Why Not 'Sustainability Fundamentals' in Corporate Reporting?

Why Not 'Sustainability Fundamentals' in Corporate Reporting?

Sustainability reporting is often derided as being outside the mainstream of financial reporting, devoid of any relationship to performance. The Economist calls it "corporate storytelling."

Unfortunately, The Economist is right. Reports are unique accounts of each company's journey, impossible to compare with other reports, even when reporting frameworks such as the Global Report Initiative's are applied. The hard analytics (earnings per share, price-earnings ratio, return on assets) and sophisticated comparative reports of financial reporting are absent from the practice of sustainability reporting.

One cannot imagine the financial markets functioning without public disclosure of financial fundamentals in a form that allows for benchmarking with competitors. Yet investors who wish to take a longer-term view of risk and consider sustainability performance are left hanging. And without key performance indicators, sustainability performance will never improve.

Just like financial fundamentals, sustainability fundamentals can be defined for issues that describe performance and will enable comparison within a sector. Once they are reported, they can be managed. Market leaders will drive performance to capture efficiencies and reduce risk, while laggards will be subject to public derision. Ultimately, this will affect the flow of capital, rewarding companies that contribute to sustainable development.

Looking Ahead

Imagine if comparable sustainability reports were readily available in a public forum. Would BHP Billiton begin to care if its energy use per unit produced were less than Alcoa's? Would Rio Tinto begin to manage its reliance on potable water for production if it were at a competitive disadvantage? Would shareholders begin to see the connection between sustainability indicators -- such as resource use, fines paid, executive pay -- and the bottom line?

The mock-up above is a fictional comparative report that would be possible in a world with sustainability fundamentals. How far are we from achieving this vision? To explore the possibility, I attempted to identify quantifiable sustainability indicators for the mining and metals sector. I started with Rio Tinto's 2003 social and environmental report because it is notoriously comprehensive -- rumored to be 1,700 Web pages.

In less than an hour of digging, I was able to extract more than 20 social and environmental indicators that are quantifiable, characterize performance and are relevant to the sector. An indicator was deemed relevant if at least three reports from the sector mentioned it. (For Rio Tinto, the data presented are the actual numbers from its report, where available. All other companies are illustrative.)

This exercise confirms that it's entirely feasible to define quantitative sustainability fundamentals that can be compared across companies, or to a sector norm. Without this context, individual reports have little discernible meaning.

So what's needed to make this happen? In basic terms, companies need to report the same thing in the same way, and the information needs to be aggregated and presented in a public forum.

Reporting on the Same Thing …

Sustainability fundamentals are the basic building blocks for comparative reports. All companies consume energy, use water, produce waste and emissions, and employ human capital to produce goods and services. These "global" fundamentals help assess a company's relative contribution to global sustainability challenges such as water scarcity and global warming.

In addition, there are sector-specific fundamentals: factors like access to drugs and residual organic chemicals in the environment for the pharmaceuticals industry, or mineral waste and occupational disease in the mining industry.

The United Nations Conference on Trade and Development (UNCTAD) in conjunction with two accounting standards boards recently defined five globally applicable eco-efficiency indicators -- environmental basics that are normalized to economic value added. Their approach is rigorous, the definitions are precise, and the units are internationally accepted.

If each of the 2000 companies that are currently producing sustainability reports reported on these five indicators alone, we would be a lot closer to understanding not only the links between financial and non-financial performance, but also the relative impacts of the various sectors on the world’s common resources.

Within a sector, it’s entirely possible for companies to report on the same material issues -- using relevant quantitative indicators that accurately reflect sustainability performance and the concerns of industry stakeholders.

Defining them remains a challenge, but industry associations can play a key role.

To obtain a complete data set for a sector, reporting on at least the fundamentals will need to be compulsory. This entails a cultural shift from thinking about sustainability reporting as a voluntary, extraordinary effort designed to tell a unique story, to a sector-wide initiative designed with peer-to-peer comparison in mind.

The benefit will be that individual reports will become more concise and better reflective of issues agreed on by the sector and its stakeholders.

In time, the availability of comparative sustainability reports may even obviate the need to read individual sustainability reports. After all, how many people bother to read annual reports?

… in the Same Way

Though some companies do include global and sector-specific fundamentals in their reports, methods and units have not been standardized. Therefore, comparing simple quantities such as energy use might involve converting British Thermal Units to petajoules, something few people have the patience for.

The primary organization declaring responsibility for defining parameters for sustainability reporting is the Global Reporting Initiative. However, it is woefully behind in both establishing technical protocols and addressing sector issues.

The GRI’s next generation of guidelines (G3) to be released in 2006 promises to deliver technical protocols for the current set of general indicators, including calculation methods and reporting units. However, sector supplements are developed only when a quorum of companies in the sector approaches GRI -- hence there are only a handful completed to date.

A recently released mining and metals sector supplement prepared by GRI and the International Council on Mining and Metals (ICMM) outlines sector issues, but does not specify data collection, calculation methods or reporting units.

Key performance indicators were not established -- a huge missed opportunity to enable comparative reporting. With all the time and resources devoted to producing a sector supplement (this one involved 20 people over a year) shouldn’t we expect more? All of ICMM’s member companies have now promised to report using the GRI framework within two years.

Although they may be reporting on the same issues, the lack of a standard format means that a complete, comparable data set will not emerge. One can only wonder if it was intentional.

In the Public Eye

The socially responsible investment industry currently analyses sustainability performance as part of its due diligence research, but analysis is kept proprietary. Strategic Asset Management’s impressive Sustainability Yearbook 2005 (a href=http://www.sam-group.com/downloads/publications/Yearbook_jan05.pdf target=new>PDF) identifies issues and ranks companies in 60 sectors, but performance data are not presented. As such, we have no way of knowing in which areas a company excels or needs work.

While the final ranking provides these companies with bragging rights, it offers no insight into the drivers of performance. Transparency should not just be for reporters.

In the early 1990s, Schwab transformed the investing landscape by making use of technology to provide financial information to the public that previously had only been available to analysts and brokers. Others soon followed suit. This access to financial information empowered individuals to make informed decisions and created a new class of demanding investors.

Information brokers play a key role in aggregating and disseminating information that is easily digestible and allows public scrutiny of performance. Peer pressure, in turn, drives performance.

Where are the information brokers for sustainability data? To date, attempts have been limited to co-locating reports. But when sustainability reports are devoid of comparable indicators, the value of having them in one place is marginal.

Stepping up to the Plate

If sustainability reporting is to become a respectable and useful business activity, businesses need clear standards and concise fundamentals with which to report. Standard-setting bodies and industry associations need to rise to the occasion.

Presumably, standard-setting organizations know a bit about writing good standards: they can contribute the consistent approach and standardized format that is so sorely lacking in sustainability reporting. Industry associations know the business.

They can define the issues that are material to stakeholders. In partnership, they have the clout to establish standards and make reporting on sustainability fundamentals a compulsory part of business reporting. In the meantime, reporters can do their part to cover global and sector-specific fundamentals, telling not only a unique picture but a comparable one, in a concise and understandable format.

We are, after all, human, and we make sense of unusual and disparate things by drawing comparisons. Until reports that compare sustainability performance are freely available, as ubiquitous as financial reports, we will remain lost in the quagmire of intriguing anecdotes, unable to determine who performs better, or even what indicators really matter in the quest for sustainability.

Realizing the Vision

If I had a nickel for every time someone said to me, "sustainability performance can’t be compared -- there are too many qualitative factors," I’d be able to retire to an eco-friendly resort on a tropical island, organic drink in hand. The fact that there are "soft" issues related to sustainability performance is no reason to shy away from developing the quantitative framework and presenting the data that can be compared in a rational format. Sector by sector, sustainability fundamentals can be developed and consistently reported.

Qualitative issues will always be addressed in narrative form, (and there are even ways to turn qualitative data into semi-quantitative data if desired.) But again we have an analogy in the financial sector: qualitative factors that impact financial performance are presented in the management analysis or notes accompanying financial statements, to provide additional context and explanation for anomalies.

In a world with comparable reports, sustainability reporting can fulfill its true potential: providing concise, transparent information that clearly reflects the reality of environmental and social issues, allows for benchmarking, highlights long-term risks and opportunities, and contributes to improved levels of public and investor confidence.

Standard-setting bodies, reporters, information brokers and analysts all need to do their part to make this happen.

Otherwise sustainability reporting will remain an exercise in creative writing, and the hopes of directing financial capital to companies that contribute to sustainable development will never be achieved.

Jean Rogers is associate principal of Arup, a design and engineering consulting firm.

This column has been reprinted courtesy of Ethical Corporation. It was first published on Feb. 25, 2005.