Start integrating ESG by rethinking the 10-K
When it comes to integrated reporting, the US lags behind its peers. A recent Global ESG Monitor report (‘GEM Report’) found that six out of 30 (20 percent) Dow Jones companies published integrated reports, compared to 54 percent of the ASX 50, 77 percent of the DAX 30, and 86 percent of the EURO STOXX 50. Not only are there fewer American examples, they’re also of poorer quality – the highest scoring Dow Jones integrated report (Cisco Systems at 18/66 points) remained below the average score of all reports assessed globally (22.55/66 points).
As readers will know, investors, regulators and the community more broadly are demanding that companies demonstrate how their business models contribute to social and environmental outcomes. Given these expectations, US companies should consider starting their integrated reporting journey for at least two reasons. First, integrated reporting provides a framework for organizations to demonstrate how they embed environmental and social considerations into their business model so that they promote an economy that serves all Americans.
There’s also the reality that ESG issues will vary in importance across industries. Waste from packaging is important for consumer goods, green building ratings are important for real estate, and financial literacy is a focus for financial services.
Second, the US-based Sustainability Accounting Standards Board (SASB) is merging with the International Integrated Reporting Council (which oversees the continued development of the International <IR> Framework) to create the Value Reporting Foundation. The increasing expectations on US corporates to adopt the SASB Standards, therefore, may soon expand to include demands for integrated reporting.
Getting started with integrated reporting involves understanding how your business depends on its economic, environmental and social context to create value. The best integrated reports demonstrate this understanding by publishing value creation models that describe how ESG is integrated into a business model:
- Inditex, a Spanish apparel company, produced the best integrated report globally according to the GEM Report. Its value creation model explains how Inditex’s guiding principles, corporate values, and product development combine to create both economic value and positive impact (pages 38-39 Inditex 2019 Annual Report).
- Dexus, an Australian real estate company, topped the ASX 50 according to the GEM Report. Its 2019 Annual Report featured a value creation model showing how its business model leverages key resources to create value for investors, cities, employees, the environment, and other stakeholders (pages 12-13 Dexus 2019 Annual Report).
When included as part of the main financial filings, value creation models signal to investors that an organization understands how ESG risks and opportunities affect financial performance. When it comes to integrating ESG considerations into main financial filings in the United States, however, companies have been reluctant to depart from the traditional SEC Form 10-K.
The growing calls for ESG integration, however, have motivated some US-based companies to rethink their approach. A few years ago, Intel redesigned its Form 10-K and has continued with the new format to the present; evidence that the benefits of the decision have outweighed any costs or perceived liabilities. Its 2020 Form 10-K integrates ESG factors and a value creation model into the Fundamentals of Our Business section, which is aligned with the SEC Form 10-K requirements for “Item 1. Business”.
Some 10-K requirements, such as data validation combined with the 60-day filing deadline, will need to be revised before an organization can comprehensively integrate ESG performance metrics into its Form 10-K disclosure. Even within the current regulatory framework, however, the opportunity exists for companies to start their integrated reporting journey. This involves using value creation models to explain how ESG considerations are integrated into the business model to create value for investors and other stakeholders.
- Integrated reporting is on the rise, and presents an opportunity to demonstrate to investors that your organization understands how ESG factors contribute to financial outcomes.
- Recent US examples show that there is flexibility to include some elements of integrated reporting into an organization’s Form 10-K.
- A useful starting point that aligns with global best practice is to develop a value creation model, which explains how your corporate strategy leverages financial and non-financial resources to create value. This can be included in your Form 10-K.
Editor’s note: A version of this article appeared in the May 2021 edition of IR Magazine.