitative things around their culture – ‘we've got a great culture, because we've got a great culture’ –  they will say, ‘we've got a great culture because we measure it in these ways. This is how we measure it and this is what our scoring was like, and this is what we're doing about that, and this is what the feedback is like.’ That feels much more robust, I think, than just saying, ‘we've got an open and honest culture.’ There's a couple of things there around the ‘S’, but I think conceptual clarity is helpful on what your ‘S’ is, both as a board and then showing that in your annual report.

RJ

Because in some ways, it's a bit more challenging, isn't it, to be able to articulate that because in some ways, the ‘E’ has those obvious metrics of carbon emissions. You can quantify it, but with ‘S’ it can feel a bit less tangible.

DR

I think that's right. I suppose that with the Parker Review (into the ethnic diversity of UK boards) and [the] Hampton-Alexander (Review into increasing the number of women in senior positions in FTSE 350 companies) and then those things being integrated into Listing Rules. I suppose that is an effort to quantify diversity, at least at the top level of an organisation.

RJ

You mentioned diversity reporting. What are some of the benefits of that, and also, the challenges that face companies when it comes to diversity reporting?

DR

I think we would all say that having organisational diversity is inherently beneficial. I think the benefit of good diversity reporting is that users of those reports and investors can actually see what's going on in that organisation. They can understand it, and they can get their head around it. Then they can get behind that organisation and ultimately want to invest in it because it has a healthy degree of diversity and it's working on that. I think that's a main benefit of decent diversity reporting. It's more than just [saying] we're ticking a regulatory box therefore aren’t we good? Again, it's that point of showing what's actually going on in an organisation and celebrating that.

Challenges. I think this is obviously a moveable feast diversity reporting and it's evolving all the time. I think the challenges are different in nature. But if you're a company which doesn't have a diverse board that is a challenging position to be in. Obviously, gender diversity in terms of women on boards is way ahead of ethnic diversity. It's a challenge, I think, for boards at the moment. They're having to think through succession planning, they're having to think about disclosures in their annual reports, they're having to get their head around the new requirements. They've also got the real challenges too of finding candidates from a sufficient pool size that will support their diversity in terms of succession planning.

I think too that in having to get their head around some of this reporting, existing boards and existing directors are having to make disclosures about themselves too, which some of those directors are finding uncomfortable. You will see in annual reports that sometimes a significant percentage or a significant minority of directors are saying, ‘actually, I prefer not to specify or say what my ethnicity is.’ It'll be interesting to see how that evolves over time as the regulation becomes more embedded.

RJ

I think that can be a challenge in terms of understanding the diversity of your organisation as a whole. Getting that kind of data depends on how willing your employees are to disclose it. So, sometimes it can be hard to get a true picture of the organisation. You mentioned best practice diversity reporting evolving, was there anything in particular that you were thinking of there?

DR

I think what we're seeing is lots of metrics around diversity. Obviously, the Listing Rule is stipulating gender and ethnic diversity. But I think, in terms of best practice, we're beginning to see diversity around age of boards being disclosed, tenure of directors.

Also, a contextualising of that and a situating of those metrics within broader data points across the organisation, as you sort of alluded to. Whether that's gender pay gap, whether that's women across the whole workforce and seeing almost slice by slice what’s the percentage of women at board level, management level, [at] different pay grades? How does that work?

We're seeing more granular diversity disclosures in that sense which both situate and sometimes offset the picture at board level. I wonder if it's done because it indicates that an organisation is working on this from the grassroots and there is a diverse pipeline that's coming through even if it's not there yet. You'll see all sorts of KPIs (key performance indictors) around female representation in companies and percentage changes year on year and all of those sorts of things to demonstrate that.

If the best reporting isn't just facts and figures, it's telling a story, I think those companies would be hoping that users can see that [story]. Whether or not they always do is another case, when it comes to voting! But I think good disclosure there is always the best approach.

The other thing I would say, and maybe you touched on it organisationally, is that there is an interesting dynamic whereby obviously, corporate governance is very focused on female and ethnic diversity. There's a celebration of that, and an encouragement of that, of course, which is only a good thing. But there is an interesting issue there, which is problematic, as you said, which is that, particularly when you go workforce wide, people don't necessarily want to disclose all of those things. So how do you celebrate those things and encourage those things whilst not creating issues for your workforce or your board?

RJ

Yeah, it's tricky to do it in a way that that still feels respectful to the workforce. Well, that's perhaps one of those challenges that will continue to be discussed between governance professionals or company secretaries and their boards as they keep on addressing ESG issues and how they affect the company and stakeholders.

Thank you so much, Daniel, for the discussion today. It's been really interesting looking at those core ESG issues that governance professionals and company secretaries are facing and how they're affecting reporting in this area. From the relevant regulation and voluntary standards that are coming into effect and investors’ and proxy advisors’ expectations and how these issues are making an impact at the AGM and discussing those central ESG questions that are facing a business and how they can help themselves by thinking about their stakeholders and their sector and making it about what they can do meaningfully and how they can address this in the annual report. Thank you, Daniel. It's been really great to speak to you today.

DR

No, thank you. Thanks for your time. I've really enjoyed it.

ESG Reporting: Where to next?

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