Environmental Reporting: The need for open transparency in environmental reporting.
Following well publicised scandals in the corporate world, such as Enron and Parmalat, there have been calls for greater and more transparent reporting. Increasingly pressing environmental issues, such as the issue of climate change recently discussed at the G8 Summit, are driving more transparent reporting.
The directors of companies that do not report on their environmental impacts are under increasing legislative pressure to do so. From 1st April 2005 the Operating and Financial Review (OFR) requires around 1,300 UK companies to provide information in their annual report on environmental issues that may materially affect their business - the first ever mandatory reporting requirement of non-financial elements under UK company law. The OFR requires directors of all listed UK companies to provide shareholders with a balanced and comprehensive analysis of the main trends and factors underlying the development and performance of their business - both today and in the future. It is hoped that such information will encourage greater exchange of relevant information between companies and their shareholders in much the same way as the recent legislation on directors' remuneration has done.
Research commissioned by the Environment Agency, and conducted by Trucost, analysed current environmental disclosure levels in the Annual Reports and Accounts of FTSE All Share companies in order to establish a baseline of reporting prior to the onset of the OFR regulations. It found that, although some reporting was good, the majority of disclosures lack depth, rigour and quantification, and few could be described as comprehensive or adequate for shareholders to properly assess environmental risks or opportunities facing companies.
If the poor quality of environmental reporting highlighted by this study is anything to go by, few listed companies would comply with the requirements of the OFR on the basis of their current annual reports and accounts.
Key Performance Indicators (KPIs)
The OFR regulation requires the review to include the use of KPIs. The exact content and number of KPIs should be determined by the directors themselves based on their view of what is significant to their company, although the Accountancy Standards Board Reporting Standard 1 details information that should accompany each KPI to enable shareholders to understand and evaluate them.
It is generally acknowledged that the use of appropriate environmental KPIs is more likely to result in information that is consistent and comprehensive, allowing shareholders to make comparisons both over time and between companies.
New KPI Guidelines developed by Trucost for Defra have recently been published. They aim to help businesses address their most significant environmental impacts and report on these in a way that meets the needs of their shareholders and other stakeholders. The guidelines outline how environmental impacts can be measured through KPIs and how to report them.
Elliot Morley, Minister of State for Climate Change and Environment, said: "The recent growth in environmental reporting has led to a number of different approaches and this has led to reports of varying quality, depth and rigour. These guidelines seek to set a standard which will give business some assurance that it is has reported its environmental performance to an appropriate minimum level of accuracy and detail."
Socially responsible investors have been in the vanguard of efforts to promote greater transparency in corporate reporting to enable better informed investment decisions. Directors of companies, and their shareholders, will need to consider whether their companies are adequately prepared to operate in a world where carbon emissions will be required to be 60% lower than 1990 levels. Henderson Global Investors recently commissioned Trucost to conduct a carbon profile of the FTSE 100. The Carbon 100 highlights to investors how their investments are contributing to climate change and how these could be affected by policy measures to reduce emissions in the future. Trucost found that these 100 companies accounted for 1.6% of the world's total carbon dioxide emissions, which represents about 73% of the UK total. Just five of these companies generated more than two-thirds of the FTSE 100 total emissions. It is interesting to note that under half of FTSE 100 companies disclose their carbon emissions, accounting for over two-thirds of estimated emissions. In addition, even for those companies that do report, there is still a considerable lack of comparability in reported data.
David Pitt-Watson, chief executive of Hermes Focus Asset Management, said that: "Their [Trucost's] ability to dig out the data about the environmental consequences of production is absolutely second to none anywhere in the globe."
It is clear that companies that do not manage their environmental risks will face increased exposure to future regulation and potentially higher cost of capital. Companies that do report well, and that in the future produce relevant and concise OFR reports, will benefit from differentiation from their competitors and will be able to use the new reporting requirements as an opportunity to demonstrate management quality.
Practical issues for environmental reporting
The fact that a company already produces supplementary reports will not exempt it from the obligation to produce an OFR. Indeed one of the difficulties for directors will be how they decide which, if any, are the relevant environmental impacts to discuss in their OFR.
Understanding how a company is performing and how it compares with its competitors, in terms of environmental efficiency, is just one potential aspect of the OFR. Nonetheless it is a key issue for business and shareholders alike. The OFR will have major implications for environmental disclosures and for the first time in company law there will be a requirement for directors to make forward-looking statements.
Increasing environmental regulation, environmental taxation and emissions trading schemes are forcing companies to consider their impact on the environment. As a result, companies that manage their environmental impacts well will be better positioned to meet the challenges and grasp the business opportunities of the future. As put by Environment Minister, Elliot Morley: "Failure to minimise environmental impacts and plan for a future in which environmental factors are likely to be significant may risk the long-term value and future of a business."
The reporting burden on companies may not be as bad as some think. The aforementioned Guidelines set out 25 KPIs but no one company is expected to report on all of these and in many cases the KPIs make use of standard business data that many companies will already collect. In fact 80% of UK business has 5 or less significant KPIs against which the Guidelines recommend they should report their performance.
The regulatory changes described above make companies more accountable to shareholders regarding environmental matters. It remains to be seen whether these changes will, on their own, lead to a situation which will encourage more companies to measure, manage and communicate their environmental performance. There is every possibility, however, that increased transparency will allow for more informed investment decisions, which will mean appropriate allocation of capital to the best performing companies whilst demonstrating to poor performers the ways in which they can improve.
Simon Thomas is chairman of Trucost, an environmental research organisation that quantifies environmental impacts in financial terms.