Sustainability Matters

The corporate responsibility reporting environment is changing rapidly with a move towards more transparency and greater integrated reporting driving new rules, regulation and sustainability objectives. Colleen Theron discusses why it is important that law firms and lawyers drive the agenda for sustainability transformation

The notion that business operations should be more transparent, particularly in respect of their environmental impact, is evidenced by the enormous growth in legislative reporting requirements. Companies are required to report

on their overall impact on the environment under Companies Act 2006, Climate Change Act 2008 and where their businesses are regulated by a specific environmental regime such as the EU Emissions Trading Scheme (EUETS) and the CRC Energy Efficiency Scheme (CRC). The US Securities and Exchange Commission (SEC) also has stringent reporting requirements.

Growing environmental risk and compliance issues have given rise to a greater demand for corporate transparency and new, more stringent governance and financial disclosure requirements. In the US, the passage of the Sarbanes-Oxley Act placed more emphasis on environmental disclosure. In the UK, the reform of the Companies Act requires the directors of all companies, except small ones, to produce a business review that sets out how directors have taken into account the impact of the company’s operations on the community and the environment.

The requirement that directors have to report on the environmental impacts of their company inevitably raises the challenge of relating environmental policy, management and performance directly to the core management and financial performance of the business – issues that were previously linked to the concept of corporate social responsibility (CSR).

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Sustainability Matters

The financial and economic crises have prompted companies to move away from a “business as usual” approach. Companies are aligning financial interests with environmental objectives due to legislative changes, but also because of stakeholder and investor pressure. For companies that have truly embedded sustainability into their strategy and operations, there is a move towards integrated reporting. What, however, does this mean for law firms? Companies in the UK continue to be the world leaders in corporate responsibility reporting, with 94% of FTSE 100 companies disclosing environmental information despite only 35% making disclosures in their annual accounting and reports. But why are law firms and lawyers not involved in this evolution?

Mandatory reporting The UK government has made it clear that environmental reporting is a permanent fixture in company reporting. This approach is embedded by the changes in regulation. A fundamental review of the Companies Act 2006 (CA 2006) has tightened statutory controls on directors as regards environmental issues.

Under the CA 2006, s 415, all companies must prepare a directors’ report, which should include a business review, for each financial year. The business review must provide a fair review of the company’s business and give a description of the principal risk and uncertainties facing the company so that the shareholders can assess how the company’s directors have performed their duties.

“Because of increased legislation and a lack of harmonised standards globally, companies are faced with complex corporate reporting procedures. If more reporting is made mandatory it can only result in further complication unless a uniform approach is adopted”

“The conflict between the duty to maximise profits and the extent of ethical investment is arguably the result of greater interest in sustainability issues”

Section 417(5) sets out the reporting requirements for quoted companies. They are to provide:

●● Information about environmental matters (including the impact of the company’s business on the environment).

●● Information about any company policies relating to environmental matters and the effectiveness of those policies.

Section 417(6) requires that the review must include an analysis using financial key performance indicators (KPIs) and where appropriate, analysis using other key performance indicators, including information relating to environmental and employee matters.

Defra has published guidance on KPIs and how to use them in reporting. It suggests that three key principles should be followed by

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companies to provide assurance to business and its stakeholders that appropriate processes and procedures have been followed, those of:

●● Transparency.●● Accountability.●● Creditability.

Defra suggests that environmental information should be published at the same time as the annual report and accounts and relate to the same accounting period. The convergence of annual reports and CSR reports will no doubt become more evident following the business review requirements under the CA 2006.

Closing the gap between financial and non-financial reports is currently one of the main debates in the sustainability agenda. Integrated reporting has been the focus of the recent Global Reporting Initiative (GRI) summit in Amsterdam and on Friday, 28 May 2010, the GRI and UN Global Compact issued a press statement agreeing to align their work in advancing corporate responsibility and transparency.

Accounting standards When companies are preparing financial statements they can apply accounting standards. Most companies prepare their accounts in accordance with Generally Accepted Accounting Principles (GAAP) or the International Financial Reporting Standard (IFRS), prepared by the International Standards Board (IASB). In the UK, under FRS12, companies must make provision in their accounts for the financial impact of certain environmental liabilities. For example, a company should make provision in their accounts where clean-up of contamination is required under legislation. The equivalent standard under IFRS is IAS 37. Both the ASB and IASB are currently reviewing FRS12 and IAS 37.

Pension fundsSince 1995, UK pension fund trustees have been required to disclose the extent to which they take environmental issues into account in their investment decisions. They are required to disclose their policies in considering social, environmental and ethical matters in selecting, retaining and realising investments. These disclosures are made in the Statement of Investment Principles that has to be prepared and maintained. Underlying this requirement is the trustees’ obligation to maximise financial returns for their beneficiaries. The conflict between the duty to maximise profits and the extent of ethical investment is arguably the result of greater interest in sustainability issues.

While in 1984 the court decided, in Cowan v Scargill [1984] 2 All ER 750, that trustees primary concern must be to maximise financial returns for beneficiaries, a joint 2005 report from UNEP and Freshfields Bruckhaus Deringer LLP argued that the decision in this case was wrong and that institutional investors can integrate environmental, social and governance issues (ESG) into investment decisions and that this would result in a more reliable prediction of financial performance.

A follow-up report, produced by UNEP F1 in 2009, provided further commentary on trustees’ fiduciary duties to integrate ESG issues into investment decisions. The key element was a growing emphasis on the integration of social and governance issues in decision making, beyond environmental impact alone.

In 2006, UNEP F1 and the UNEP Global Compact launched a set of voluntary principles called the Principles for Responsible Investment (PRI). They provide a framework for institutional investors, including

pension fund investors, to integrate environmental, social and corporate governance issues into their investment decisions. The follow-up report by UNEP FI states that the market impact of the voluntary instruments should not be underestimated. In practice, they are applied widely by their signatories throughout the financial sectors where they have been adopted.

The interest in robust corporate disclosure by investors has been gathering momentum. In the US, through the Ceres Investor Network on Climate Risk, over 40 institutional investors have asked regulators, including the SEC, to provide better guidance to companies on disclosure of key ESG issues and climate change and water scarcity. In January 2010, the SEC acted on these requests issuing guidance to companies clarifying what publicly-traded companies need to disclose to investors in terms of material climate-related risks and opportunities, including physical risks like water scarcity.

Sustainability and corporate social responsibility The concept of “sustainability” is often used interchangeably with the concept of CSR at corporate levels, but clarity on the differences is important for the way business behaves. The European Union started to develop the concept of CSR in 2000/01 in line with the strategy adopted in Lisbon in 2000.

The Lisbon objective called on the EU to become the foremost economy in the world, focusing on sustainable economic growth and greater social cohesion by 2010. The EU’s sustainability strategy is also tied up with the Lisbon objective. From a business perspective, CSR came first and was primarily concerned with social matters. Sustainable development emerged from the environmental protection debate. The Bruntland Commission concluded that social, ecological and economic concerns must be given equal weight. CSR tends to be restricted to ecological and social challenges and economic contributions to sustainability are not considered in detail. So while the concepts overlap they are applied differently.

The concept of “sustainable development” is not always interpreted in the same way across the globe. The standard definition is the one contained in Brundtland’s report, namely:

“Sustainable development that meets the needs of the present without compromising the ability of future generations to meet their needs.”

While the concept of CSR broadly stems from that of sustainable development with an initial objective of accountability, it still largely appears to be an evolving paradigm. It is essentially used by companies to measure, manage and communicate their environmental performance to investors and the general public. For many companies CSR has become a key feature of business strategy. More than 1,000 companies worldwide that currently report on their environmental performance can be found listed on CorporateRegister.

Sustainability, in a business context, is used to refer to how environmental, social and economic considerations are integrated into corporate strategy and capital markets for the long term.

Ceres, a coalition of investors, environmental groups and other public interest organisations working with companies to address sustainability challenges, states that the “licence to operate” can no longer be taken for granted by business. Companies, they suggest, cannot consider sustainability challenges in isolation. A recent Price Waterhouse Coopers survey of 140 chief executives of US-based multilateral companies found that 85% believed that sustainable

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development will be even more important to their business model in five years time than it is today.

While we are beginning to see some of the major law firms in London embrace the notion of CSR, there does not appear to be any apparent shift towards integrating sustainability into either the way law firms are run, or in fact advising clients on these matters . Lawyers risk being left out of the development of these issues, while the accountancy firms are leading the way. At a recent conference in Amsterdam in Holland there were three lawyers (including the author) present at a discussion on how the financial sector is influencing reporting.

The move towards mandatory reporting should also be a concern to the legal world.

The quandary of voluntary reportingIndustry has stressed that undertaking CSR reporting on a voluntary basis allows companies to find methods suitable for their own cultures and needs. On the other hand, non-governmental organisations such as Friends of the Earth, have claimed that social reporting, auditing and labeling are inefficient and lack credibility without standardised methods or independent monitoring. For example, definitions of CSR vary across different cultures, companies and industries. There is also the question of how CSR practice remains credible and transparent.

As a result of the financial crises, there have been amplified calls by stakeholders for greater regulation aimed not only at the financial sector but at all industries. It is recognised by stakeholders that ESG measures have a significant effect on company valuation.

Over the years a fusion of guidelines and standards has emerged to provide a framework for companies that wanted to pursue voluntary reporting. There is also body of relevant law and regulation which, inevitably, provides a certain amount of the framework for CSR/sustainability strategies, especially as regards reporting. For

example, the Combined Code of Practice on corporate governance provides that:

“The board should set the company’s values and standards and ensure that its obligations to its shareholders and others are understood and met” (supporting Principle A1).

Good governance includes systems of internal control to ensure that a company operates effectively and complies with legal requirements. Listed companies have to state whether they have complied with the Combined Code provisions and justify and explain any non-compliance. Although the Code does not include specific recommendations on environmental matters, companies should apply the principles and consider whether they need to include systems to manage environmental risk within their internal control systems.

Many companies (and a few law firms) now publish separate CSR reports, independent of their statutory annual reporting. There are many drivers for this, such as reputation risk management and a need to satisfy pressures from investors.

In recent years, more companies have started integrating their financial and non-financial data into the same report, which raises the question whether mandatory CSR reporting will help standardise and align the way companies report annually.

There is also recognition that due to increased legislation and a lack of harmonised standards globally, companies are faced with complex corporate reporting procedures. If more reporting is made mandatory it can only result in further complication unless a uniform approach is adopted.

In 2009, the ASB published a report, A Review of Narrative Reporting by UK Listed Companies in 2008/09, that analysed how companies report on CSR in their annual reports. It indicated that while companies often provided relevant discussion of all three areas, they continue to struggle to explain the reason why CSR is important to their business. This could be why we are now seeing increased emphasis on adopting a sustainability approach, so that these issues become embedded in company strategy and operations.

After the European Commission’s 2001 Green Paper and 2002 communication on CSR, discussions have focused on the choice between mandatory and voluntary rules. In March 2007, the EU executive reaffirmed its long-held stance that CSR is a uniquely voluntary measure that should not be regulated at EU level. However, the European Commission now appears to be aligning its position close to the views expressed by NGOs.

In Denmark, the voluntary approach to CSR reporting is mandatory. From 2010, the 1,100 largest private and state-owned companies and institutional investors are to include corporate social responsibility information in their annual financial reports. This appears to go further than the UK Company Law requirement that a business review should contain information about the company’s impact on the environment and the community. The Danish model however encourages companies to use the international framework that already exists for CSR, such as the UN Global Compact and the UN Principles for Responsible Investment, thereby endorsing sustainability reporting.

Notwithstanding the debates on the status of CSR reporting, the inclusion of sustainability into company strategies is gaining momentum, as many more global companies are seeking to operate in line with best practice.

“Businesses can no longer afford to ignore the movement to establish a low-carbon, sustainable global economy. Corporate bottom lines will be impacted by emerging ESG issues, particularly where disclosure must now be included in financial filings”

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Business issuesBusinesses can no longer afford to ignore the movement to establish a low-carbon, sustainable global economy. Corporate bottom lines will be impacted by emerging ESG issues, particularly where disclosure must now be included in financial filings. Impacts will flow from the physical risks of climate change, whether or not anthropogenic, or those risks arising from the scarcity of energy and water resources, or from legal and regulatory burdens that may be imposed by reference to those risks. The overall governance and disclosure by companies relating to ESG issues must be improved. More details are required on actions and policies or assessing and managing environmental risks.

Companies should also be aware of the growing trend of the global business and human rights agenda. Companies are also going to have to track their policies and operations on the local communities within which they operate.

Business cannot ignore the fact that social technologies, media and networks will transform the reporting landscape. The Web 2.0 revolution is levelling the playing field by giving stakeholders the opportunity to initiate and drive conversations with (or around) companies.

Why should law firms think about it?Instead of reacting to the global transformative changes in this area, lawyers should be helping to drive the agenda. In the past, many major social changes were driven by, or at least supported by lawyers. There is no doubt that lawyers will be involved in climate change litigation but there is an important role for them to play in defining the sustainability and reporting agenda.

Many law firms’ clients are pursuing sustainability as part of their strategies. At the very minimum, lawyers should understand the issues to advise their clients. Employment issues are a big part of sustainability. Also, as more graduates are looking to find places to

Colleen Nelson, “Corporate Behaviour: How Environmental Risk and Corporate Governance are Shaping Change, or Are They?” (2005) ELM 17 pp 66-68

Colleen Theron, “Environmental Disclosures Under the New Companies Act’ (2008) ELM 20 pp 84-87

Environment Agency Report, Environmental Disclosures (www.lexisurl.com/LawBusinessReview835)

Defra, Environmental Key Performance Indicators (www.lexisurl.com/LawBusinessReview845)

A Legal Framework for the Integration of Environmental, Social and Governance Issues into Institutional Investment (October 2005, UNEP F1 and Freshfields Bruckhaus Deringer LLP) (www.lexisurl.com/LawBusinessReview878)

Fiduciary Responsibility – Legal and Practical Aspects of Integrating Environmental, Social and Governance Issues into Institutional Investment (July 2009) (www.lexisurl.com/LawBusinessReview444)

“Commission Guidance Regarding Disclosure Related to Climate Change” (www.lexisurl.com/LawBusinessReview839)

Future E. V. and Institute for Ecological Economy Research GmbH (IOW), Significance of the CSR Debate for Sustainability and the Requirements for Companies (www.lexisurl.com/LawBusinessReview813)

Bruntland Report 1987 (www.lexisurl.com/LawBusinessReview374)

“Corporate Social Responsibility: Back on the EU agenda?” (www.lexisurl.com/LawBusinessReview41)

Financial Reporting Council, The UK Corporate Governance Code and Associated Guidance (www.lexisurl.com/LawBusinessReview223)

Accounting Standards Board, Reviews of Narrative Reporting 2009 (www.lexisurl.com/LawBusinessReview856)

European Sustainability Reporting Association, Denmark (www.lexisurl.com/LawBusinessReview828)The GRI Learning Series, The Transparent Economy, 2010, p 15 (www.lexisurl.com/LawBusinessReview2)

Web resourcesThe Global Reporting Initiative (www.globalreporting.org/Home.)

The UN Global Compact (www.unglobalcompact.org)Corporate Register (www.corporateregister.com)Ceres (www.ceres.org)

CasesCowan v Scargill [1984] 2 All ER 750

Further reading

work that share their values, law firms may find themselves losing out on recruiting top graduates, who may choose to work elsewhere.

Firms that have not come to terms with the development of a low-carbon economy and the new areas of law that are emerging to create frameworks for renewable energy and carbon trading, potentially cede the ability to extend their practices to their competitors.

Law firms and lawyers that also fail to embrace the movement towards more mandatory reporting will fail to reap the benefits of wider market opportunities.

Law firms also cannot afford to ignore the changes that will be introduced by the Legal Services Act (LSA). The LSA enables alternative business structures (ASB) that will allow external ownership of legal businesses, including companies floated by the stock exchange. Any law firm taken over by a listed company will have to comply with their disclosure requirements. Those law firms considering ASBs might want to look at how they can enhance their reputation to “catch up” with current sustainability trends.

Inconvenient truthThe move towards more transparency and greater integrated reporting is driving new rules, regulation and sustainability objectives, but the inconvenient truth is that most companies, and this includes the majority of law firms, are not taking a proactive approach to managing sustainability.

2010 is the year of the Tiger in China. The animal represents turbulence, but also energy, strength, courage and power. The shift in the world’s trading conditions and the challenge of climate change, means that these four characteristics will be much in demand for business tackling the new global transparency, accountability and sustainability strategies.

Colleen Theron is an environmental lawyer and consultant. She works for LexisPSL and is a director of CLT Envirolaw

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