EFRAG report finds investors struggling to assess sustainability risks due to flaws in corporate reporting practices.
Businesses are failing to see sustainability as a growth opportunity rather than a risk according to a new report.
The Project Task Force on Reporting of non-financial risks and opportunities (PTF-RNFRO) – part of the European Financial Reporting Advisory Group (EFRAG) – identified less mature reporting of sustainability opportunities compared to risks as part of a review of corporate disclosures.
“This possibly suggests that sustainability is perceived as a restraint on the business rather than an opportunity for growth and development,” it said. “The leap is still to be made by some to move from construing it as a cost or risk rather than as an opportunity that brings potential new areas of growth.”
Overall, the PTF-RNFRO found that investors are struggling to properly assess the sustainability risks of businesses because of a lack of information in corporate reporting.
It said disclosures of value creating aspects of business models have found their way into corporate reporting, but these are at an early stage of development.
The report said: “Current disclosure practices are often failing to provide content that can be used by capital providers to predict the future performance of the business”, noting that “sustainability-related intangibles” are rarely considered to be major drivers of value creation, by companies surveyed.
The PTF-RNFRO added that destruction of value, such as may be caused by an underestimation of environmental or social risks and/or inaction, was inadequately developed and discussed in disclosures.
“New methods of ‘value’ and ‘impact’ assessment are more inclusive of risks related to social and governance issues, and it remains difficult to relate the ‘direct’ and ‘indirect’ impacts of decisions on either the company or its stakeholders,” the report said. “We also note that even among the identified good reporting examples, opportunities are sometimes only presented to mitigate value destruction. Disclosures were sometimes found to lack a balanced perspective and sometimes only portray positive impacts.”
The PTF-RNFRO was asked to review the current state of play and identify good practices in the reporting of non-financial risks and opportunities and their linkage to the business model. Its work will feed into the framing of the Corporate Sustainability Reporting Directive (CSRD), which replaces the Non-Financial Reporting Directive and is due to take effect in 2024. EFRAG is responsible for drafting the European sustainability reporting standards which will be used by corporates to comply with the CSRD.
The findings of the report are based on a review of the reporting practices of 44 EU companies alongside the feedback received from stakeholders through an online survey, interviews, written submissions, and outreach events.
Limited value to investors
The PTF-RNFRO report found that sustainability risks were disclosed in various locations across corporate reports and lacked coherence.
“Current general practices lack a structured approach where risks are clearly linked to the business model. For example, companies rarely explain if, and how, their business model and strategy are resilient to environmental and social risks,” it said.
“Although a majority of respondents to the PTF-RNFRO survey considered the application of the EU Taxonomy to investments as an opportunity to review/enhance their business models, only a few of the reviewed companies report on their current alignment with the EU Taxonomy or describe a future plan for its implementation.”
The report said disclosures on sustainability risks and opportunities currently have limited use for investors due to inadequate disclosure on the future cash flow implications of achieving sustainability targets and strategy.
“This can mask how an entity’s future cash flows are affected by changes to the business model, either positively or negatively,” it said.
The PTF-RNFRO survey found insufficient deployment of technological solutions such as structured data and AI to report sustainability information. To facilitate digitisation and thus reduce the burden of sustainability reporting, it recommended translation of the classification and segmentation of sustainability disclosures into a digital taxonomy.
It also called for a clearer description of the business model and linkage to sustainability risks and opportunities when reporting, quantification of risks and opportunities and cash flow generation and better connectivity of financial and sustainability information.
There was also a need, it said, for application of evidence-based and science-based targets, optimising the use of available technologies; and attaining credibility through third-party assurance.
“It is the view of the PTF-RNFRO that there is considerable scope for improving the quality and usefulness of reporting on sustainability risks and opportunities and their linkage to the business model,” the report said.
“Business predicated on the perpetual consumption of materials, which is unsustainable ecologically, socially and ultimately economically needs rapid redress in the face of our global climate and environmental emergency,” said Mario Abela, Co-Chair of the PTF-RNFRO.
“The role of reporting has shifted to going beyond explaining financial performance to understanding the risks and opportunities inherent in business models driving those results, encompassing both people and the planet. Profits can no longer be disconnected from the impacts and dependencies of business models.”