2020 is gone but the realignments that it forced companies to undergo are simply starting. The full impact will be seen soon and one area to keep an eye on is disclosures in environmental, public health, governance, and diversity issues. In this post we highlight what to expect in company disclosures in the near future.
Most companies that included ESG issues in their annual reports in the past have taken a broad approach. And, hardly any specific figures are attached to those issues. Rather, the reporting is meant to show that the company is aware of their existence.
However, 2020 revealed that what may be non-material today can change rapidly to impact the company’s bottom line. Going forward, investors will be more interested in the risk assessment and reporting on a spectrum of materiality issues seeing that many companies failed to predict and quantify the risk of a pandemic.
Increased Focus on Systematic Risks
In this decade, there will be more scrutiny on reporting of systematic risks including climate change, water security, and social welfare. In 2020, 30% of US companies made no mention of climate risk in their financial reports. Another 30% of US companies did not report anything on workplace inclusivity. Prior to 2020, many companies in Europe and the US never reported public health risks they faced.
The question of materiality will be high on the agenda list of company boards. More significance will be placed on ‘dormant risks’ or any lurking ‘around the corner.’ These are risks that are yet to materialize. The COVID-19 pandemic drilled holes into the assessments of most businesses about their business continuity.
To improve the accuracy and reliability of such assessments, there is a need to rely on more real-time data that spans the business value chain. Boards also need to consider perspectives of more stakeholders when assessing risks and opportunities. So far, about 30% of companies have updated their business continuity plans considering the pandemic.
More Detail in Climate-Related Risk Disclosure
In 2015, the Task Force on Climate-related Financial Disclosures was launched. It released a set of recommendations in 2017 and since then, among the S&P 500 Companies, 43% of companies now report climate-related risks up from 5% in 2012.
Heading into 2021 and beyond, there will be more emphasis placed on specific revelations related to climate change. For instance, does a company have set policies and governance practices on climate issues? Are there clearly drawn lines of responsibility on climate-related decisions?
There is a realization that so much information is being generated in climate-change discussions that people cannot scan and process all the information without the aid of software. To attain a granular look at the issue, companies need to leverage technology to track regulatory requirements, performance benchmarks, and drive operational outcomes on the topic.
Equity and Inclusivity Reporting
2020 brought to the forefront issues of discrimination, equity, and inclusivity. While companies have always been keen to make public statements on social justice, they have provided little in the way of specific internal policies, governance practices, and goals for improvement within the business ecosystem.
In August 2020, the Securities Exchange Commission issued new rules that will force companies to publish a description of its human capital resources as long as it is ‘material to the understanding of the business.’ The new rules will result in an uptick in the number of companies reporting on these issues as well as greater detail on how companies are handling these issues.
There is a stark difference between diversity, equity, and inclusion reporting in Europe and America. This is partly attributable to differences in culture and regulations. There are more laws on inclusion across Europe than in the US. Perhaps as result, more companies in Europe have internal regulations that go beyond what is legislated in national laws.
Relooking at Risk & Materiality
Mainstream financial reports are likely to undergo a major shift in the near future with increased importance given to ESG issues. It is now up to the preparers of annual financial reports to figure out how best to address the issues, requirements, and expectations.
Companies must relook their risk assessment procedures. A suggestion given thus far is to place greater reliance on data and move towards ‘data-driven materiality’. This means that companies will rely on more tangible ways of determining whether an issue is important to investors and other stakeholders. In the past, something such as an environmental issue would be decided on using consensus or a gut feeling of the preparers of statements.
There will be concerns regarding the cost of providing additional ESG information. However, that is part of the materiality discussion as well. If it matters to investors and business stakeholders, then the additional cost of reporting is indeed justifiable.