Upcoming IP Investor Dialogues: Spirax Sarco, FAST, COST, CPRT, POOL, SNOW, DDOG - Register your interest at help@inpractise.com 

Anonymous

Current Board Member of The Sustainability Accounting Standards Board

ESG versus Financial Reporting

{audio:0:00:00} Bob, it's a pleasure to have you with us today. I think a good place to start would be if you just run through the founding story of SASB and its core mission.

{audio:0:02:11} SASB's mission is to develop and disseminate sustainability accounting standards that help public corporations disclose material useful information to investors. That mission is accomplished through a rigorous process that includes evidence-based research and balanced stakeholder participation. Like any mission, it’s got a lot of words in there, and every word really is important. But this whole idea of, we create and then push out to the public, the sustainability accounting standards, those are different from some other standards that were focused primarily on publicly-owned corporations - corporations that are on the Stock Exchange. It's got to be information that's materially useful to investors. Then we have a whole process, like any standard center, to go through that. That's a little bit about our mission.

{audio:0:03:06} A few other points about SASB too, in terms of its history; we have a conceptual framework that talks about the whole way we envision sustainability standards and reporting. We have very strict rules of procedure as to how a standard is developed. All of our standards are subject to public exposure. For a 90-day period, if we come out with a new standard, we let everybody comment on it. We take those comments very seriously, and in many cases, they do result in changes. We value that process.

{audio:0:04:49} Can you share a bit more insight into where the SASB fits into the reporting frameworks of corporates? It's pretty clear that, if you're a public company, you have to abide by FASB's reporting standards. How does it work with SASB today?

{audio:0:04:49} First of all, the traditional reporting in the past has been financial reporting. Many of the students are familiar with financial statements and the audited financial statements that come out. Management reports that to their investors. The investors believe this is so important, they have to have third-party assurance in it. That structure has been in place. Many of you are familiar with the fact that the criteria used for that reporting is U.S. GAAP or IFRS. Then there are other regulations around that reporting that are developed by either the stock exchanges that those companies are on or the other regulators like the SEC. That can vary from country to country.

{audio:0:05:53} What's really happened with the other side of the reporting, the sustainability reporting, and ESG reporting, that is less developed. In addition to that financial information, like earnings and earnings per share and revenues, investors have used that information to value companies and look at the risk inherent in those organizations. But now they want some other information in a more formal way, and information we call ESG reporting that is all focused around environmental, social and governance information. That whole area is really developing. It's not regulated. There aren't any mandatory standards there.

{audio:0:06:36} The idea of SASB is the financial reporting has all been subject to consistency. Everybody uses U.S. GAAP or everybody uses IFRS. On the other side, people really aren't following any standards. The notion of SASB as I say is, in a way, end the chaos and create a set of standards, which are developed by industry, that would thus create a situation where similar companies are reporting the same information, calculated in the same way, much like the financial reporting information is there.

{audio:0:07:15} What's also happened lately is some companies now have reported that, using certain standards. You're actually seeing some of those companies, not all of them, actually obtain third party assurance from their accounting firm for ESG information, like they do for the financial reporting information, though the actual opinion is a little different. That's how we fit in if that makes sense to you now.

{audio:0:07:40} What are the major challenges that SASB has in standardizing sustainability reporting?

{audio:0:07:48} The biggest challenge we have all the time, that will determine if we're effective or not is, do people use our standards? Do they use nothing? Do they use someone else's standards? One of the challenges we have is getting everybody on board. Obviously, investors want this information. In many cases, they're not just requesting it, they're demanding it. Just like they use financial information to value a company, they believe they need this other information to do a complete valuation and evaluation of the company. There's an investor demand side that wants everything.

{audio:0:08:27} Remember, the victims of that discussion and viewpoint are the companies themselves, the organizations that have to report to satisfy the investor. On one side, you have the investors wanting a lot of everything and the companies, in some cases, being a little reluctant to provide that information or all that information. Some of the reasons why they are reluctant to do that is, it's going to take more time, and time costs money. There are some views that you need to be careful about the information that you provide, because there could be some legal issues related to that. There even could be some competitive disadvantage to reporting all of that information and the like. The challenge we have is really taking those two views and coming to a compromise.

{audio:0:09:22} One of the things that I think we do well at SASB is we spend a lot of time listening to investors as to what they want and why. At the same time, we spend a lot of time with the companies that have to produce that information.

{audio:0:09:33} Another concern also is, if you think about it, the financial information that's been reported for many, many years are all part of rigorous internal control and information systems. The ESG reporting that goes on now at many companies hasn't been that well developed. Another concern is the actual accuracy of the information that's provided. If you were to provide what is determined to be inaccurate information, again, you'd have some legalized ability. Hopefully that answers your question.

{audio:0:10:05} I'm just thinking of the financial accounting. Correct me if I'm wrong, but I believe this came into action in the 1930s, or even just slightly before or after the war, due scams in the public market. What do you think it's going to take for it to really become not enforced, but to similar standards as the financial standards reporting?

{audio:0:10:32} Just to give you color on that, you're right. At least in the US, the Securities and Exchange Commission came out in 1930s, because investors were being fooled and companies were reporting bad information. That's the whole investor protection concept. I think, again, back to my point, investors will drive the ultimate reporting. Investors in public companies own those companies. Companies pay attention to their owners. And I believe if investors continue to push that they want this information, that they have to have it, that it'll be forthcoming.

{audio:0:11:09} The trick then, as I mentioned is, is that reporting all consistent and similar? One group is reporting greenhouse gas emissions and another company doesn't report that; that's a problem. Or another company does report it, do they report it on the same basis?

{audio:0:11:26} If you think about financial information or our accounting standards, you report revenue, but revenue is calculated in this way. There are specific standards as to how you do that. Or depreciation, there are specific ways that you do that, and people would understand that.
{audio:0:11:41} What SASB does, because we've used the word accounting in our name, we have what we call technical protocols. When we have a standard around greenhouse gas emissions, or the use of water, or the amount of renewable energy that a company uses, it's not just that the SASB standard says you should disclose that amount or that number. We have quite a bit of detail again, because we're an accounting standard that explains how you would calculate that information.

{audio:0:12:12} What I think has to happen is more investor push, and maybe we can talk a bit more about the benefit that some companies are seeing from this. But that's, to me, at the end of the day what's going to happen. Certainly, there can be regulation that would force that and there are some discussions going on at different levels, in different stock exchanges, by country in different country regulators and even in the US at the Securities and Exchange Commission level and even in the federal government of the US, where some groups have started to petition now that there be a regulation to mandate sustainability or ESG reporting. And all that sounds good.

{audio:0:12:53} Again, that still doesn't solve the usefulness issue, in that if you mandate that reporting on what basis is that recording going to be prepared of. For example, U.S. GAAP or IFRS are the criteria you use for that reporting Therefore, we would hope as SASB that if that reporting was mandated or just driven by investors that they use a framework like SASB, so that the information between companies is consistent, standardized, and comparable.

{audio:0:13:27} Does the industry rely on limited partners or asset owners to push the demand for ESG reporting?

{audio:0:13:42} Yeah, primarily investors at the public company level because, generally, they are not limited partnerships or things like that, but yes. There are a couple of good examples of that. Some of the largest asset managers in the world today are BlackRock, Vanguard, Fidelity, and others. And if you would do a little googling around, you'll find that the CEOs, specifically of BlackRock and Vanguard who, in essence, own a piece of every single public company in the world, have written to those companies, to their boards, and their management to say that, "This ESG information and sustainability information is now important, if not critical, to us. We do own these companies." In a nice way, they said, "We're not just asking you for the information. We're telling you to provide the information and we're coming for it." That's my view of why I think the investor push is critical and why it's happening.

{audio:0:14:43} Again, specifically the CEO of BlackRock, his name is Larry Fink, if you simply google "Larry Fink letter" you'd find his letter that he wrote to every single public company in the world. Then a fella named Bill McNabb is the CEO at Vanguard and he's done the same thing. And those companies have somewhere in the order of between $5 and $7 trillion of assets under management.

{audio:0:15:12} What's stopping the corporates?

{audio:0:15:15} Like I said, there are a couple of things. One is, no one likes change, no one likes doing more at times. There are certainly legal concerns about what's the legal liability of that information. You think about it, the legal liability around financial information is at least sort of structured. So there's a non-structuring element. Then there's a fair argument that the fact that investors are going to rely on this information, it creates some liability and that certainly, the systems and protocols and internal controls around that information, need to be looked at and considered.

{audio:0:15:54} To me, the bottom line is, no one likes change, and no one likes what they think might be spending more money that will reduce their profit. There are a lot of stories now about how this sustainability activity can improve products.

{audio:0:16:26} To your point on legal liability, let's say that a corporate reports certain ESG metrics, but when they're audited, they are proved to be incorrect. Therefore, you have to price that liability for the investors, because they've invested based on those metrics.

{audio:0:16:49} The idea would be, that that's why they're saying they want this information. It impacts their valuation. So now you report this information, and let's just say for whatever reason, there isn't the robust internal controls and systems around, that information is determined to be inaccurate to some degree or enough of a degree, and then we have a legal system that looks to find a victim. There's a legal process and the company ends up paying something. That's part of that.

{audio:0:17:17} That may not be a completely valid concern, but as you know, we have a legal system and legal structure where they're always kind of two sides of every argument. There's one side of that saying, we probably shouldn't report this because you've got liability, and you don't have to report it. If you don't have to report it, what why should you?

{audio:0:17:36} I will say, though, for US Stock Exchange companies, if the information is material and there's a specific definition approved by the Supreme Court of the United States, it must be reported to investors. And that becomes a little bit of a slippery slope in that ultimate determination of material is in the eyes of the company. But it's important to note that if it is material, it's got to be reported.

{audio:0:18:04} One of my views is, issues around climate change, if you want to use that word or use of natural resources and treatment of people, there've always been issues. They really now come to the forefront and to the top of the list that are critical, for lots of reasons. They're just more critical or social judgments and norms have changed, so all this information now I think in the end will end up getting reported.

{audio:0:18:34} Taking the role of the corporate then, who is the core decision maker that decides on what gets reported?

{audio:0:18:42} I think it starts with discussing two things internally. One is, who are our stakeholders and investors, and have they told us what they want in this regard?

{audio:0:18:58} The other thing is, now this is the topic, what do we as a company want to do? What's important to us in there? Then it really becomes a team of people within the company, and hopefully I'll try to list most of them. But it certainly is the investor relations group. It's the legal function to understand the securities law and reporting requirements and the legal liabilities around that. It's actually the various reporting functions in the company, because a lot of this information does, in part, reside in some of the existing systems in financial systems.

{audio:0:19:35} One of the pillars of ESG is S, which stands for social and involves a lot of employee issues. So many times do you see the HR groups now getting involved. That kind of team working together. And ultimately, of course, there's a group of management, the CEO and the CFO, as people call the C-suite, that should be part and parcel of that discussion or decision making.

{audio:0:19:56} Ultimately, there should be some oversight by the board. Why did the company choose to report or not report? Why do they choose to report these items and not these items? What do the investors really want? And is that reporting accurate? So I think it's a whole group of people. But again, the driving force is, what do the stakeholders want?

{audio:0:20:20} A very key part of what SASB has done is, we've set up our standards by industry because we know this environmental, social, and governance, these three pillars, the importance, the materiality, the investor pressure around that information varies widely by industry. Take an oil and gas company and think about their environmental-related concerns and issues. And then take a company like Accenture, that's a technology company, or let's take Facebook; their environmental issues are totally, totally different than the oil and gas companies.

{audio:0:21:03} What has been your experience in how corporates balance the short-term focus of investors on next quarter's EPS and the cost and focus to build out the metrics to report on the ESG?

{audio:0:21:23} I have a little saying, you know, you have to make the next quarter, but we also have to be here in 100 years. The real dynamic is, how do you balance both of those things? We have investors and we have this short term system where we need to make the next quarter, we need to make the earnings for the year. At the same time, we now have issues like how much water is available and what's the cost of water, regulations on greenhouse gas emissions, the use of certain kinds of materials, the use or non-use, hopefully, of child labor. You have to begin to look at and focus on those things.

{audio:0:22:04} I mentioned that many companies now, don't just see this as a cost. They see this as a way to increase profitability. What do I mean by that? Well, if you think about these issues, if you do things like use less resources or use more economical resources, or recycle materials, or have fewer accidents, for example, etc., at the end of the day, that all actually costs less money. Some companies, I use the word sustainability activities; they've now described how these sustainability activities that some people might think of generally as a cost, actually improves profitability.

{audio:0:22:44} Let me give you an example of that, that's in writing. The airline JetBlue issues a standalone SASB report that takes all the SASB standards and lays all that out. But then they talk about how their activities make them a better and more profitable airline. They have a story that I call the water tank story. For an 18-month period, JetBlue studied every single plane that landed and looked at how much water was left in their water tanks. They provide water while you're on the plane. They found that over 18 months essentially, every single plane that landed, landed with their water tanks more than half full. They certainly don't want to run out of water on any one airplane, but they came to a conclusion after that study that they didn't have to fill the water tanks all the way to the top. Well, that's sort of a sustainability activity, right because they're using less natural resources.

{audio:0:23:40} But what did it do to their business? By not filling the water tanks all the way up to the top, they used less water, which cost them less money, because they bought less water. Having less water on the plane makes the plane lighter, so that lighter plane uses less gasoline. Therefore, they came to the conclusion that this sustainability activity that they now followed, which didn't create any unsafe situations, actually increased the profitability of the airline.

{audio:0:24:11} There's story after story from companies. It could be around the amount of packaging that's being used, the sort of suppliers that use.
{audio:0:24:19} Another example is putting in some more protocols around safety. Because when they have an accident, look at what an accident costs them. Now, I think what's turning around is rather than now this being a cost, that this is an opportunity to, in some ways, increase short term profitability. But remember my valuation comment that investors see companies thinking about the future, being more thoughtful about how they're planning their business for the future, they are also worth more.

{audio:0:24:48} I think you end up getting two things. You can get some short-term profitability through these sustainability activities. But in some cases, you also will get or may get an increase in your valuation, because investors think, first of all, you’re doing the right thing, you're doing things that are better at making more money, but you've got a focus on the future beyond just those couple of quarters. So you're the kind of company that's going to be there in 100 years, and, therefore, you're worth more money.

{audio:0:25:25} I completely agree in that these decisions are crucial for long term sustainability of companies. There's no doubt about it. But I think, regardless, corporates are under so much pressure to perform quarter after quarter, that it's very difficult for some managers to overcome those incentives. What type of strategies or examples do you have that management have been able to signal to investors, this is what we are doing, or is it really down to the investors then to drive that long-term focus?

{audio:0:26:06} The mismatch here is yes, investors want you to make the quarter, but there's a lot of investors that then will call long term money. Think about pension plans and all that. They're hoping this money is going to be worth more in the long term. There's a buzzword now called ESG integration. The investors are now saying, as part of our evaluation approach of you, we're not just using the traditional financial statement information, the earnings projections, the EPS projections to get a number of what you're worth. We're also using this ESG information. There's an integration.

{audio:0:26:51} I think companies are now waking up to the fact that, “We need to provide this information because our investors are saying they're using it and they're demanding it." Therefore, you get to the full circle, which is, if we present that information, it should be accurate. The investors are asking all these questions, so let's sort of use some type of framework. It’s driven by investors, but companies are seeing the value in some short-term profitability impacts, as well as the fact that investors are using it for their long-term valuation of the company.

{audio:0:27:25} Can we discuss, specifically, the internet companies and how SASB looks at reporting metrics for those businesses?

{audio:0:29:26} If you think about what's going on today, yes, they're under a lot of pressure related to topics like security; how secure is that information? The privacy of that information, what's shared, what's not shared? What we call content evaluation, so what content do you allow on? What content do you take off? What's the criteria? The identity verification of people. Are people able to use pseudonyms and fake IDs to communicate and be part of those platforms? Those are some of the topics that we heard from investors and we heard from the companies, as well.

{audio:0:30:07} Now let me give you some of the actual examples from these SASB standards. When we think about environmental, the topic, as we call it, is the environmental footprint of their hardware infrastructure. Think about the large server firms they have and all the equipment they have. Think about the business. What does that do environmentally? It produces energy. Again, working with investors and listening to companies.

{audio:0:30:34} One of the metrics we have, and that's a key difference with SASB, it's not just about words, it's about what are the actual numbers that investors need to use. One thing around the use of energy is that, to report the total energy consumed, the percentage of that energy that is grid energy and the percentage of that energy that is renewable. Those are quantitative metrics that have to be produced. The units of measures in some cases are kilojoules and we have a whole technical protocol of how you would do that.

{audio:0:31:52} To my comments around data privacy, we do have some descriptions that describe policies and practices relating to behavioral advertising and user privacy. Another thing is the number of users, so if the information is used for secondary purposes, the amount of monetary losses as a result of legal proceedings associated with user privacy?
{audio:0:32:17} Another one would be the number of government requests to remove content and the percentage of compliance with those requests. Again, things coming from investors.

{audio:0:32:48} That gives you a flavor that these are very focused on what would be most important to an industry. These standards will be different to other industries or not material. And they're not just about some platitudes and words and paragraphs; they’re about really true calculated metrics that have got guidance as to how they're calculated. Again, two similar companies required or producing the same SASB standard would, in theory, be calculating their amount the same way so they can be compared.

{audio:0:33:25} Let's take Facebook then. Given Zuckerberg’s ownership, how difficult is it to really to force Facebook to report on these metrics, if they’re not legally compulsory?

{audio:0:34:07} I don't know that SASB can solve the issue, but what SASB can do is, through talking to investors and certainly listening to companies, understand what is the information that comes through.
{audio:0:35:16} Maybe a more recent situation around this, is around the company called WeWork, where the owner had 30 votes per share. That was out there. In fact, that was a very big issue. Remember, that's not a financial statement number in a way, but that's sort of the environmental, social, in this case, governance issues that people think are very important that had a big impact on the confidence in the company, and thus to govern itself appropriately and lessen its valuation.

{audio:0:36:25} But you can't get those companies with huge founders, to report on stuff like the SASB metrics, like description of policies and practices related to behavioral advertising, for example, unless it’s compulsory?

{audio:0:36:43} There you get to the point where the owner is a single person that has a big stake, then the owner, which I've said are the people that are pushing this won't push that.

{audio:0:36:54} But I will say that the Googles and the Facebooks and Salesforces and others with owners like that, if you would look at their sustainability and their ESG reporting, they are making some progress. Many of them actually want to do a good job, and some of them are doing a pretty good job because there are employees. Not just the investors, but they are other stakeholders like employees and the community. You're finding that more and more employees want to have a voice and do have a voice around this, when you think about some of the demonstrations that have happened at certain companies. That stock ownership issue that you described certainly is an issue. And again, that impacts the valuation by other investors. It could be too risky for some.

{audio:0:37:47} Do you have a specific view on what you would like Zuckerberg to specifically do, in terms of consumer privacy? What do you think is really responsible of him?

{audio:0:38:00} SASB would say, we've listened to investors, and Facebook fits in this internet media services industry. Hopefully they would agree with that. We have six data privacy advertising standards and freedom of expression standards. They're a combination of discussion and quantitative. We listened to investors who are saying they believe these are material items.

{audio:0:38:26} Our job is not to make companies do the reporting. Our job is to create the reporting framework that everybody seems to say they want. I think the proof in the pudding would be, will the investors push for more of this disclosure to a point where they ultimately may or will? But your point is well taken, in that maybe they won’t, because the ownership of the shares and the voting that goes on is invested very highly in a small number of people, even the case you described, one person.

{audio:0:38:59} How do you look at the responsibility of investors in this case? It seems like they have a real duty to push corporations to report on ESG.

{audio:0:39:09} There are two views there. One is that the investment managers have a fiduciary duty in thinking about their customers, and then recommending stock and value stock. They have a duty to use this ESG information in their valuation. That's clearly out there.

{audio:0:39:28} There's another view too, on the other side, but if you think about this ESG information and value companies on that, and then have fewer companies you invest in because they're, let's say, ESG leaders rather than laggards, you have a less diversified portfolio. So, you may actually create more risk in a portfolio, because you're holding fewer companies that you chose because they're higher ESG performers but history over time shows the more diversified portfolio does better. Like everything, there's kind of two sides because everybody doesn't know what the future holds. But there is a viewpoint that is fiduciary.

{audio:0:40:11} Now, when you think about reading a newspaper about climate change and social injustice and those things, those items are really important to the valuation of a company. So that if you're not considering those things, back to my words of ESG integration, you're not doing the best job for your customer whose money you take to make those investments.

{audio:0:43:04} So you’re seeing asset owners really changing their mindset, in terms of looking at investing capital today into more longer-term focused?

{audio:0:43:12} Yeah, absolutely. Take those pension plans; that money needs to be there in 100 years. And then let's talk about climate change, or the use of water, or greenhouse gas emissions. They're looking for companies and valuing them that are really thinking about that. Have you thought about how your earnings are going to change if water becomes much more expensive or not as plentiful? What are you going to do if there are heavy regulations around greenhouse gas emissions? Like I said, they’ve got to make the quarter and have a successful short-term business model, but they have to be thinking over the horizon, because those in particular pension fund managers have to have those companies be successful, not just next quarter.

{audio:0:44:06} Maybe, more importantly, they need to be successful out there X years from now. They're probably willing to take a little bit of a haircut on short term profitability, if they know the company will be more successful in the longer term.

{audio:0:44:28} What's your vision in how ESG reporting will evolve over the next decade?

{audio:0:44:34} What I think happen is this information has always been important. The strategy of the company, its product, its customer satisfaction, its supplier really, all those things have been important. But now investors, because of the Information Age, know that information is out there, and they want it. I think that the two sides of the reporting, the financial reporting, and the ESG reporting is here to stay. Hopefully over time, for everybody's use, it will become more efficient in that companies will report and limit amount of information likes SASB, and say, what's most material, what's most impactful for their industry?

{audio:0:45:17} I also think what's going to happen is that because information is that important to valuation, they will also get third party assurance, just like financial information. As I mentioned, that's already happening at some companies like Salesforce and an Etsy and others.

{audio:0:45:38} Ultimately, though, the question then becomes, does all of this reporting spanned as two different types of reports become what we call one single integrated report? There's a group out there called the IIRC, the International Integrated Reporting Council that is espousing that view. If all of this information is important, that's all part of corporate reporting, it should simply be combined, so that Nirvana of this would be that someday maybe there is only one report, with all that information, and then one singular third party attestation on all of that information, both financial, and what some people call nonfinancial. That's where I think it's going in the long term.

{audio:0:46:27} Bob, thank you very much for your time today.

SASB: Reporting on Sustainability Metrics

What is the biggest challenge for SASB reporting to become industry standard?

What is the role of investors in helping drive the adoption of SASB reporting?

As an investor, which metrics would you want Facebook to report under SASB?

What do you believe is the duty of the investor in driving the adoption of ESG reporting?