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Sustainability Disclosure in External Reporting: Current and Future Trends

Merrill Disclosure Solutions | October 13, 2014

Sustainability Reporting

Sustainability Disclosure 

An umbrella term referring to disclosures about how a company's activities may impact the environment, society, and economy - may someday seem commonplace in SEC filings. With sustainability accounting standards currently being developed by an independent board, the SEC is expected to issue rules or at least further guidance on sustainability disclosure at some point. Broader sustainability reporting on a range of topics, whether in standalone reports that follow a reporting framework or as part of an integrated financial report, might become a standard practice for external corporate reporting. Many international companies, for example, now follow the guidelines for sustainability reporting developed by the Global Reporting Initiative (GRI). Other organizations in the United States are also pushing for both voluntary and mandatory sustainability disclosures.

S&P 500 Companies Now Making Sustainability Disclosures

The movement toward universal sustainability disclosure has grown rapidly. According to the Governance & Accountability Institute, “sustainability reporting has become the clear norm in the US capital markets.” The Institute is a sustainability consulting firm and the exclusive data partner for the Global Reporting Initiative in the United States, the United Kingdom, and Ireland. As recently as 2011, fewer than 20% of the S&P 500 companies had published a sustainability or corporate responsibility report. The percentage jumped to 53% in 2012 and continues to climb. The Institute's researchers find that 72% of the S&P 500 issued sustainability or corporate responsibility disclosures during 2013.

Sustainability Reporting

“The S&P 500 companies in the lead on disclosure and reporting are focusing much more now on the materiality of [environmental, social, and corporate governance] issues, and engaging with internal and external stakeholders to determine the materiality of report content,” observes Louis Coppola, the Institute's co-founder and executive vice president. “So now, along with the sheer volume of corporate reporting increasing, we are seeing greater intensity of focus on what really matters in the report.”

The Institute has analyzed corporate disclosures in other research publications, such as Sustainability - What Matters?, an examination of more than 1,200 sustainability reports for 84 GRI performance indicators. The researchers devised a ranking methodology for 35 industry sectors to reveal the information that companies deemed material enough to disclose.

Benefits Of Sustainability Disclosure Go Far

The growing appeal of sustainability disclosure goes beyond just good publicity for companies or a conviction that socialjustice and environmental protection should be as important as profits. These types of disclosure may actually have a pragmatic value in the capital markets. “Sustainability reports may offer a more accurate picture of a company's long-term value-creation potential than traditional financial statements,” David Lee, a partner at accounting and business advisory firm Peterson Sullivan, confirmed to Dimensions. “These companies have stronger financial performance in capital markets over the long term and improved access to capital markets. This type of reporting also increases the trust and loyalty in a company by its investors, employees, and other stakeholders.” In addition, Mr. Lee points out, companies making sustainability disclosures seem to be proficient at anticipating, managing, and mitigating sustainability-related risks.

Creating New Sustainability Accounting Standards

An initiative now underway is the creation of accounting standards focused on sustainability disclosure. Backed by prestigious board members, including former New York mayor Michael Bloomberg and two former SEC chairs, the Sustainability Accounting Standards Board (SASB) wants to create sustainability accounting standards for publicly listed corporations to use when disclosing material sustainability factors. The SASB is an independent nonprofit organization (not affiliated with the Financial Accounting Standards Board). Its sustainability accounting standards will cover more than 80 industries across 10 sectors seeking to comply with the SEC disclosure requirements in Form 10-K (or Forms 20-F and 40-F, for foreign or Canadian issuers) and in other periodic SEC filings, as well as allow companies to improve their sustainability performance and increase the usefulness of the information available to investors.

The SASB identifies sustainability disclosure topics that are likely to be important to a reasonable investor. Its definition of materiality for these disclosures follows the standard used by the US Supreme Court in a 1976 ruling and confirmed in later decisions: For a fact to be material, “there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available.” Each company ultimately must decide what it considers to be material, but the SASB standards can help to identify sustainability areas that are important.

Some organizations have lobbied the SEC to adopt mandatory sustainability reporting.

The SASB's first set of standards - for companies in the healthcare sector - was published in July 2013, followed by standards for financial services, technology and communications, and nonrenewable resources. The SASB anticipates publishing sustainability accounting standards for other major sectors by 2016, and it encourages companies and institutional investors to join its working groups on industry standards.

Lobbying The SEC For Sustainability Reporting

To date, the SEC does not require broad sustainability disclosure and has avoided having a separate line item for sustainability in Regulation S-K. However, SEC rules and guidance do cover specific points of disclosure in a few areas that qualify as sustainability issues, such as climate-change impact and the use of conflict minerals from central Africa. In addition, Regulation S-K touches on some core disclosure items in 10-K filings that can fall into the sustainability purview, including Item 101 (business description), Item 103 (legal proceedings), Item 303 (MD&A section), and Item 503(c) (risk factors). In Staff Accounting Bulletin No. 99, the SEC asserts that “a matter is 'material' if there is a substantial likelihood that a reasonable person would consider it important,” although the SEC rejects the exclusive reliance on quantitative benchmarks to determine materiality. Some organizations have lobbied the SEC to adopt mandatory sustainability reporting. For example, the Social Investment Forum (now part of the Forum for Sustainable and Responsible Investment) sent a detailed letter to the SEC in July 2009. It proposed that the SEC require companies to report annually on sustainability indicators, with both universal and industry specific components, using the GRI reporting guidelines. It also sought interpretative guidance from the SEC clarifying that companies need to disclose short- and long-term sustainability risks in the MD&A section of Form 10-K.

In March 2014, the Investor Network on Climate Risk at Ceres, a nonprofit organization advocating sustainability awareness, published Investor Listing Standards Proposal: Recommendations For Stock Exchange Requirements On Corporate Sustainability Reporting. The proposal (on page 5) offers the following disclosure items for stock exchanges around the world to consider:

Item 1. A “materiality” assessment disclosed in annual financial filings, where management will discuss its approach to determining the company's material environmental, social, and governance (ESG) issues;
Item 2. Specific ESG disclosure, on a “comply or explain” basis, covering 10 key ESG topics, in the format and location of a company's choosing;
Item 3. A hyperlink in annual financial filings to an ESG Disclosure Index (a table or spreadsheet), based on the Global Reporting Initiative Content Index or its equivalent, indicating where existing ESG information can be found.

Reform Of SEC Disclosure

For some critics, information overload can easily obsure information of greater importance.

There seems to be consensus that the framework of SEC disclosures and financial reporting does not always provide the information that investors may need and does not fully communicate a company's strategy and methods for creating value. In light of the SEC's current noncommittal attitude toward sustainability issues, it is unclear whether the trend toward voluntary sustainability disclosure will lead the SEC to introduce formal reporting requirements on sustainability topics or to require integrated financial reporting.

“Arguably, the SEC's disclosure reform initiative could not have come at a better time for sustainability and environmental groups who have been working for years to achieve better corporate sustainability disclosure,” writes attorney Betty Moy Huber from Davis Polk & Wardwell LLP, in an article published by the American Bar Association's Environmental Disclosure Committee (Will The SEC's Current Disclosure Reform Initiative Result In Stricter Environmental And Sustainability Disclosure Requirements?). However, it is not clear to her if these lobbying groups will be able to
convince the SEC that sustainability issues should be a priority.

Ms. Huber wonders whether the SEC will adopt sustainability reporting requirements. One persuasive influence is the impact of the SASB, whose standards could become “stakeholder-drafted, turnkey replacements” for the SEC's existing disclosure guidance. Another influence is that concerns about climate change have grown so widespread that even investors without an environmental agenda are starting to consider it material. On the other hand, some SEC commissioners and key staff members, including chair Mary Jo White, feel that reform should not be driven by special-interest groups seeking politically motivated disclosures and believe the SEC should focus on streamlining the reporting rules.

For some critics, information overload (including repetitive environmental disclosures) in SEC filings can easily obscure information of greater importance to investors, so adding new disclosure requirements may have to wait. Anyway, the SEC is preoccupied with finalizing rules required by the Dodd-Frank Act.

“Certain investors have indicated that sustainability disclosure should be a priority for the SEC,” Ms. Huber explained to Dimensions. “For instance, approximately 20% of the public comments submitted as of September 2, 2014, on the Disclosure Effectiveness portion of have urged the SEC to require more stringent sustainability disclosure.” Ms. Huber also told Dimensions she has reason to believe that Congress is considering bills which would require corporate disclosures about greenhouse-gas emissions.

Integrated Reporting May Be The Next Step

Sustainability issue chart

Some experts contend that the benefits of sustainability information are enhanced when it is combined with financial data into an integrated report. One group pushing for this type of disclosure is the International Integrated Reporting Council. This global coalition, which includes regulators, investors, companies, standard-setters, accountants, and NGOs, views communicating about value creation as the next evolution in corporate reporting. On its home page, the Council explains that the integrated report is “a concise communication about how an organization's strategy, governance, performance, and prospects, in the context of its external environment, lead to the creation of value in the short, medium and long term.”

The GRI Sustainability Reporting Guidelines offer principles, standard disclosures, and an implementation manual for preparing these integrated reports. In Section 6.1 (page 85) of the Guidelines, the GRI addresses the relationship between integrated reporting and sustainability disclosure. The integrated report should not merely combine the financial statements and the sustainability report but should also build on them by providing insight into the material issues that impact the company's current and future value creation.

In Integrated Financial And Sustainability Reporting In The United States, a research report from the Sustainable Investments Institute (Si2) and the Investor Responsibility Research Center Institute (IRRCi) analyzed disclosures in 10-Ks, annual reports, and proxy statements from S&P 500 companies during 2012. It concludes that integrated reporting is “at a crossroads” in the United States. Only seven (1.4%) of the S&P 500 companies either included a statement integrating financial and sustainability reporting, following the GRI reporting guidelines, or suggested that their annual report is also a sustainability report, but 499 of the companies made at least one sustainability-related disclosure. About three-quarters (74%) placed a monetary value, along with unquantifiable benefits, on at least one sustainability initiative. The table below indicates the sustainability issues cited as risks in the S&P 500 companies' filings.

The Path Forward

Assuming that corporations continue to expand their sustainability disclosures, the GRI reporting guidelines and the SASB sustainability accounting standards become widely adopted, and the SEC issues rules or guidance on sustainability disclosure, sustainability reporting will inevitably become as standard a corporate practice as financial reporting is now.

Click here to access all Dimensions eNewsletters

Sustainability Disclosure: Key Organizations And Resources

Securities & Exchange Commission,

Regulation S-K: Items 101, 103, 303, 503(c)

Commission Guidance Regarding Disclosure Related To Climate Change

Conflict Minerals Rule

Sustainability Accounting Standards Board,

SASB Standards

Key Dates & Status

Global Reporting Initiative,

Sustainability Reporting Guidelines: Reporting Principles And Standard Disclosures

Governance & Accountability Institute,

International Integrated Reporting Council,

Sustainable Investments Institute,

Global Initiative for Sustainability Ratings,

Forum for Sustainable and Responsible Investment,

Comment letter to the SEC on sustainability disclosure

Climate Disclosure Standards Board (affiliated with CDP, the Carbon Disclosure Project),

Investor Network on Climate Risk (affiliated with Ceres),

Investor Listing Standards Proposal: Recommendations For Stock Exchange Requirements On Corporate Sustainability Reporting

IRRC Institute,

Integrated Financial And Sustainability Reporting In The United States (with the Sustainable Investments Institute)

Environmental Disclosure Committee, American Bar Association Will The SEC's Current Disclosure Reform Initiative Result In Stricter Environmental And Sustainability Disclosure Requirements? by Betty Moy Huber, Davis Polk & Wardwell

Sustainability Disclosure In Public Company Annual Reports And Proxy Statements-State Of Play And The Future by Betty Moy Huber, Davis Polk & Wardwell


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