4.3.3.1 Shortcomings

Lack of regulation might not be seen as a shortcoming yet. This is a phase of raising global awareness, engagement, experiment of reporting instruments and exploring the potential of the frameworks developed until this day. Stakeholders are not all aware and fully engaged with sustainability and integrated reporting. Despite some early evidence of studies of, among others, Eccles, Ioannou, and Serafeim from Harvard Business School1 and RobecoSAM, 2 the link between financial performance and sustainability reporting and integrated reporting might yet be insufficient for convincing the reporting organizations and investment community. Given data limitations, the business case is for some not strong enough were not financially penalized for engaging with sustainability reporting practices.3 In addition, companies show increased ESG management. In a later phase, and in order to reach a harmonized and comparable set of guidelines, the lack of regulation might be then considered a shortcoming. Law practitioners believe there is always room for improvement of the legislation, and as it is the case in Brazil, the challenge lays in the lack of monitoring and not in the lack of legislation.

In Europe, the European Commission’s Directive on non-financial disclosure gives companies flexibility to choose the reporting guidelines and framework deemed most suitable to their business. With this Directive the European Commission aims at ensuring a level playing field lowering the fragmentation of the legislative frameworks within the EU. However, the use of multiple reporting tools might slow down the aimed goal of the European Commission of lowering the fragmentation of the legislative frameworks used by EU companies.

Whilst the reality is that there is no globally accepted and mainstreamed sustainability reporting set of guidelines, if we want sustainability reporting practices to be mainstreamed and achieve comparability of information, in the future the European Commission will need to require, or, at least, recommend a given standard-setter. As referred above in section 2, the European Commission considered the endorsement of the IIRC framework to be a step ahead. However, this may be about to change with the recent development of the EU Action Plan on Sustainable Finance of 2018.4 The European Commission endorsement of a particular sustainability reporting tool at this moment would be too risky as financial market players, particularly companies and investors, still did not agree upon the most suitable framework to their interests. A flexible and non-intrusive approach is necessary as a base for advancing to a next level as soon as there is an agreement between companies and investors on which sustainability reporting framework directly answers to their information accuracy and comparability demands.

For large investors, regulation comes with the risk of mandating too detailed requirements, as the GRI guidelines or the questionnaires of Dow Jones Sustainability Index (DJSI). Investors complain about the mismatch between the data disclosed by companies in a sustainability report and the data which is material to investors. If under legislative pressure, companies tend to provide a huge amount of data without evaluating the materiality of the information they are disclosing.

The quality of sustainability reports in Brazil is raised only among the minority represented by the largest Brazilian companies, who already report on ESG risks of their business activities and show their interest for the topic. There is a discrepancy between what readers expect from a sustainability report, from a sustainability index or financial terminal, and what is actually reported. Cardoso, L. and Lemme, C.F., 2011 researched the content of 31 sustainability reports and found that several companies (even from different sectors) still do not make the link between corporate financial advantage and sustainability practices. Regarding the quality of reports it is also interesting to note that the lack of experience of companies in writing sustainability reports makes them look for an example in other companies’ reports. Given the fact that these companies may be from a different sector, providing different products and responding to different challenges, the reports tend to provide very similar information and to be disclosed in a similar way. Those writing sustainability reports have a certain “degree of freedom” once they do not know precisely who the readers are. External assurance is not yet common and the reports are written on a “free style”, with a weak consistency of information and difficult to compare. Brazilian stakeholders, mostly the writers and users of sustainability reports, explain that the problem is not the use of a given framework but the single use of only a few key performance indicators and principles taken from different frameworks and included in an organization’s own methodology to write a report. The lack of knowledge about who the readers of a sustainability report are and lack of accuracy and comparability of information, is an urgent shortcoming to be overcome. When investors are provided with high quality of information communicated in a comparable way, they will use this information to make more responsible investment decisions.

In all the four countries part of this research, large investors look at the information disclosed through sustainability indices and financial terminals, as Bloomberg. However, there is a limitation on the quality of the data and its coverage. Most of the data available covers ESG housekeeping issues rather than strategic issues. There is more information on the behavior of the companies than information related to how companies manage their risks, and deal with the big currents of change. A large index investor such as the Dutch pension fund PGGM,6 which invests 40 billion Euros through the FTSE4GOOD Index (London Stock Exchange Sustainability Index),7 cannot individually analyze all the companies’ part of the index portfolio. 8For these companies, PGGM mostly uses information provided by financial terminals, as Bloomberg. Differently, for active managed portfolios, PGGM goes deeper in the analysis of the companies and looks at the individual sustainability reports. However, a sustainability report often provides a very selective reading of how a company positions itself in the market and how it manages ESG risks. The information provided on a sustainability report is also hard to compare, given the multiplicity of reporting tools used and flexibility of sustainability reporting.

There are high expectations for the future developments of communication of integrated reporting. With the technology we have today it seems to be easy to separate information accordingly to the different stakeholder’s demand, easily accessible at a low cost. Cloud computing allows a user to store, access and share real time-data in an online platform. This means that data can be accessed through the internet, via web browser from any location and any device.9 Professor Robert Eccles and Mr. Kyle Armbrester, CEO of Glenelg Partners, explain how the new technology of cloud computing can make a difference in the future of integrated reporting.10 Through cloud computing, companies would benefit from an efficient and cost-effective integrated website, make use of interactive tools, real-time data, improved engagement with stakeholders through feedback exchange. Due to a capacity limit, investors do not have the time to read immaterial information, there is too much data but not enough intelligence. Investors want a short report that concentrates on the financially material ESG risks and opportunities combined with the ability to compare them. External assurance and cloud computing can contribute to improving data quality and quantity.

Assurance can be defined as “an important means to enhance the credibility of sustainability reports” (GRI in Carrots and Sticks, 2010 report); or as the term “used to describe formal statements issued by independent professional assurance providers, including accounting, certification, and technical firms (…) to draw conclusions on the quality of the report and its data (…). (KPMG, 2008); or as “an evaluation method that uses a specified set of principles and standards to assess the quality of an organization’s subject matter and the underlying systems, processes and competencies that underpin its performance.”11 (The Association of Chartered Certified Accountants and AccountAbility) The two most used assurance standards worldwide, are the AA1000 Assurance Standard (AA1000AS), an assurance standard developed in 2008 by AccountAbility to provide companies with assurance on sustainability reporting;12 and the International Standard on Assurance Engagements (ISAE) 3000, developed by the International Auditing and Assurance Standards Board of the International Federation of Accountants (IFAC).13 It was developed in 2003 and it is designed to guide companies providing assurance on their sustainability reports. In the Netherlands the Standard COS 3410N “Assurance Engagements relating to Sustainability Reports” is the national assurance standard. It was launched on 1 January 2007 by the Royal Dutch Institute for Registered Accountants (NIVRA).14 It is based on the International Federation of Accountants Framework for Assurance Engagements and ISAE 3000. This standard complies with the most commonly used standard for independent verification, the AA1000AS and also with the GRI guidelines. The AA1000AS is flexible and allows a significant contribution of the organizations in their reports, e.g. in the key issues of the engagement, for example, the scope and level of assurance to be obtained by the practitioner. Brazil also developed two national assurance standards, in 2004 the Federal Accounting Council issued the NBC T 15 providing guidance for environmental and social reporting. In 2007, the Independent Auditors Institute issued the NPO 1 provides an assurance standard for other types of assurance besides the financial assurance.

Drivers for assurance of sustainability reports differ. In some countries, like the Scandinavian the main driver is legislation while in others, as Brazil and the Netherlands, reputation and marketing, is an important trigger national and international credibility and boost market competition. Assured reports bring trust and credibility to the data disclosed, and increase quality. Investors and other users of the reports will be certain about the reliability and accuracy of the information they are using (KPMG, Survey 2008).15 Companies have their reports assured mostly by major accountancy firms and certification bodies. In 2008, 70% of the G250 companies had hired an accountancy organization as an assurance provider (KPMG, Survey 2008).16

Companies in general do not invest the same financial efforts and people on sustainability assurance as they invest on financial assurance. Non-financial information is covered by an assurance standard so it is called “assurance” and you can still give the same level of comfort as for financial assurance. Reasonable assurance is considered to be an audit. In a financial audit accountants focus on the annual accounts (the numbers) and do not assure the whole report. In the audit of a sustainability report it is different as for many sustainability assurance engagements the whole report is assured, including data and numbers.

Brazilian companies must comply with the Brazilian securities regulator’s financial reporting requirements which are very demanding and time consuming so they believe it is a barrier to development and need to be stimulated with clear incentives to support potential new legal requirements, in particular if they cannot see the benefit of compliance. Companies reporting requirements’ overload are common not only in Brazil. An alternative to compliance-only approach, could be the development of incentives for reporting organizations.

In the Netherlands, FMO, the Dutch Entrepreneurial Development Bank, developed a framework for offering a reduced interest rate to borrowers who complete ESG action items within a set timeframe. FMO calls it a “margin reduction incentive” and it was launched already 10 years ago in 2009. It is offered on an ad-hoc basis (not a structural product) and it is meant for high environmental and social risk clients and/ or where investments are large enough to make improvements. The margin reduction incentive is provided only once a client has achieved the outcome and it is checked by a third party e.g. external consultant. It has proved to be a useful tool for clients to invest more energy in completing ESG action items. However, further research is needed to clarify whether this finding is applicable to all FMO’s clients or only true for clients already interested in ESG. FMO’s initiative shows how a financial institution can play a crucial role in promoting the benefits of the long-term view through an ad-hoc incentive, encouraging sustainable practices among its clients.

Mainstream rating agencies could also play a role pushing companies to manage ESG risks. If Bloomberg starts ranking companies on their ESG risk management, we would play the game at a platform where finance happens. Credit rating agencies together with financial terminals and stock exchanges can be a powerful incentive to drive change. By rating companies on their financial and non-financial performance as a whole this information would be taken into consideration by the investment community, by the stock exchanges and by the corporate sector. This could be an alternative to developing more regulation. Credit rating agencies would change their company evaluation methodology by including ESG risks in the evaluation of corporate performance. This would have an immediate impact on how companies behave because they need good ratings. If companies would not show full consideration of ESG risks in their strategy they would be downgraded. Besides, an integrated financial and non-financial analysis of companies could be developed. E.g. development of integrated rating agencies.

Another alternative to regulation is the development of tax benefits for complying companies. This could be allied with the new methodology required for rating agencies (integrated rating agencies) also giving a tax benefit to better rated companies, or by giving a tax benefit to companies producing an integrated reporting duly audited by external audit firms.17