In this issue of ARCUS, our Sustainability Panvestor, Tayef Quader will cover the ever-increasing non-financial disclosures by companies and the critical role these disclosures are playing in how companies are being viewed and valued as investments. We believe that companies reporting in the future will have fully integrated disclosure of financial and non-financial information. This means investors will need to evolve to properly understand their investments beyond the traditional financial context. He will also share with you how despite some challenges, non-financial disclosures are becoming standardized, either due to stakeholder demand, regulatory requirements and even many companies through their own initiatives.
Happy Panvesting!
Munib Madni,
Founding Panvestor
“The new source of power is not money in the hands of the few but information in the hands of the many”
John Naisbitt
Further to Munib’s intro, non-financial disclosures are making sustainable practices more commonplace amongst companies.
But you may be wondering what is non-financial reporting?
Well as the name suggests, anything and everything that has to do with a company’s internal and external impact beyond pure financial statements can fall under non-financial topics. Non-financial reporting generally cover governance, environmental, social and human capital issues.
Non-financial disclosures are often interchangeably referred to as Corporate Responsibility (CR), Environmental, Social and Governance (ESG) reporting, and/or broadly Sustainability Reporting. KPMG’s 2017 study on CR practices of 250 global companies accurately reflects this rapid growth of non-financial reporting as we can see from Figure 1. There’s no doubt that non-financial reporting will play a pivotal role in the years to come, and hence we will reason in this piece why non-financial reporting can no longer be ignored.
Figure 1: Growth in CR rates from the 1990’s. KPMG's 2017 survey of CR practices of G250 companies. Why are non-financial disclosures important for investors? Traditionally, financial disclosures have protected investors as stakeholders and allowed them to judge and value their company’s financial performance. Now, non-financial disclosures are providing the same to all stakeholders and in doing so are making companies accountable for what has in the past been either ignored or outright abused, returns for all other stakeholders. As a company discloses its non-financial credentials it also provides an added layer of information about its risks, costs to mitigate, revenue opportunities, ability to lead, first mover advantage, knock on benefits and finally a true picture of their business and financial model. All things critical for an investor. The majority of investors in today’s business climate do use non-financial disclosures as supported by Figure 2. The Principles of Responsible Investment (PRI) and the Chartered Financial Analyst (CFA) Institute in 2018 conducted a study across 1100 financial professionals in 17 financial markets on E/S/G integration and concluded the following: "E/S/G integration in investment decision making is gaining traction as investors acknowledge these issues, however, barriers such as ‘no one way of doing things’, limited understanding and data issues still remain."
Figure 2: Investor’s method for evaluating non-financial and E/S/G disclosures
Source: EY’s report on non-financial reporting and value creation.
Which non-financial disclosure should you look to?
Non-financial disclosures have become the talk of the town in the last decade or so. Both the sustainability and the investment landscape has seen a proliferation of various acronyms, ratings, awards, indices and benchmarks. However, we are still far from seeing global standards being adopted and agreed upon. This should not come as a surprise as non-financial information measurement, collection, collation and reporting is still evolving.
This does not mean that smart investors will wait for a global standard to appear before they act on what is available now. The International Financial Reporting Standards, or IFRS is the most commonly accepted and used financial reporting framework globally - used in over 140 jurisdictions. Interestingly, United States Steel is the first company in recorded history to have published an annual report in the year 1903. A good 70+ years later in 1973, the Accounting Standards Committee was formed which subsequently came out with the International Accounting Standards (present day IFRS). This did not stop legendary investors like Jack Bogle, Benjamin Graham, and Warren Buffett determine their investments strategies, if anything they benefited from financial factors becoming standardized.
The global corporate and investing community took over seven decades to standardize financial and accounting guidelines, which even to this day comprises some differences.
By that logic, we are probably not even half way there in terms of standardizing non-financial reporting. However, with the power of technology, access to data, and increased awareness on non-financial capital, we certainly do not need to wait another 70 years for non-financial reporting to standardize or make an impact on companies.
Challenges for streamlining non-financial disclosures
Businesses have been reporting on non-financial disclosures from as early as the 1990’s, albeit on a rudimentary level with only environmental and social impact data. As reporting guidelines and frameworks have improved, there has been a broader acceptance and uptake of non-financial reporting within annual reports or standalone sustainability or integrated reports. Some companies are also making an attempt to be leaders in this such as: KERING SA- with their Environmental P&L measurement tool that quantifies the environmental impact of its activities, andDanone- with theirBCorp certificationwhere they employ responsible strategies that use profit and growth as a means to create greater positive impact for employees, communities and environment.
Despite thought leaders like Kering and Danone, the lack of a globally accepted non-financial disclosure standard coupled with a variety of independent assessment providers of sustainability information has proved to be quite the stumbling block for standardizing non-financial reporting.
Can regulators change that?
Integration of non-financial reporting has no doubt gained momentum in the last decade, particularly from regulatory bodies. Presented below is an overview of a few country’s regulatory approach on non-financial reporting primarily for publicly-traded companies. While some may argue that making non-financial reporting mandatory for businesses may cost them to lose competitive advantages, the overall benefits that the broader business ecosystem can enjoy far outweigh the inconveniences.
CONCLUSION To round off, the true benefits of non-financial reporting can be achieved when it is integrated with financial reporting and not treated as a separate exercise by a team in silo within the organization and by investors. Global corporations are definitely progressing towards this direction, and investors are also trying to invest in such companies (not always successfully as Munib will share with a piece on ESG ETFs soon). While the non-financial information around human, social and environmental capital gets standardized, we at Panarchy Partners analyse progress on material non-financial topics and relevant issues as a true measure of a company’s resilience through our proprietary resilience framework. Essentially, giving our Panvestor Partners sustainable financial return and progress on all forms of capital. Feel free to reach out to me to discuss any points from this month's ARCUS. Tayef Quader Sustainability Panvestor