Advisory Commitee on Business and the Environment (ACBE), UK, 1997
1. The Advisory Committee on Business and the Environment (ACBE) was originally appointed in 1991 by the Secretary of State for the Environment and the Secretary of State for Trade and Industry. The Committee comprises a number of leading business people, and it is charged with giving Ministers advice on specific aspects of the interaction between business and the environment, from a business point of view. A Financial Sector Working Group, led by Derek Higgs, Chairman of Prudential Portfolio Managers Limited, has examined the growing importance of environmental management to the financial community from the point of view of risk management. This position paper sets out ACBE's views and proposes an approach to good practice for businesses to follow in reporting on their environmental performance to financial audiences.
2. ACBE considers that improved communications on environmental matters between financial institutions and the businesses with which they deal will be in the best interests of both parties. For investors, lenders and insurers (and their advisers), better information will lead to an improved evaluation of the financial risk associated with the environmental performance of existing or potential clients. For the businesses being evaluated, the acts of collecting and presenting relevant information may themselves yield scope for improved management practices, leading to increased competitiveness. It may also lead to better terms being offered by financial institutions - or at least no penalties being exacted.
3. These guidelines are directed at all businesses. ACBE appreciates that they will be more relevant to larger, publicly quoted companies than to smaller ones. Smaller companies can already claim dispensations from full reporting requirements as regards their statutory accounts, and ACBE stresses that its guidance on environmental reporting should be viewed in the context of standard financial reporting requirements. ACBE urges smaller companies, however, to consider the benefits (in terms, for example, of maintaining compliance with regulations and retaining the business of important customers), as well as the costs, of collecting relevant environmental performance information in a reportable form compatible with that suggested by these guidelines.
4. Nonetheless, a challenge evidently remains, in the formulation of a language in which the financial implications of environmental performance can be communicated in terms which permit comparability over time and between like businesses. ACBE's Financial Sector Working Group prepared a set of draft Guidelines for Environmental Reporting to the Financial Sector in Spring 1996. They created much interest, among reporting businesses, the financial community, the professional institutions and informed observers. Almost without exception, respondents welcomed, in principle, ACBE's initiative. The Group held a workshop in October 1996 to discuss the constructive comments from respondents. The final version of the Guidelines take these views into account.
5. It is emphasised that ACBE's Guidelines carry no official endorsement from financial or other authorities, and have no mandatory force. Nonetheless, as the appended lists of those who contributed to the draft and those who responded to it show, the present version can be taken to be an authoritative set of guidance notes on good practice, the adoption of which should yield the desired improvement in communications between business and that important set of stakeholders, the financial community.
Environmental Information and the needs of the Financial Audience
6. Several analyses and sets of guidance over recent years have made the point that the various stakeholders in a business have differing, if equally legitimate, requirements for information about its environmental performance. The financial community is concerned, generically, with the evaluation of risk in assessing whether to lend to, insure, or invest in a business (or to advise others about these matters). Annex 1 gives some concrete examples of environmental performance having a material impact on financial performance.
7. Without relevant, quantified, and comparable data, the financial community will be making its judgements on risk with incomplete information. Further, financial institutions need to know whether there is evidence that the management of the business is properly in control of its performance. Does it breach its permitted discharge limits and how closely does it operate to those limits? Do trends indicate steady improvement or deterioration? How often do unforeseen, accidental, events occur? Is it accredited to a recognised environmental management systems standard?
8. Clearly, the institutions will find it valuable to examine adequately reported financial, physical and managerial information on these topics. The evidence is beginning to mount that businesses are being asked more frequently to provide it. ACBE's Guidelines are not designed with a view to stimulating more environmental reporting as an end in itself; their underlying aim is to improve the capacity of the financial community to evaluate and deal with the implications of environmental risk. Greater insight on the part of the financial world should also lead to benefits for the businesses prepared to report, fully and comparably, on their performance.
9. These Guidelines are concerned with presentation of environmental information in the formal documents, some or all of which all reporting businesses prepare: the Annual Accounts, the Operating and Financial Review in its Annual Report, and a stand-alone environmental report if one is produced. Only a few companies, at present, prepare all three sets of material, and indeed only a limited number make any reference to environmental matters in their published financial documents.
Environmental Reporting: Formal Documents
The Annual Accounts
10. The professional accounting bodies (in the UK, across Europe and in North America) are currently examining their standards and conventions as regards the financial reporting of environmental costs and liabilities. In the main, these studies conclude that existing accounting standards and practices will yield reasonably comparable, quantified information on material environmental costs and liabilities, whatever the reporting business.
10.1 Existing requirements for financial statements
The present requirements of UK company law and existing and proposed accounting standards cover the following accounting issues of recognition and measurement which may have environment related implications:
balance sheet provisions for liabilities and risks;
estimation of the amount of a contingency;
provisions for long term decommissioning costs;
capitalisation of costs;
offsetting of liabilities and expected recoveries;
asset impairment and provisions for repair costs;
as well as the following issues regarding disclosure in financial statements:
the position and/or separate disclosure of environmental provisions in the balance sheet;
environment related disclosures required in the Notes to the Accounts (valuation methods and accounting policies; exceptional environmental items; disclosure and details of 'other provisions'; contingent environmental liabilities).
Subject to the application of the materiality concept, these accounting and disclosure requirements already apply to all companies regardless of size or sector.
10.2 Discretionary financial disclosures and environmental costs
In recent years there have been many examples of companies making discretionary disclosures of financial information, over and above the statutory minimum. Examples of such discretionary disclosures which, it has been suggested*, it would be useful for the financial community to be aware of, include:
the amount of environmental expenditure charged to the profit and loss account;
the amount of environmental expenditure capitalised, to the extent that it can be clearly differentiated from other capital expenditure;
the amount of costs incurred as a result of fines and penalties for non-compliance with environmental regulations, and compensation to third parties, where material.
There is some debate regarding:
the ease with which environmental capital expenditure can be separately identified; and
the actual usefulness of the information in interpreting corporate environmental performance - for example, is a low level of environmental expenditure to be interpreted more or less favourably than a higher level?
Nevertheless, it is important that whenever such discretionary financial disclosures are made, the accounting policies and definitions used are fully disclosed and that, wherever possible, comparative data compiled on a similar basis is also disclosed.
10.3 Non-financial discretionary disclosure
Finally, there is some non-financial environment related data which, it has been argued*, could also be of use to the financial sector. This includes:
where environmental issues are relevant to a complete understanding of the financial position and performance of the undertaking, a description of the respective issues and the undertaking's response to them. Summary data of a non-financial nature can be very useful for this purpose. Clearly this is likely to affect businesses in some industries more than those in others;
the policy that has been adopted by the enterprise in respect of environmental protection measures;
the improvements that have been made in key areas of environmental protection;
the extent to which environmental protection measures, arising from changes in future legal requirements that have already been enacted or substantially enacted into law, are in the process of implementation;
reference to other quantitative or qualitative environmental information provided in a separate environmental report.
This information is very unlikely to have to be included in a company's audited financial statements. Financial audiences would prefer to see such disclosures being made in the annual report itself, rather than in a stand-alone environmental performance report. Such disclosures could be made within the Operating and Financial Review (see below). Where reporting companies choose to disclose such information through a stand-alone environmental report, there should be cross references to relevant data in the annual accounts.
ACBE strongly supports continuous experimentation by businesses with this type of non-financial discretionary disclosure through the unaudited section of the annual report to shareholders, but has no wish to attempt to prescribe their precise form or content.
11. The Accounting Standards Board published a discussion paper earlier in 1996 on provisioning and the recognition of liabilities, which included a section on environmental liabilities. The Institute of Chartered Accountants in England and Wales issued a paper on 'Environmental Issues in Financial Reporting' in October 1996. The EU's Accounting Advisory Forum also published a report on environmental costs and liabilities in April 1996, while other European level bodies are examining auditing practices and the preparation of 'opinions'. ACBE welcomes these studies and urges the preparers of reports to take account of their conclusions.
The Operating and Financial Review
12. The Financial Reporting Council strongly recommends listed companies to support Operating and Financial Reviews (OFRs) alongside their annual financial statements, as narrative amplifications of past performance and planned strategic direction. The OFR format, as drawn up by the Accounting Standards Board, explicitly provides for the inclusion of environmental information. Listed companies should thus ensure that their OFRs include descriptive and quantitative details of the environmental risks they face, the environmental costs they have incurred, and the environmental initiatives they have taken. The discussion should be linked to amounts charged, provided for or disclosed in the Accounts, and it would thus cover capital and revenue expenditure, liabilities and provisions.
13. ACBE considers that the OFR should also state whether a formal environmental management system is in operation, and the extent to which management action has led to changes in the business's environmental performance. It should for example, include a statement of the business's record as regards its compliance with environmental requirements, with an indication of significant infringements of them. The policy for managing environmental risks should be stated; this will help to demonstrate and ensure appropriate Board responsibility towards environmental issues and their integration throughout the business.
The Environmental Report
14. ACBE is concerned to encourage more widespread dissemination by businesses of their environmental affairs to all audiences and stakeholder groups. Often this will best be done through the medium of a specially prepared environmental report. Such a report might be a separate section in a standard Annual Report aimed largely at the financial sector and shareholders, or a separate publication, targeted at a wider range of stakeholders. Individual firms hold different views about the merits of each approach, but ACBE feels that a stand-alone environment report is a complement to, not a substitute for, the inclusion of environmental information in the annual accounts.
15. When structuring a report for a financial audience, the key messages to convey will be strategic, illustrating, in particular, the extent to which the company's environmental management system implements its environmental policy and is an integral part of its overall corporate plan and business operations. Data that can be benchmarked against similar companies will be especially valuable. More work is needed to identify appropriate measures of performance and develop guidance on measurement and monitoring. Reporting companies and their financial audience should work together to ensure that such indicators are useful and meaningful.
16. Factual information in an environmental report needs, of course, to be compatible with that in the OFR and the Accounts, and there should be adequate cross references between them. The report should include physical and technical data, and social information such as that on health and safety. Consistency of preparation is needed to permit comparisons across time and with comparable businesses. Details should be included of the systems and controls used by the business to monitor compliance with its own policy and with regulatory requirements.
17. The report should where possible quantify the financial implications of the reported physical performance measures, giving details of such matters as fines and prosecutions. Comparisons with peer group businesses, perhaps with performance measures established by trade associations, would be helpful where possible.
18. There should be a Directors' Responsibility statement which makes it evident that there is clear Board approval for the report.
19. An authoritative, independent, review of an environmental report can be a major spur to improving the quality, integrity and credibility of its content. Different forms of review may be appropriate for different parts of the material presented: environmental liabilities and costs will be reported in the Accounts and thus subject to financial audit, while physical information in the OFR and environmental reports may be scrutinised by environmental auditors. Their skills differ and they are regulated by different professional bodies; it would be valuable if a coordinated approach could be taken by the two review functions. The following points should also be noted:
(i) Independent verification should be encouraged but not made mandatory. The pace of its development should be determined by user demand and the availability of suitably qualified verifiers.
(ii) The Auditing Practices Board, in consultation with the UK Accreditation Service, could be charged with investigating the feasibility of developing standards for verification of the disclosures, which should be compatible where possible with those of the Eco-Management and Audit Scheme.
20. ACBE appreciates that, with the reporting field itself in a state of rapid evolution, a flexible approach to the auditing and review process for environmental information is required. The remit of the financial auditor in respect of the financial accounts is well established, but differing forms of scrutiny may be appropriate for environmental information, depending on where it occurs.
* See, for example, the EC Accounting Advisory Forum (1996) and the European Federation of Financial Analysts (1995)
Annex A: Examples of environmental performance having material financial implications
* Capital expenditures required for compliance with BATNEEC process authorisations under EPA 1990
* Capital expenditure for the remediation of contaminated land - or provisions for this if a future liability can be foreseen
* Capital expenditures which may ensue from the need to respond to specific customers' requirements - the competitive 'licence to operate'
* Revenue expenditure on improved waste management, thereby minimising the burden of landfill taxes
* Capital or revenue costs in improved management practices, e.g. to attain energy or materials utilisation rates per unit of output which match those of comparable competitors.
* The cost of dealing with unexpected environmental impacts - whether accidental discharges due to operator error or arising from inherently hazardous processes - and whether in the form of physical damage to be rectified, or the payment of fines or damages imposed by the regulators or the courts.
Annex B: Respondents whose views were taken into account in preparing the revision and/or those attending the workshop
Albright & Wilson
Auditing Practices Board
Biffa Waste Services
British Secondary Metals Association
Central & West Lancashire Chamber of Commerce
Confederation of British Industry
Deloitte and Touche
Eclipse Research Consultants
Environmental Industries Commission
H A Masons Metals
The Hundred Group of Finance Directors
The Institute of Chartered Accountants in England and Wales
Jupiter Asset Management
King Sturge & Co
Lloyds TSB Group
London Chamber of Commerce & Industry
Loss Prevention Council
Morgan Grenfell Asset Management
The Royal Institution of Chartered Surveyors
Simmons & Simmons
UK Centre for Economic and Environmental Development
University of Hertfordshire
Wolverhampton Business School
ENVIRONMENTAL REPORTING WORKING GROUP
Derek Higgs (Chairman)
Roger Adams, Chartered Association of Certified Accountants
Janet Asherson, Confederation of British Industry
Brian Birkenhead, National Power
Robert Charlesworth, Auditing Practices Board
Clare Craig, Confederation of British Industry
Bill Dale, SBC Warburg
Brian Griffin, Royal and Sun Alliance Insurance
Philip Hillman, King Sturge & Co
Philip Jones, Institute of Investment Management and Research
Mike Kelly, NatWest
Robert Langford, Institute of Chartered Accountants in England & Wales
Andrew Lennard, Accounting Standards Board
Jon Symonds, KPMG
Tessa Tennant, NPI Global Care Investments
Hilary Thompson, NatWest
Charles Duff (Secretary), Department of the Environment