Field Notes: The Future of Accounting Standards

SEC Commissioner Kara Stein recently spoke on the importance of incorporating ESG factors in financial reporting. The Volkswagen debacle shows why.

In her address to the Institute of Chartered Accountants in England and Wales, SEC Commissioner Kara M. Stein spoke about the increasing demand by investors for information about social and governance concerns in this age of disruptive digital transformation. But the current accounting principles, she says, do not reflect this rising trend:

Accounting standards need to evolve to meet the needs of investors in the digital era. Isn’t it time we updated our metrics to provide this type of important information to investors? Wouldn’t investors – and companies, through increased investor confidence – benefit from having that information audited or evaluated by independent accountants? Are there other assurances that accountants could provide?

Imagine if such information had been readily available to Volkswagen investors. Now of course, what Volkswagen committed was corporate fraud, purposely hiding information from investors. However as Howard Sherman, head of corporate governance business development at data-provider MSCI notes in a Financial Times article, investors could still have identified problems with the company long before the scandal broke.

"We have had concerns about VW for some time,” he said. “[The carmaker’s] corporate governance score [on an MSCI proprietary ranking] was already in the 28th percentile, which means it was lower than 72 per cent of companies globally."

ESG factors serve not only to achieve social goals, they can become indicators of a company’s long term performance as well. In the same article, Jeroen Bos, head of equity research at NN Investment Partners, says that the emissions scandal is a clear example of why environmental, social and governance factors need to be integrated in the investment process. He says,

"With a huge share price decline, an immediate €6.5bn provision taken and further actions expected, it again demonstrates that ESG factors can have a material impact not only on a company’s share price and near-term financials, but also on its longer-term reputation and business success."

Sustainability Accounting Standards Board (SASB, a Heron investee) is one such organization that aims to provide investors a true comparison of peer performance and benchmarking. By issuing provisional standards for different industries – such as Financials, Tech and Transportation – it enables companies to disclose sustainability information likely to be material. Information is power and SASB’s growing popularity in the U.S. will only lead to greater investor confidence and a renewed focus on ESG activities by companies.

This year, Heron made the decision of excluding CSR activities from ESG screenings as they can be a “false positive” for socially responsible business practices. Debacles such as this Volkswagen one show why that’s a smart move.

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