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March 29, 2013

Accounting for a Sustainable Future

A new initiative is trying to do for social responsibility what FASB did for accounting. But will companies go along with mandatory reporting of their dirty deeds?

Betsy Wiesendanger

If you’re trying to find a stock you can stick with for the long term, there’s a raft of financial data to help you choose, including annual reports, regulatory filings, and financial databases. Nonfinancial data, however — say, a company’s record on carbon emissions or on monitoring suppliers for human rights violations — is a no man’s land. Many firms offer informal reports on something called ESG — Environmental, Social, and Governance — but what they disclose, if anything, is up to them.

Robert Eccles would like to change all that. He is chairman of the new Sustainability Accounting Standards Board (SASB), a nonprofit organization seeking to establish industry-specific measures for sustainability that can be incorporated into filings such as 10K forms Eccles, who was a featured speaker at a recent conference on long-term investing organized by Chazen Senior Scholar Patrick Bolton, talked with Chazen Global Insights about the challenges of getting companies to fess up.

Chazen Global Insights: I can see the case for sustainability standards. But if firms self-report, how trustworthy will that data be?

Robert Eccles: Financial reporting is self-reporting too. The difference is that [with financial reporting] there’s standards and there’s audits.

CGI: So will there be verification or audits of this nonfinancial reporting?

RE: Ultimately, that’s where I think you’re going to see this go. In South Africa, where reporting of both financial and nonfinancial data is mandated through integrated reporting, investors are starting to go to companies and saying, “Well, okay, it’s nice that you’ve got this integrated report. But now we want some assurance that the sustainability data is of the same quality as the financial data.”

CGI: At SASB you’re establishing industry-by-industry standards, right?

RE: That’s right. It’ll be an apples-to-apples comparison in 89 industries organized into 10 large sectors. That way, information on customer loyalty or carbon emissions within each sector is done the same. So you can look at two different companies and basically measure and report the same way. The reason for this sector approach is that the material ESG issues from an investor perspective vary by sector. A bank’s carbon emissions are not important, although they are for a coal-fired utility company. Conversely, how a bank manages market risk is very important.

You could get a third party to provide some kind of assurance opinion on it. But until you have standards you really can’t do any sort of meaningful verification.

CGI: Who would these third parties be?

RE: Probably the Big Four accounting firms. There are some boutique firms that will do environmental verification or human rights audits, but they tend to be very specialized people who cannot provide assurance across the entire range of material ESG issues in a sector. As investors start asking for audits of integrated reports, they will want the capabilities and credibility of a Big Four firm that’s got skin in the game to put their name on it. And even these firms have a long ways to go in having the necessary capabilities to do an integrated audit.

CGI: If we haven’t been able to achieve unanimous adoption of global standards for accounting, how can we hope to do it for nonfinancial measures?

RE: First of all, standard-setting is hard, and nobody is happy with the result in the end. Everybody thinks their situation is different.

In the end it’s up to governments to decide whether they’re going to require reporting or not. Companies would generally prefer not to provide this information, or to do so on a selective basis. But standards actually lessen the burden, because once you know the rules of the game, software companies can develop software and IT firms can develop platforms that make it relatively easy to do.

CGI: So it sounds like the initial impetus will start in Congress.

RE: No, not necessarily. I think if it started in Congress it would be too soon. The ideal model for SASB would be for companies start to adopt these standards on a voluntary basis because it’s in their self-interest to do so and investors start pushing for them. My fantasy scenario is that you’ve got companies and investors holding hands, going to the SEC, saying, “we’re already doing this; why don’t we make sure it’s a level playing field for everybody?”

CGI: What’s the one thought you want to leave readers with concerning this whole push for mandatory sustainability reporting?

RE: The Financial Accounting Standards Board (FASB) was formed forty years after the SEC basically created accounting standards. I don’t think we would have the capital markets we have today without accounting standards and financial reporting requirements. And I don’t think we’re going to have the capital markets and the society we want for tomorrow without standards for nonfinancial information and some reporting requirements. To create a sustainable society, companies and investors need to be taking all of these issues into account. What SASB and integrated reporting will do is make that possible.

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