Recent years have witnessed profound changes in how businesses around the world understand the risks they face and what actions are necessary to better manage them.
Central to these changes has been a re-evaluation of the environmental and social issues that companies contend with. Once solely the concern of corporate social responsibility for many companies, matters such as climate change, supply chain conditions and water stress have increasingly become material concerns for risk and financial departments and important topics for boards.
This change can be explained by three key and interrelated driving forces.
Firstly, the research findings from bodies like the IPCC and IPBES have mounted and mounted, showing ever more clearly the severity of interconnecting societal and environmental crises and the threat they pose to communities and companies around the world. This mounting evidence has increased expectations on companies to contribute to the Sustainable Development Goals (SDGs) and to help accelerate the transition towards a world where we live within our means.
Second, governments and regulators are increasingly attuned to these potential risks and responding with reporting requirements for the biggest companies, important examples being the EU’s Non-financial Reporting Directive (NFRD) and the Taskforce on Climate-related Financial Disclosures (TCFD) Recommendations.
Finally, companies and investors are growing aware that their value creation lies upon a foundation of factors sometimes conceptualised as natural, human, and social capital.
But just as our understanding of the nature of environmental and societal crises matures, so does our grasp of the risks they pose to businesses. An important recent development has been the growing appreciation of the dynamic nature of risk and materiality.
Environmental and social issues are too often understood in a discrete and almost static, dislocated manner, often treated as box-tick exercises. Dynamic materiality, however, centres business within the human and natural worlds around them and understands that material risks emerge out of the complex interconnections between business, environment, and society. For example, while climate change has been an issue growing consistently in importance for companies over the past decade, plastic waste became a material concern for companies across many sectors on a scale of weeks and months.
Crucial to this is the speed at which consumers can become informed and begin to act, transforming plastic waste from a data point in the sustainability report to relevant information integrated within mainstream disclosure. While questions may be raised about the robustness of the evidential basis for similar such demands, they are illustrative of a new reality for companies, centred on interconnection and feedback. It heralds a time that necessitates companies better balances the needs of risk management and resilience.
Are we getting ahead of ourselves, though? Is it the case that we are moving far quicker conceptually than we are in corporate practice and reporting?
To help us answer these questions, we can turn to the information collected by the World Business Council for Sustainable Development (WBCSD) on the last three years of reporting by 300 of the world’s largest companies.
Through comparing the risk disclosures made in the sustainability reports with those presented in the mainstream reports, results show an obvious misalignment. While for issues such as climate change, governance, and labour practices, there is a considerable alignment between the two sets of disclosures, the same cannot be said for ecosystem services, human rights, and social issues.
We may question whether this misalignment is simply reflective of the differing potential for financial impact of these issues for companies, meaning that some are more likely to pass the materiality tests of the mainstream report, but this does not convincingly explain the pattern. Why, for instance, are labour-related risks more consistently reported by companies between their sustainability and mainstream report than those pertaining to human rights, despite the two often being deeply interconnected for companies?
This disconnection indicates a need for the development of greater understanding and management of all environmental and social risks, and further support on how companies can most effectively report on these issues to investors in the mainstream filings.
The guidance produced by WBCSD and the Committee of Sponsoring Organisations of the Treadway Commission (COSO) for applying enterprise risk management to environmental, social and governance issues is a key tool for companies to keep up with the ever-changing nature of risk. It offers companies an important manual and is aligned with the reporting principles and requirements of the Climate Disclosure Standards Board (CDSB) Framework. Building on this guidance, WBCSD have further advanced innovative and practical approaches to enhanced risk assessment to capture ESG-related risks interconnectedness and complexity.
For CDSB, though, these results, as well as the growing understanding of the important and dynamic interconnections between environmental and social issues, encourages consideration of the need for a re-evaluation of the scope of the CDSB Framework. While presently focussed on environmental issues, the disclosures principles and requirements of the CDSB Framework are equally applicable and useful for the reporting of social matters in the mainstream report.
CDSB is now embarking on a project to expand the scope of its Framework to cover social as well environmental and climate change issues. The guidance offered by WBCSD and COSO on risk management is key to this. The new edition of the CDSB Framework, due later this year, will offer companies the means of disclosing this essential and material information to investors effectively and efficiently in their mainstream report.
This article was in written in collaboration between the Climate Disclosure Standards Board and the World Business Council for Sustainable Development. For more information visit cdsb.net.
David Astley is Senior Technical Officer at CDSB.