Deloitte Outlines Process for Choosing Environmental Metrics

Public and private companies are finding it a major challenge to determine what environmental, social and governance (ESG) information to disclose, according to a new report from Deloitte.

According to the report, Disclosure of Long-Term Business Value: What Matters?, leading companies already are working to bring reporting on non-financial ESG performance to the same level of maturity as financial reporting. This comes years ahead of any expectation for a movement toward widespread mandated disclosure, the report said.

Six in ten CFOs at large global enterprises believe that sustainability challenges will change financial reporting and auditing, and these companies are looking for ways to leverage these metrics, Deloitte said. Many companies are trying to apply the principle of materiality from traditional financial reporting to ESG performance metrics.

The consultancy said the long-term success of a company is in some part determined by the non-financial intangibles of ESG materiality. Today 55 of the world’s stock exchanges issue sustainability indices, and the evidence of a stock price impact related to ESG performance appears to be getting stronger.

To help make ESG results core to the firm’s business and investment decision-making, the report says that four core factors should be considered in the choice of ESG metrics. They are corporate strategy; value drivers – including stakeholder interests; organizational objectives; and the competitive environment.

Deloitte finds that materiality of ESG topics starts with stakeholders who decide whether or not to react to corporate behavior, with a certain probability. Not all corporate behavior triggers stakeholder action, which might include activism, boycotts, divestiture, or buying more or less of a product. The strength of this reaction shows the importance of the sustainability impact.

Once relevant topics have been identified based upon internal and external stakeholder input, the next step is to identify which are material. This depends on the perception of whether the company’s behavior creates or destroys significant amounts of value related to ESG, Deloitte said.

The materiality filter should capture areas of ESG with the greatest potential to impact company valuations within a time frame. Such impacts can include a loss of license to operate, change in cash flow, and reputational or brand value losses across a range of relevant time frames, Deloitte said.