Financial and non-financial reporting: Two sides of the same coin?

Annual reports have long been recognised as an important medium through which companies disclose information to external stakeholders regarding performance, strategy, risks and opportunities for growth. As good reporting stems from good governance, most companies will have sophisticated and mature systems in place to manage financial information throughout the year, across all parts of the business, thereby enabling timely disclosure at year end.

Imagine trying to operate in an economy where companies approached financial disclosure in the same way they currently manage and report on non-financial matters, such as energy, emissions, environmental and social issues. Would you invest in a company if you could find no mention of any financial information in its annual report? Or if the financial performance of individual business units were simply estimated due to insufficient data? Or if the only remotely finance related disclosure available concerned voluntary initiatives of staff in local communities? Of course not! Such a situation would clearly be absurd. And yet, sadly, this is par for the course for non-financial reporting.

Across the EU, just 6% of EU large companies provide any form of non-financial disclosure whilst the overwhelming majority, around 42,000 companies, do not. But the reporting landscape is changing and companies ignore this at their peril. Since 2013, all UK quoted companies have had to include greenhouse gas (GHG) emissions within their Annual Reports. The Strategic Report and Directors’ Report Regulations introduced legislation requiring quoted companies to disclose information “necessary for an understanding of the development, performance or position of the company’s business”, which includes disclosure of KPIs on non-financial matters, such as energy consumption. And regardless of Brexit, by December 2016, the UK is required to transpose the EU directive on non-financial reporting into law, placing obligations on companies to include relevant and useful information on policies, main risks and outcomes for non-financial issues.

Following the UK government’s consultation on “Reforming the business energy efficiency tax landscape”, a new, consolidated reporting regime is now expected in April 2019 to reduce the administrative burden of complying with several overlapping schemes (such as ESOS, CRC and MGHG). Whilst the results of the consultation revealed scope for consolidating tax and reporting requirements, the business community remains unequivocally clear in supporting the benefits of non-financial disclosure. Prior to the March 2016 budget, representatives of several leading organisations including BT, Aviva, Nestle, National Grid and IEMA signed an open letter stating that mandatory GHG reporting has helped to improve board level oversight, investor engagement, resource efficiency and productivity. Earlier this year, Larry Fink, CEO of Blackrock, with $4.6 trillion assets under management, stated that “over the long-term, environmental, social and governance (ESG) issues, ranging from climate change to diversity to board effectiveness, have real and quantifiable financial impacts”. And a recent survey conducted by PWC revealed that 97% of Limited Partners (LPs) carry out an ESG assessment prior to allocating funds and that “70% of institutional investors are turning down projects on environmental, social and governance grounds”.

As the saying goes, you cannot manage what you cannot measure. The financial industry is increasingly awake to the risks presented by a failure to manage and report on ESG issues. Although legislation may currently be targeted primarily at larger companies, a trickle-down effect is inevitable as they demand greater disclosure from suppliers in order to meet their obligations.  Aside from need to ensure compliance and meet rising expectations of external stakeholders, a robust and proactive approach to non-financial disclosure presents an opportunity for companies to report on their “handprint”, i.e. the positive effects they have, as well as their “footprint” – the impact they leave behind. In the 21st century, can companies afford to manage non-financial disclosure with any less rigour than traditional financial concerns? For leading companies, it is already clear that financial and non-financial reporting are simply two sides of the same coin.

*This article was published in The Energyst magazine Aug/Sept 2016 edition originally.

 

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