As Executive Director, Education, at the Chartered Institute of Management Accountants (CIMA), Robert Jelly is at the forefront of research on finance, accounting and related matters.
Sustainability Reporting: What It Means For Finance
He sat down with CFO Innovation’s Cesar Bacani on a key initiative at CIMA – the seemingly inexorable move towards sustainability reporting, which CIMA believes should be part of tomorrow’s balance sheet. Excerpts:
I read the CIMA report, Tomorrow’s Balance Sheet, and I think it’s useful in that it gives a progress report of what’s happening. It just seems rather woolly to me.
You’re absolutely right, and that is because this is just Stage 1 in a much longer process. Part of what CIMA does is to try to find good, if not best practice, and work with those organisations to help promote and refine sustainability and corporate reporting it.
What is happening is I think there are two extremes. Some countries and governments want to basically impose rules on this whole area of reporting. What South Africa is trying to do, for example, is to put numbers to the issue of sustainability and the impact [of business activities] on the environment and society.
The reasons for that are obvious because there is a huge issue around natural resources in that country. But the challenge for the accounting profession is that not all of this can be expressed in numbers, in terms of an old model [of accounting], if you like.
The other extreme is people simply trying to explain [sustainability] in terms of narrative. That’s still quite woolly.
So what does CIMA want to happen?
To some extent, we’re neutral. Our key goal is to identify best practice, to provide a forum whereby people can come right to the table [and discuss the best way forward]. We’re not doing this on our own. In the UK, we’re working with the Prince’s Trust. The Prince of Wales is supporting the whole sustainability agenda.
What are the best practices you’ve identified so far?
I think it’s just about openly reporting on a narrative basis. The best practice is in being very transparent.
Then there is establishing key performance indicators or KPIs. For example, if 60% of your workforce is receiving anti-viral treatment for HIV, then you may target 70% next year. It’s not just what you have done in the past; it’s also about your future KPIs.
What do you expect these things to be in a year’s time, in five years’ time? CIMA itself, in our own annual reports, are trying to do that. We are not yet reporting it, but we are looking at, for example, energy use, we are looking at water use, at our carbon footprint.
Interestingly, carbon management has found a way of adding a price [to a company’s carbon footprint through emissions trading]. This has an impact not only on the environment and sustainability [but] also as applied to risks. People haven’t really put a price on the risk of cleaning out the environment.
Having societal responsibility comes at a price. Companies will have to build that in. The best example of that is if we want to buy a car that is more environmentally friendly as a consumer, we are likely to pay more for it. There will be a price to pay.
But that’s only in the beginning, isn’t it? When everybody is driving greener cars, their price should drop.
That’s right. In fact, the other side of the coin is that they can save on costs over the longer term. So it might well be that if you take cars for example and more people buy them, you’ve got volume production.
If a company buys greener cars despite the higher costs now, presumably that would be reflected positively in its sustainability reporting? And because of the cost, the savings and so on, this will be reflected as well in the financial reporting?
That’s where you would hope that companies are doing this in the long run – that might be five, 10 years, which is not the normal range of measurement for historic cost accounting finance reporting.
If you look at, let’s say, the FTSE 100 companies or the Fortune 500 companies 50 years ago and today, there aren’t a lot of the same companies around. They might have been absorbed, so in many ways the old models hasn’t helped longevity. Maybe this [sustainability push] will.
Companies that are beginning [to address sustainability] today, including companies like Tata in India, you can see are those that want to be around in 20 years’ time. A lot of nuclear companies today are thinking maybe wind and solar aren’t a bad idea after all [after the Fukushima disaster in Japan].
The report distinguishes between legislation and voluntary compliance.
One of the things [that worry us is that] by legislating, companies won’t innovate. Companies compete. Very often, in certain areas including financial reporting, by encouraging that voluntary competition, the standards go up.
Is there a middle way between these two extremes?
You have to marry the two. We know from financial reporting that if governments intervene too much, people will start to do things [just to comply with regulations], to put numbers on a piece of paper.
At an early stage, you don’t want government to come along and say: This is what you should do. The chances are, if governments say that, that’s what companies will do and nothing more. We’re trying to break through that and allow people to innovate.
But the CIMA report [also recognises] that the chances are nothing will happen without government intervention. Just as if you have no employment legislation, minimum wages, maximum number of working hours, many companies would just take advantage of [the lack of regulations].
So legislation, but not too much legislation.
A fine balance, and also within the legislation, to encourage companies to report beyond [what is required]. In most countries, legislation on financial reporting says ‘this is the minimum requirement,’ but many companies will do the minimum and no more.
One example [of voluntary compliance] is retail companies in the UK. Tesco, Walmart and others have all placed recycling at the heart of their agenda. They have recycling bins in all their carparks so people can deposit their bottles, paper and so on. They see a USP [unique selling proposition], but eventually everybody will be doing it.
And they are doing these of their own accord because they see the USP; it’s not legislated. How do they report these sustainability initiatives?
It’s largely in the narrative reporting side. Some of them may have put in KPIs [key performance indicators]. They may say: When it comes to packaging, all our packaging will be recycled. Of course, the logistics chain needs to be brought into this.
Another very important sustainable reporting issue is the use of labour in the supply chain. So you’ve Company A committing not to use child labour [as KPI]. Some companies respond to this issue very quickly and others don’t.
The narrative part of the annual report is not audited, isn’t it? The external auditor does not really certify to compliance with standards as it would with the financial statements . . .
That's a challenge. It’s an interesting issue, the extent the information provided should be checked, for want of a better phrase. The numbers are relatively easy to audit. But I think increasingly the auditors are being asked to comment on [the narrative reporting] based on the information they have at their disposal. This widens the remit of the audit, but it means the skills of the auditor [must be upgraded].
Are there companies in Asia that are embarking on tomorrow’s balance sheet, as it were?
Interestingly we highlight Tata, the Indian company, in the report. Tata recognised that arriving at a number [for sustainability] is not the same as buying that digital recorder from you for HK$1,000.
What they’re doing instead is saying: We’ll talk to a range of stakeholders and ask them how we’re doing in terms of sustainability. So there’s a lot of subjectivity around it, which in effect makes the number much less solid, much less reliable.
But their argument is it’s better to come up with this index and monitor it over time, so that if it’s going up in terms of how we’re behaving, if people think we’re doing a good job, then you’ll see the index rising.
Is this index included in Tata’s annual financial report?
Yes, they are reporting and explaining it. They are saying to the public: We will very openly tell you. The risk, of course, is that it may be that the index will fall from time to time and you therefore have to explain [why this is the case].
Is there an attempt to directly correlate the index with the bottom-line?
Not in the short run. I think the general belief is that by reporting the sustainability index, it will [improve the financials] in the long run.