August 2010 The sustainability journey - Tapestry Networks€¦ · InSights for North American Audit Committee Members August 2010 The sustainability journey: from compliance, to

InSights for North American Audit Committee Members

August 2010 The sustainability journey: from compliance, to opportunity, to integration

Executive summaryCompanies are facing growing pressure to explain — and improve — their sustainability performance. Key financial stakeholders, like investors and equity analysts, are building sustainability factors into their analysis and investment decisions. Stakeholders like consumers and non-government organizations (NGOs) are demanding more data regarding companies’ environmental and social performance. Regulators and standards setters are piling on the pressure, too.

Sustainability has not typically drawn the attention of the audit committee chairs who participate in Tapestry Networks’ audit committee networks.1 However, management has long been pushing sustainability as a key business driver, and, as one contributor said, “sustainability has made its way to the boardroom.” Now, sustainability may be on the cusp of more active audit committee involvement, particularly given the need to embed it firmly into risk and compliance processes and to improve sustainability reporting.

In this context, Tapestry Networks interviewed a diverse range of subject matter experts to examine how companies are confronting these external pressures and incorporating sustainability into their corporate strategies and cultures. In addition, Tapestry Networks drew on interviews with audit committee chairs in its audit committee networks. (A full list of contributors can be found in the appendix, on page 14.) Key findings include:

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• There is more pressure on companies to embrace sustainability. (page 4) In the face of more intense stakeholder scrutiny, companies are embarking on a three-stage sustainability “journey.” Initially, they build sustainability into their risk management approach to comply with regulations. Next, they capture the economic benefits offered by sustainability. Finally, they seek to integrate sustainability into their corporate strategy and culture. There are reporting challenges at each stage of the journey.

• Stage 1: Building sustainability into regulatory compliance and risk. (page 6) The risks of non-compliance with regulatory standards often trigger companies’ initial focus on sustainability, particularly as they are under pressure to reduce and report on carbon emissions. Early on, companies have some basic reporting questions to address: Are they in compliance with mandatory requirements? Which voluntary reporting standards should they adopt? And, how can they ensure financial filings are fully transparent about sustainability risks?

• Stage2:Focusingonandreportingtheeconomicbenefits. (page 8) Companies find that as they become more effective at dealing with sustainability risks, they unearth potentially significant cost savings and revenue opportunities. When the focus of sustainability turns to economic benefits, senior management is more likely to support efforts. While business managers may initially be skeptical of the opportunities provided by sustainability programs, effective coordination across the organization and openness to external advice can help. Managing the burgeoning array of often-haphazard sustainability data systems and reports can be a challenge.

• Stage 3: Integrating sustainability into the core strategy and culture. (page 10) While companies’ approaches to their sustainability journey are “always evolving,” global leaders at this stage of the journey strive to integrate sustainability fully into their corporate strategies and cultures. This means gaining full CEO, top-management and board-level commitment to sustainability and incorporating it into top-level decision-making processes. With sustainability fully ingrained into a company’s external communications, companies focus attention on validating the data — a task increasingly undertaken by external parties.

• Conclusion: Audit committees could play a critical role in sustainability. (page 12) Leading companies are accelerating their progress through the three stages of the sustainability journey. Throughout, the board should be questioning management on its sustainability strategy, and ensuring stakeholder expectations are met through clear, transparent reporting. Audit committees are well placed to help, given their expertise in compliance, risk management and reporting. Indeed, our research found that the evolving complexity of the regulatory environment may demand increased audit committee involvement in the very near future.

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4 The sustainability journey: from compliance, to opportunity, to integration

A growing number of external stakeholders are asking companies to account for their sustainability performance. This scrutiny is pushing companies to work towards fully integrating sustainability into the corporate strategy and culture, and, along with way, presenting the board and management with some difficult decisions on how to oversee and report on the company’s progress.

The external stakeholdersParticipants universally agreed that companies’ sustainability performance is subject to significantly greater scrutiny than in the past. They highlighted several key stakeholders that are leading the charge:

• Equity analysts. According to an Ernst & Young survey, “43% of respondents believe equity analysts are currently including climate change-related factors in the valuation of their company … A further 30% believe analysts will incorporate climate change factors within the next five years.”2

• Investors. In recent years, institutional investors have stepped up their direct engagement with companies and used more powerful means to press those companies on their sustainability record. In October 2009, the US Securities and Exchange Commission (SEC) further empowered investors by issuing interpretative guidance that will make it harder for companies to exclude shareholder resolutions related to “environmental, financial or health risks.”3 There was a surge in such proposals this year.4

• NGOs. NGOs such as Greenpeace and Oxfam have won vast support for their causes by drawing public attention to corporate environmental mishaps, public health and safety disasters and violations of labor law. One participant said, “You do not want to be on the wrong side of a carefully orchestrated plan by an NGO. They know how to draw attention and reach your customers.”

• Regulators and standards setters. Regulators are implementing a complex set of rules, many of which are focused on reducing or reporting carbon emissions and climate change risk.

• Banksanddirectorsandofficers(D&O)insuranceproviders. Several participants noted that, increasingly, these institutions are building sustainability factors, such as climate change risks, into their underwriting practices and pricing decisions. One participant said, “D&O liability insurers are settling with plaintiffs in private over some of these issues.”

The sustainability journeyIn the context of this external scrutiny, more companies are reviewing their sustainability approach to determine what changes may be required. InSights participants described a three-stage journey that companies go through when they decide to embed sustainability in their corporate cultures:

1. Ensuring they are in compliance with regulations

2. Focusing on and reporting the economic benefits

3. Integrating sustainability into the core strategy and culture

For a variety of reasons outlined in this report, it is difficult to accelerate through these stages. Systems need to be built, communication strategies developed and, most importantly, executives, employees, suppliers and customers need to buy in to sustainability — something that generally only happens through experience. The journey is like “crawling, then walking, then running. A company cannot walk before it can crawl. You cannot skip over any of the steps in making sustainability part of your company,” one contributor noted.

InSights participants agreed that having a common definition of sustainability is a crucial first step on the journey toward embedding sustainability into the core strategy and culture. However, they also agreed that the word means very different things to companies, governments, NGOs, shareholders and other stakeholder groups. For the purposes of this report, the term ”sustainability” is used in an expansive manner, to include issues such as climate change, resource usage, social factors and other such issues.

There is more pressure on companies to embrace sustainability

“A company cannot walk before it can crawl. You cannot skip any of the steps in making sustainability part of your company.”

5The sustainability journey: from compliance, to opportunity, to integration

GovernanceMany stakeholders agree with the position laid out by Ceres, a well-regarded group of investors and NGOs: “As fiduciaries, corporate board members are obliged to assess risk. The financial impact of climate regulation, the scarcity of water and other resources and litigation over poor labor practices — all represent examples of risks to businesses.”5 However, the experience of most participants in our research is that board or board-committee oversight of sustainability risks is only in its early stages for many companies.

As companies move along the sustainability journey, the manner in which the issue is managed by the C-suite and business line heads and overseen by the board or one of its committees evolves. Initially, sustainability tends to be overseen by technical experts within the management ranks, notably in the areas of environmental or health and safety. The extent to which these issues are reviewed at a senior management or board- or committee-level depends greatly on their significance. Where these are material risks, separate management and board-level committees are often tasked with overseeing the company’s sustainability strategy. Otherwise, oversight at the senior levels is limited. Later, as sustainability is more integrated into the company’s business plans, and eventually its corporate strategy, it is elevated to the C-suite and the board.

At present, regardless of what stage their companies are at in the journey, audit committees have not waded too deeply into this reporting issue, but given the considerable reputational risk at stake, they are likely to be called to oversee and improve sustainability reporting.

Reporting There are reporting challenges at every step of the sustainability journey: “We started with compliance data, then moved to issues-based reporting and then to a comprehensive section on our website. Eventually, we had a fully integrated environmental, economic and social picture of our company.” The sustainability journey evolves from ensuring the company is in compliance with mandatory requirements and deciding which voluntary standards to adhere to; to managing the burgeoning reports and data systems; to validation and full integration with the company’s financial reporting.

Questions for audit committees:

• Which external constituents are pushing the company the hardest to improve its sustainability record?

• How does management oversee the company’s sustainability strategy? Which board-level committee is tasked with overseeing the company’s sustainability initiatives? How broad is that committee’s oversight of sustainability?

• What elements of sustainability reporting does the companyfindmostchallenging?Whatrolehastheaudit committee played in overseeing this reporting?

• Doestheboardhavetheknowledgeandskillstoprovide governance over the sustainability strategy andreporting?Doestheauditcommittee?


Building sustainability into regulatory compliance and risk

There was broad agreement among participants that “risk was the trigger for our first [sustainability] efforts.” Indeed, companies are increasingly focusing on sustainability due to concerns about the growing number of emerging risks primarily driven by regulatory requirements tied to climate change and other sustainability related issues. “We wanted to make sure we weren’t in contravention of laws and regulations,” noted one contributor.

Pressures to reduce carbon emissionsNorth American companies could soon be facing a significantly more complex and onerous regulatory landscape. The US Environmental Protection Agency’s (EPA) and individual state environmental agencies both regulate the environmental effect of businesses. The EPA develops and enforces regulations that implement environmental laws enacted by Congress. Likewise, state agencies enforce regulations and implement laws enacted by the state legislature.

Actions by the EPA over the past 18 months have led companies to conclude that regulations forcing companies to reduce greenhouse gases (GHGs) are on the horizon. Most worrisome for corporations is the EPA’s ruling in December 2009 that GHGs threaten public health.6 Subsequently, under its Clean Air Act obligations, the EPA issued draft rules that would effectively force automotive manufacturers and other heavy emitters to reduce their emissions.7 These rules have caused much consternation in the private sector, with one contributor calling the EPA’s approach “cap-and-trade by the back door.” Several contributors speculated that the EPA’s action may encourage Congress to implement a cap-and-trade system, with one

saying, “Legislative action is a big mess, and no one has a clear vision of how this mess is going to play out. But everyone would sooner have Congress do this than the EPA.”

Companies are also increasingly concerned about the legal risks associated with climate change. Two federal appeals courts have refused to dismiss lawsuits by plaintiffs who argue that companies’ carbon emissions are responsible for harmful climate change, which has fueled speculation that the US Supreme Court may soon rule on whether these types of cases can be heard.8 Participants said that if these types of claims are allowed to go forward, companies will face a host of complex legal challenges that could significantly tax the organization’s resources. One participant said, “The courts are saying these nuisance claims have validity. This is very worrisome … There would be chaos in the courts.”

Mandatory and voluntary reportingParticipants said the overall lack of standards requiring companies to report on transactions which “emanate from the new economy” has caused confusion for companies and makes it “harder for stakeholders to make appropriate decisions.”9 As such, companies must first ensure they are in compliance with mandatory reporting requirements, and then decide which voluntary reporting standards to follow.

Mandatory reportingThere has been a heightened focus on enforcing existing, or establishing new, mandated sustainability-related reporting standards in the US and Canada over the 18 months, with potentially more to come:

• EPA. The EPA has a long tradition of setting standards for environmental disclosures. Most recently, it finalized its mandatory GHG reporting rule,10 which requires large facilities emitting over 25,000 tons of GHG a year to submit annual reports on GHG emissions to the EPA. This rule went into effect on December 29, 2009, with the first reports due on March 31, 2011.11 At that point, “the carbon emissions of these polluters will be public knowledge, and on a facility-by-facility basis.” Several participants speculated that as the information becomes public, “it could create a hailstorm of local media reports and local-resident disquiet.”

• SEC and OSC. In January 2010, the SEC voted to provide public companies with interpretive guidance on existing SEC disclosure requirements that “may require a company to disclose the impact that business or legal developments related to climate change may have on its business. The relevant rules cover a company’s risk factors, business description, legal proceedings and management discussion and analysis.”12 The Ontario Securities Commission (OSC) is running in the slipstream of the SEC and aims to issue similar guidance for Canadian companies by the end of the year.13 Investors are pleased with these developments, particularly because the SEC announcement focused on potential prospective risks, but the corporate reaction has been subdued. One participant said, “The SEC guidance on reporting was not at all unexpected or a great deal different than what companies are already doing.” Nevertheless, the guidance may signal the SEC’s willingness to get more involved in reviewing the quality of climate change disclosures.

“Risk was the trigger for our first [sustainability] efforts.”

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• ApotentialInternationalFinancialReportingStandard(IFRS).Internationally, the US Financial Accounting Standards Board (FASB) is working with the International Accounting Standards Board (IASB) to develop guidance on emissions trading schemes (ETSs). In March 2009, the boards tentatively decided that allowances received free of charge from the government should be recognized as assets that should initially be measured at fair value, and that if the allowances are received for free, the organization is obliged to reduce its emissions below the level represented by those allowances.14 In a June 2010 statement, the boards said they recognize “importance of emissions trading schemes as a mechanism to help manage carbon dioxide emissions” and said “the financial reporting consequences of the many different allocation and trading systems will become increasingly important as more and more countries adopt them.” However, the boards said they decided in May that “other [Memorandum of Understanding] projects had a higher priority” and “now expect to publish an exposure draft together in the second half of 2011 with the aim

of issuing converged standards in 2012.”15 Despite the delay, however, audit committees should be considering how to account for their companies’ carbon emissions allowances and credits and ensuring that management has the systems in place to capture and report their emissions data clearly and accurately.

Voluntary reportingCompanies also face external pressure to adopt evolving voluntary reporting standards to help stakeholders compare companies’ sustainability performance. While there is no universally accepted set of unified reporting standards in this area, several contributors referenced two major reporting approaches that have gained significant traction:

• GlobalReportingInitiative(GRI).Many InSights participants cited the GRI framework as an example of best practice in sustainability reporting. One participant said that over “1,500 organizations” have completed a GRI report, and several others said that the “GRI’s influence is increasing.”

• CarbonDisclosureProject(CDP). Around the globe, thousands of organizations measure and disclose their GHG emissions and climate change strategies through the CDP. The CDP aims to “harmonize climate change data from organizations around the world and develop international carbon reporting standards.”16 One participant noted the increasing relevance of the CDP: “Companies are reporting more about how they are reducing energy, especially along the supply chain. Right now, these are Fortune 500 companies [mostly not large caps] reporting through CDP … There are a few large caps reporting through CDP as well.”

Each company has to determine when and if to issue a voluntary stand-alone report. For example, a company just starting to report on sustainability may simply develop an internal report, containing technical data on compliance with laws and resource usage. At some point, a company may decide to use these materials in a stand-alone sustainability report.


• Whatarethemostsignificantsustainabilityrisksfacing the company?

• Has the company issued a stand-alone sustainability report? How has that report evolved? Which board-level committee reviews draft versions of the report?

• What voluntary reporting standards does the company adhere to? What factors did management use to determine which standards are most relevant to the company?

• Has the company assessed the quality of sustainability-relateddisclosuresinpublicly-filedreports, such as the annual report?

Other sustainability-related regulation across the globe

Participants noted that increasing regulatory attention on climate change may take the focus away from other sustainability-related issues, such as water use and biodiversity.17 Several participants said that the European Union’s (EU) next sustainability focus will be around resource efficiency.18 Participants said that companies should “prepare now” for potential resource efficiency regulation that goes beyond carbon emissions:

• Water use. Several participants called companies’ management of their water use the “next big issue.” Indeed, one contributor said, “Water tables are decreasing, even in the Western part of the US … Meanwhile, the population is increasing.”

• Biodiversity. Participants suggested that, without a change in industry or consumer behavior, the EU may turn to regulating the destruction of habitat for industrial production. Participants said biodiversity-related regulation is increasingly emerging as a topic of discussion among politicians. Some observers are calling for “systems to encourage investments in projects that would restore a site or enhance its ecology in return for tradable credits.”19 One participant said, “The next issue … for regulators is biodiversity. There’s a lot of talk about it in political circles … This may have a major impact on companies.”


Focusing and reporting the economicbenefits

While many companies are initially driven to embark on the sustainability journey because of the risks of non-compliance, participants said senior management truly commits to sustainability when the economic justification becomes apparent: “In the past, companies tended to look at [climate change and sustainability] as just compliance [risk]. Now, companies are making decisions as to the value of sustainability compliance, not just the cost. There’s a thought process that wasn’t there a year ago.” Another contributor said, “Once you know what the risks are, you see where the opportunities are. You have a better understanding of consumer trends and where the business is going.”

Gainingfinancialbenefitsfromsustainability initiativesAn Ernst & Young survey of 300 global executives said that a strong driver of climate change initiatives is the desire to meet changes in customer demand: “On average, 89% of respondents identify changing customer expectations or demands as very important or important in their thinking.”20 One participant said, “Customers in the last five years have been the biggest driver of our focus on sustainability. [Customer demand] has been a real boost to business.” Several participants said investment in sustainable products not only drives tangible revenue gains in the short-term, but also enhances companies’ reputations as sustainability leaders. One said, “This is called the halo effect.”

However, for most firms, cost savings, rather than revenue opportunities, are driving the economics of sustainability. According to the Ernst & Young survey, “when asked what factors will be important in driving their climate change initiatives in the coming 12 months, 92% of respondents consider energy costs to be a very important or important driver over this period.”21

Cost-cutting initiatives involve employees, suppliers and consumers:

• Energizing employees. Saving energy and managing waste requires behavioral changes throughout the workforce. One participant, whose company’s “burning platform” in the last two years has been to cut costs through better management of energy resources, said, “We knew this initiative would only work if we convinced our employees to get on board.”

• Influencingsuppliers. A company that has had success establishing a culture of energy and resource savings may choose to bring about broader change by bringing its suppliers on board. This may only be possible if the company has strong purchase power over them. Another factor influencing this movement is the CDP Supply Chain

Report, in which the CDP discloses findings from interviews with its member corporations’ suppliers. The CDP asks the suppliers about four key factors relating to carbon emissions and water use.22 Major firms have used the CDP questionnaires to great effect. One participant called it “the supply chain ripple effect: if Walmart tells you to disclose, you do it.”

• Changing consumer behavior. Influencing customers is perhaps the most challenging, but potentially rewarding, task for companies looking to bring about broad changes in energy and other resources usage. Indeed, an analysis by Procter & Gamble found that only a few customers make purchasing decisions based on a product’s sustainability. Consumers in the “sustainability mainstream” are motivated to some degree by the environmental impact of products, but will not sacrifice economic value for environmental benefit.23 Some companies have undertaken “cradle-to-grave, life- cycle analyses” whereby they examine the carbon footprint and resource use at every step of the product value chain, from the sourcing of raw materials to waste disposal by their customers: “The life-cycle approach [to assessing our resource usage] has allowed us to see where we need to improve throughout the organization. Through the life-cycle approach, we’ve developed the tools to assess where we need to make further investments to decrease our emissions. We are helping our customers save more than we produce.”

Nurturing the sustainability strategyParticipants pointed to a number of factors they believe companies can work on to improve the strength of a corporate sustainability strategy:

• Line management buy-in. Winning buy-in from senior management in the business lines is a critical step in driving sustainability throughout the organization. Those heading sustainability initiatives have to “make a business case” that includes “demonstrating the value of sustainability from a monetary perspective [and showing that] … reaching sustainability goals allows [executives] to do other things.”

• Effective coordination across the organization. Oftentimes, the elements necessary to advance the sustainability agenda — creative ideas, a passion for sustainability and a dynamic and motivated workforce — are present in the organization, but “exist only in pockets of excellence.” Hence, a clear sign that companies are taking sustainability seriously is the appointment of a senior-level executive with a broad business background who can take these pockets of excellence and oversee their extension to the rest of

Stage 2


the organization through a sound business strategy. (See, “The evolving role of the Chief Sustainability Officer,” above.)

• Openness to external input. Some companies have hired outside consultants to inform their sustainability strategy: “We formed a sustainability advisory board [of outside experts] that helped us design a set of principles and set some performance goals. This sent a signal that we were serious.” However, companies seem reluctant to benchmark their sustainability performance: Ernst & Young’s recent survey found that only 28% of companies said they benchmark their climate change initiatives, and only 28% said they compare key metrics of their climate change initiatives.24

Managing reportingCompanies that have reached the stage of issuing sustainability reports that cover key risks and commercial opportunities find themselves wading into deep reporting waters. Few boards have effective committee-level oversight of this reporting. The challenges are considerable:

• Coping with an increasing demand for data. One participant said, “With more and more demand for data, the sustainability report has grown and grown.” Companies are facing increasing demands for more streamlined reports that focus on the essentials: “We need to know, ‘What are the fundamental issues?’ And that’s it. We don’t need pages upon pages of glossy photographs.”

• Ensuring consistent data. Participants said that it is a “very difficult task” to ensure their reports are consistent. Reports focused on voluntary standards, such as CDP and GRI, should be consistent with reports to investors, regulatory authorities and others.

• Linking to annual reports effectively. As sustainability moves to the fore of management’s business messaging to the markets, companies must decide how best to connect the key elements of their sustainability reports with their annual reports. Several use cross-references. “The challenge is one of timing. The annual reports have a strict deadline that cannot be missed. The

sustainability reports can lag.” Many companies have decided, pragmatically, to run the drafting processes in parallel to allow for some element of connectivity, if appropriate, but avoid excessive cross-referencing.

• Consolidating data systems. Without a mandate from the top or standardized sustainability reporting standards, companies developed the systems they needed to gather the most important data and collated it all centrally, often with significant dependence on manual systems. Few companies at this point in their sustainability journey have used internal audit or compliance professionals to assess and strengthen reporting processes, and fewer still audit the data on a routine basis. Yet, as sustainability data becomes more prominent in annual reports, some companies are consolidating and improving their data systems to build a solid foundation for reporting, similar to the systems that are used for financial reporting.

The evolving role of the Chief Sustainability Officer (CSO):

As sustainability initiatives advance up the corporate agenda, more companies are appointing high-level sustainability officers to lead the initiative. These were previously compliance officers whose role was to ensure the company was in compliance with health and safety operations. Now, as a Verdantix study points, out, the CSO is urgently needed to spearhead complex strategies to help their companies adapt to the intense competitive and regulatory pressures introduced by the sustainability movement.25

The CSO, who participants said “is increasingly someone with a broader business background,” oftentimes reports to the CEO and has significant, complex and evolving challenges. As one participant said, “The Chief Sustainability Officer’s job is to put ourselves out of business. But that might not happen for awhile. It is constantly evolving.”


• Whatarethemostsignificanteconomicopportunitiesthat sustainability presents to the company?

• What steps has the company taken to more fully integrate sustainability into the company’s operations?

• How does the company coordinate its sustainability activities?

• Has the company done an extensive review of its sustainability reporting? What changes would give stakeholders better access to key sustainability information?

• How does the company ensure published sustainability information is consistent and accurate across all reporting channels?

“Now, companies are making decisions as to the value of sustainability compliance, not just the cost.”


Integrating sustainability into the core strategy and culture

A major McKinsey & Co. survey on sustainability reported that “just over 6 percent of executives say that sustainability is a top-three priority in their CEOs’ agendas, that it is formally embedded in business practices, and that their companies are ‘extremely’ or ‘very effective’ at managing it.”26 Our InSights research supported those findings. To a great extent, this reflects the fact that integrating sustainability into the core strategy and culture takes years. As one participant said, “I think it is evolutionary. [Sustainability] becomes part of the culture over a long period of time after [stakeholders] and the media constantly talk about it.”

Signs of full and sustained integrationA company that has fully integrated sustainability into the corporate strategy and culture can be recognized by several characteristics:

• The CEO and C-suite demonstrate strong commitment. One participant said, “The CEO needs to be committed [to sustainability issues]. There must be a clear drive from the top.” Without such commitment, the sustainability efforts will stall or be slow in gaining traction across the company. Participants felt that CEOs “who truly get it” were shocked into action by “an environmental collapse” or by the actions of external stakeholders, such as NGOs, or, in some cases, they had “an epiphany.” Once the CEO embraces sustainability, the issue often ceases being overseen by a separate cross-functional group of executives and is taken up instead by the main C-suite management committee. It is also more fully integrated into core management decision-making processes, such as merger-and-acquisition due diligence analyses.

• Sustainability goals are inextricably tied to strategic goals. At this stage of their sustainability journey, companies have a holistic understanding of the key sustainability risks and the cost-saving and revenue opportunities, and have made the next step of tying sustainability to the company’s overall financial and strategic goals. For example, Unilever has committed to “double the size of our impact while reducing our environmental impact.”27

• Board-level commitment. As one participant pointed out, CEO commitment only gets one so far; these are long-term initiatives, yet the average tenure of CEOs has been falling steadily, from 8.1 years to 6.3 years during the past decade.28 To endure, sustainability needs to be embraced by the board of directors. The board can play a critical role in “the vision-setting piece,” by pushing management to examine the strategic opportunities: “How do these sustainability trends provide new opportunities for the business? For example, if you have carbon taxes, you can manage it in such a way that gives you a competitive advantage.” However,

their role extends beyond endorsing a corporate strategy tied explicitly to sustainability, to one where sustainability is a routine part of their decision-making process: “One of our first steps was getting the board actively involved in the goal-setting process,” noted one participant.

• Ambitious goals, clear accountability. Some companies set ambitious sustainability goals in order to embed the ideas into the organization. A participant said, “There are some areas where we’ve set goals, and we don’t know how we will reach them, but by setting them we encourage innovation.” Another said that stretch goals “deliver true leadership … and encourage employees to ask ‘what can I contribute?’” However, these goals also need to be realistic: “I don’t understand companies setting goals [related to the World Business Council for Sustainable Development Vision29] for 2050. People don’t think they are real.”

Articulating sustainability goals externally, and providing incentives to business units, helps embed the sustainability mission “down into the [employee workforce].” Participants disagreed on whether to promote action by linking sustainability goals into individual’s compensation. Some companies have embedded sustainability performance in top management’s compensation. For example, 20% of Royal Dutch Shell management remuneration is tied to sustainable development goals.30 In addition, AzkoNobel ties 50% of management compensation to the company’s ranking in the Dow Jones Sustainability Index.31 However, some participants described the challenges of linking short-term pay to objectives that may not be achieved for several years. Those companies seek to change behaviors by celebrating the achievements of some managers or businesses, and holding poor performers to account. One participant said, “We committed to sustainability through top-line accountability. Each business unit had a target and was held to account for their progress or lack of progress.”

Reporting challenges: validation, integrationBy the time companies have invested significantly in sustainability initiatives over many years, and fully integrated sustainability into much of the external communications and branding, they are exposed

“There’s been a shift in values over time, and companies’ behaviors need to reflect that shift in values. Trust is a driver of competitive advantage.”

Stage 3


to scrutiny by analysts, current and potential investors, employees and the media on progress compared to previous years’ achievements and against peers. Such transparency becomes a powerful force pushing companies along the journey, but also creates significant reporting challenges around validating the data and integrating it into the annual or other reports.

ValidationCompanies fear they may face litigation related to “greenwashing” (misrepresenting the nature of their products or business to suggest that they are more environmentally friendly than they actually are) because the Federal Trade Commission has stated that it will update its environmental marketing guidelines (its “Green Guides”).32 In addition, the lack of sustainability reporting standards, coupled with the increasing volume of information in sustainability reports, creates concerns over accuracy. Companies use three types of validation:

• Internal fact-checking

• Deployment of internal audit

• Hiring the external auditor or a third party consultancy

Few companies, as yet, have invested heavily in building up any of these levels. Those that have said, “We have people from internal audit and legal spot-check using the same method as financial audit. We ensure that the environmental performance and good deeds are credible. Regarding any claims on awards, we obtain a copy of that award.” Another said his company’s finance team plays a similar fact-checking role. Few internal audit teams routinely evaluate sustainability data systems or reporting processes. This may be because “there are two types of skills required – technical knowledge, such as engineering, as well as knowledge of auditing techniques.” This may also explain why few audit committees review sustainability reports – they are not sure how, especially given the lack of standards against which to evaluate the reports. By extension, few companies use external firms to review their sustainability information. Where they do, they either use an independent, third-party firm to verify technical information, but they use the external auditor for more robust, comprehensive assurance.

There is a trend toward using the external audit firms to validate sustainability reports. Indeed, according to an Ernst & Young report,

“The majority of the Fortune Global 500 most recent sustainability reports were assured by accountancy organizations. Two-thirds of the latest reports were assured by the financial auditors.”33 Where the external auditor was used for assurance, it ranged from validating the data built into the “top 10 [sustainability] KPIs” to a full audit of the sustainability data and reporting systems.

IntegrationEfforts may increase to integrate sustainability reports into company annual reports, in order to clearly articulate the relationship between sustainability performance and financial data. One participant said “there is a drive toward integrating the [annual report] and the sustainability report.” While very few companies currently produce integrated reports, as one participant put it, “It is not a matter anymore of ‘If’ companies should integrate their reports, but ‘when.’ It is not even debatable anymore.” Indeed, there is a global trend toward integrating the sustainability report with the annual report. For example, as a potential sign of things to come, as of June 2010, companies listed on the Johannesburg Stock Exchange in South Africa must integrate their sustainability reports with their annual reports.34

This integration would create significant practical challenges in terms of synchronized timelines for developing reports. It may also mean that sustainability reports will have to include more quantification of traditionally qualitative measures, “such as human rights and labor performance.” Here, too, there are reasons for bringing in more sophisticated external advice: “As the reports become more integrated, they outgrow internal validation and boutique [assurance firms].”

Participants recognized the benefits of integrated reporting. An integrated report reflects how organizations are embedding sustainability into their company’s decision-making, governance, objectives and value chain, and how transparently they do it. Indeed, participants said that companies must be accountable to consumers, investors and other stakeholders who are requesting more information about how companies are building sustainability initiatives into their core business strategy and culture. As one contributor pointed out, “There’s been a shift in values over time, and companies’ behaviors need to reflect that shift in values. Trust is a driver of competitive advantage.”


• How committed are the CEO and management team to integrating sustainability fully into the fabric of the company?

• How routinely does the board engage in dialogue on the company’s sustainability strategy and its connection with the corporate strategy and culture?

• How does the company set sustainability performance goals? How does the company incentivize senior management to meet those goals? How does it measure success?

• How does the company validate its sustainability information?

• What further steps is the company planning to take to integrate its sustainability reporting with its overallfinancialreportingandmarketingcommunications?


About Tapestry Networks

Tapestry Networks is a privately held professional services firm that brings leaders together to solve complex problems. Since 2002, networks convened by Tapestry Networks have tackled some of the most significant strategic challenges facing institutions and society, including raising standards in corporate governance in the United States, Canada and Europe, developing strategies for a more sustainable health care environment in Europe, and enhancing national security in the United States through public-private collaboration. Tapestry Networks convenes eight audit committee networks sponsored by Ernst & Young that collectively consist of more than 120 individuals, who chair more than 180 audit committees and sit on over 300 boards at some of the world’s most admired companies. For more information, please visit www.tapestrynetworks.com.

About this document

InSights is produced by Tapestry Networks to provide assessments of key issues of interest to audit committee members. It will be distributed by Ernst & Young and Tapestry Networks. Anyone who receives InSights may share it with those in their own network. The ultimate value of InSights lies in its power to help all constituencies develop their own informed points of view.

The views expressed in this document represent those of the individuals who participated in the research. They do not reflect the views nor constitute the advice of network members, their companies, Ernst & Young or Tapestry Networks.

Conclusion: Audit committees could play a critical role in sustainabilityThe pressure on companies to improve their sustainability performances is set to intensify over the coming years. A host of external stakeholders are pressing companies for information on their sustainability performance, and when they receive it, they are pushing for more progress.

Participants described a broad sustainability journey that companies typically make, from risk management, to capturing the economic opportunities, to embedding sustainability in the company strategy and culture. Leading companies are accelerating their progress to the third stage of this journey.

For the most part, audit committees have stayed away from deep — or even any — involvement in sustainability matters. Yet, there are reporting challenges at every stage of the journey, as stakeholders become increasingly sophisticated, and participants see opportunities for the audit committee to play an important role in their company’s sustainability journey. The audit committee can:

• Ensure sustainability risks are firmly embedded in the compliance and risk management processes

• Push the board to ask management how it is capturing the economic opportunities presented by sustainability

• Ensure sustainability is fully integrated in top management and board-level decision-making processes

• Ensure stakeholder expectations are met through clear and transparent reporting


Footnotes1. Since 2002, Tapestry Networks has been convening directors from Fortune 500 and equivalent companies in North America and Europe for ongoing discussions around a broad range of topics, including

financial reporting, risk management and shareholder communication. For more information, see http://www.tapestrynetworks.com/networks/net_corporategovernance.html.

2. Ernst & Young, Action amid uncertainty: the business response to climate change (Ernst & Young Global Limited, 2010), 9.

3. US Securities and Exchange Commission, “Shareholder Proposals,” staff legal bulletin no. 14E, October 27, 2009.

4. “Investors File a Record 95 Global Warming Resolutions: A 40% Increase Over 2009 Proxy Season,” PR Newswire, March 4, 2010.

5. Andrea Moffat and Andrew Newton, The 21st Century Corporation: The Ceres Roadmap for Sustainability (Boston: Ceres, 2010), 15.

6. US Environmental Protection Agency, “Endangerment and Cause or Contribute Findings for Greenhouse Gases Under Section 202(a) of the Clean Air Act,” May 14, 2010.

7. See US Environmental Protection Agency, EPA and NHTSA Finalize Historic National Program to Reduce Greenhouse Gases and Improve Fuel Economy for Cars and Trucks (Washington, DC: US Environmental Protection Agency, 2010), and US Environmental Protection Agency “Fact Sheet – Proposed Rule: Prevention of Significant Deterioration and Title V Greenhouse Gas Tailoring Rule,” September 20, 2009.

8. Ashby Jones, “Is Climate-Change Litigation the New Asbestos?” Wall Street Journal, January 27, 2010.

9. Ernst & Young, “Accounting for emission reductions and other incentive schemes,” July 2009.

10. GHGs generally refer to the six gases listed in the Kyoto Protocol: carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), and the fluorinated gases (hydrofluorocarbons, or HFCs, perfluorinated compounds, or PFCs, and sulfur hexafluoride, or SF6). Certain regulations, such as the EPA’s GHG reporting rule, include additional greenhouse gasses.

11. US Environmental Protection Agency, Final Mandatory Greenhouse Gases Reporting Rule: Overview (Washington, DC: US Environmental Protection Agency, 2010), 6.

12. US Securities and Exchange Commission, “SEC Issues Interpretive Guidance on Disclosure Related to Business or Legal Developments Regarding Climate Change,” press release, January 27, 2010.

13. Ontario Securities Commission, “OSC announces plans to enhance compliance with corporate governance and environmental disclosure requirements for 2010,” press release, December 18, 2009.

14. International Accounting Standards Board, “Emissions Trading Schemes,” Project Update, February 2010, 6.

15. International Accounting Standards Board and Financial Accounting Standards Board, “Joint statement by the IASB and the FASB on their convergence work,” June 2010.

16. Carbon Disclosure Project, “What We Do.”

17. Biodiversity is defined by the Merriam-Webster dictionary as the “biological diversity in an environment as indicated by numbers of different species of plants and animals.”

18. See, Europa, Press Releases: Action Plan for sustainable consumption, production, and industry,” July 16, 2008.

19. James Kanter, “Biodiversity: The EU’s Next Challenge,” The New York Times, June 6, 2010.

20. Ernst & Young, Action amid uncertainty: the business response to climate change, 12.

21. Ibid, 8.

22. See Carbon Disclosure Project, Supply Chain Report 2010 (London: Carbon Disclosure Project, 2010).

23. Procter & Gamble, “Designed to Matter: 2009 Sustainability Overview,” 4.

24. Ernst & Young, Action amid uncertainty: the business response to climate change, 19.

25. Verdantix, “Who should be the Chief Sustainability Officer? Expert Advice on the Ideal Profile for the CSO,” January 2010.

26. Sheila Bonini, Stephan Görner, Alissa Jones, and Michaela Ballek, “How companies manage sustainability: McKinsey & Co. Global Survey results,” McKinsey & Co. Quarterly, March 2010, 6.

27. Unilever, “Sustainable Development Overview 2009,” 6.

28. Ken Favaro, Per-Ola Karlsson, and Gary L. Neilsen, “CEO Succession 2000 – 2009: A Decade of Convergence and Compression,” Booz & Co., from Strategy & Business, Summer 2010.

29. See World Business Council for Sustainable Development, “Exploring the Role of Business Through Vision 2050.”

30. See, Royal Dutch Shell, “Royal Dutch Shell PLC Sustainability Review 2009,”

31. See, Azko Nobel, “Azko Nobel Remuneration Report 2009: Performance Share Plan,”

32. Gabriel Nelson, “FTC Moves May Signal Start of ‘Greenwashing’ Crackdown,” New York Times, February 3, 2010.

33. See, Ernst & Young, “Weathering Change: A newsletter from the Climate Change and Sustainability Services (CCaSS) of Ernst & Young, June 5, 2010, 11.

34. See, South Africa Chapter of the Institute of Directors, IoDSA King III Report, September 2009.


Appendix: Research participantsViktor AnderssonManager Investor, CDP Europe and Asia, Carbon Disclosure Project

Philip Lowe Director General, Directorate-General for Energy, European Commission

Eleanor AndrewsSenior Director, Worldwide Audit, EMC

Geoff Lye Executive Chair, SustainAbility

Suhas ApteVice President, Global Sustainability, Kimberly-Clark

Allison McManus Technical Manager, International Accounting Standards Board

Philippe AubainEMEIA Climate Change and Sustainability Services, Ernst & Young

Margaret Norton Director, Corporate Communications, NSTAR

Patricia BarmeyerPartner and Head, Environmental Practice Group, King & Spalding

Claudia O’BrienPartner and Co-Chair, Global Climate Change Practice Group, Latham & Watkins

Judhajit BasuAudit Director, Unilever

Ruth PickerGlobal Leader, Global IFRS Services, Ernst & Young

Dr. William BlythDirector, Oxford Energy Associates and Associate Fellow, Royal Institute of International Affairs

Sophie Rahm Head of Research, Eurosif

Peter ClarkDirector of Research, International Accounting Standards Board

Joel Roxburgh Head of Corporate Responsibility - Performance, Reporting and Engagment, Vodafone

Cathy CobeyCanadian Leader, Climate Change and Sustainability Services, Ernst & Young

Howard Sharfstein Senior Counsel, Environmental, Energy, Safety and Sustainability, Kimberly-Clark

Dr. Claus Conzelmann Vice President, Health, Safety and Environmental Sustainability, Nestlé

Paul SheridanPartner, Environment and Cleantech, CMS Cameron McKenna

John EhrenfeldFormer Director of the Technology, Business and Environment Program, Massachusetts Institute of Technology

Tim SmithSenior Vice President, Environmental, Social and Governance Group Walden Asset Management

Rose Fenn Corporate Responsibility Manager, Unilever

Stephen T. StarbuckAmericas Leader Climate Change and Sustainability Services, Ernst & Young LLP

Melba FoggoDirector, Global Climate Change and Sustainability Services, Ernst & Young

Robert StavinsAlbert Pratt Professor of Business and Government John F. Kennedy School of Government, Harvard University

Folker FranzSenior Adviser, Climate Change, BusinessEurope

Sophia Tickell Non-Executive Director, SustainAbility

Stephanie Hanford-HassPresident, Connectivity Consulting

Mike WallaceDirector, Sustainability Reporting Framework, Global Reporting Initiative

Jeffrey HolmsteadPartner, Bracewell and Giuliani, and Former Assistant Administrator of the US Environmental Protection Agency for Air and Radiation

Joe WalshCommunity Relations and Economic Development Manager, NSTAR

Julia KingVice President, Corporate Responsibility, GlaxoSmithKline

Peggy WardStratetgy Director, Sustainability, Kimberly-Clark

Eckhard KochVice President, Sustainability Center, BASF

John WilsonDirector, Corporate Governance, TIAA-CREF

Caroline LambertMember, Cabinet of Connie Hedegaard, European Commission

Kathrin Winkler Vice President, Corporate Sustainability, EMC

15Regulatory change is driving audit committee agendas

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