The role of disclosure and ESG in the evolving risk landscape

The risk landscape is always evolving, but there are more complexities now than ever before. Historical risks are compounded by the ripple effects of accelerated digitalization and supply chain disruption and have highlighted how interconnected we are. In such an environment, a risk to one may be a risk to all. This has coincided with a growing emphasis on environmental, social and governance (ESG) priorities to create a new crop of logistical, ethical and regulatory concerns.

With disparate ESG reporting frameworks and standards to understand, the importance of continuing education and compliance with evolving disclosure and reporting standards is crucial, as reflected in board priorities.

The risk landscape continues to evolve

The COVID-19 pandemic has rapidly expanded the risk landscape. It accelerated digital transformation plans and tightened the threads that bind technology to all aspects of business, while simultaneously pushing cybersecurity to the top of companies’ priority lists. The pandemic, along with governmental economic policy decisions, has also rendered supply chain disruption a significant challenge for many companies — 32% of boards anticipate supply chain production/disruption will be their greatest business risk for the next 12 months. Rising transportation costs, a labor shortage and a lack of materials contribute to a weakened ability for accurate forecasting and planning.

Companies must further navigate the need to budget for economic fluctuations, ensure business continuity and remain accountable in the face of climate change, human capital pressures and other risks. Risk complexity is rising, and transparency is increasingly important to investors, shareholders and stakeholders at large. In times of uncertainty, data and accurate information go a long way in allaying fears and ensuring confidence.

There is a strong need for businesses to report on metrics related to cybersecurity, supply chain management and other emerging risk areas. For 33% of corporate boards, increasing disclosure around new or emerging risks to the business will be a challenge when it comes to 2021 corporate reporting. Meeting non-financial benchmarks is a key tenet of ESG and sustainability initiatives, which are becoming more closely tied to performance, customer trust and value creation. However, ESG reporting is not yet standardized, and many companies remain unsure about where and how to begin or what next steps to take.

Reporting and disclosure requirements are evolving as well

There is a strong correlation between operating according to ESG best practices and seeing improved financial performance. There is research supporting that companies that prioritize ESG initiatives outperform competitors, both during the pandemic and in more stable times. Investors are increasingly backing ESG funds. In 2020, sustainable investment funds reached $51.1 billion in the U.S. This is more than double 2019 numbers and a nearly tenfold increase from 2018.

Some companies naturally want to proactively highlight the results of their ESG efforts publicly, while others recognize that not doing so could have negative consequences on their business prospects and reputation. Though nearly three-quarters of corporate directors (73%) are focused on keeping up with evolving regulatory and reporting guidance for ESG in the near term, one in three respondents to a BDO survey anticipate challenges related to increasing disclosures around new or emerging risks to their business. Challenges surrounding ESG reporting primarily stem from confusion about the scope of ESG, disparities in companies’ timelines for implementing ESG initiatives, the absence of a uniform reporting standard and comparability with peers.

In many cases, ESG standards overlap with best practices that many companies already use — strong data protection, transparent communications, equitable compensation. However, it can be difficult for companies to identify which of these and other activities that may be meaningful to stakeholders will have the most significant or material impact to the company. This is becoming especially challenging as the customers, employees and communities the company serves are becoming increasingly important stakeholder groups.

Organizations also vary in reporting capacity depending on company size, system requirements and internal structure and expertise. Smaller companies, in particular, may lack the resources to produce thorough and accurate yet cost-effective reports.

Today’s companies employ a patchwork of criteria and processes to meet their ESG disclosure goals. Variation offers companies flexibility, but it can be a hurdle to clearly demonstrating ESG progress. Companies that operate on a global scale may also struggle to meet accelerating international guidelines and standard-setting. Fortunately, there’s a push toward consolidating disparate ESG standards.

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Reporting uniformity on the horizon

Globally, there is so much occurring that it can be hard to keep track — from the European Union’s Sustainable Finance Disclosure Regulation to the United Kingdom’s “Greening Finance: Roadmap to Sustainable Investing” to the Global Reporting Initiative’s revised universal standards. However, willingness to work together expressed by some of the more well-known standards setters and frameworks earlier this year, along with the merger of the Sustainability Accounting Standards Board and the International Integrated Reporting Committee into the Value Reporting Foundation, are positive indicators of consolidation. The COP26 United Nations Climate Conference, which took place in November 2021, and the announcement by the IFRS Foundation of the International Sustainability Standards Board is another strong indicator that there is intentional action being made toward the convergence of disparate standards toward a global set of ESG reporting standards. Climate remains the highest area of current focus.

In the U.S., the Securities and Exchange Commission has signaled its plans to provide rulemaking in late 2021 or early 2022 on climate change specifically, followed closely by human capital, board diversity and cybersecurity risk governance issues. The SEC’s rules on climate change will likely draw from existing guidelines, including the Task Force on Climate-related Financial Disclosures, or TCFD. In recent months, the SEC began issuing comment letters to companies that they felt were falling short on climate disclosures and issued a sample letter drawing companies’ attention to areas that may require more robust disclosures, including a description of the business, legal proceedings, risk factors, MD&A and analysis of the financial condition and results of operations.

It has become crucial for accountants and financial statement preparers to stay up to date on new developments. Companies that are ahead of the curve will have a more seamless transition when adhering to the new standards and related reporting requirements. For now, the SEC is focused on disclosure accuracy and consistency. When compiling non-financial data and risk disclosures for reporting purposes, keep in mind that the regulators will compare material information to financial statements to look for discrepancies and any misleading information.

Navigating the evolving risk landscape

In this time of heightened risk, growth-focused investors, goal-oriented shareholders, and a civic-minded public are raising the bar for corporate accountability. As they await universal global ESG reporting standards, companies are setting new goals and establishing ways to measure and disclose progress. This is changing how boards are thinking about risk oversight and mitigation with respect to integrating non-financial and financial reporting. Given that, it is crucial for accountants to take a proactive approach with preparers in connecting ESG goals and measurements to the solidifying standards being established by domestic and global regulators and expectations of investors and broad stakeholders.