Non-financial reporting is the future of audit

Tidal waves of global growth, our heavy dependence on fossil fuels, and our constant need for innovation have led us to a world of inconsistencies and widening gaps between underdeveloped and developed countries. Our world is fracturing, and the fractures are growing bigger and bigger.

In a report released in 2018 by Oxfam, 82% of the wealth generated last year went to the richest portion of the global population – the  1% – while 3.7 billion people, the poorest half of the world, saw no increase in their wealth. According to the United Nations, 2.1 billion people still lack access to drinking water. We repeat. That’s billion. The average age in Africa is 19 years. Contrast that with  an average age of 41 y in France and 46 in Germany, according to WorldoMeters. At the same time, 44,400 people a day are forced to flee their homes due to war and persecution, according to the UN Refugee Agency.

These are all sobering if not terrifying things to think about. But sometimes this situation is not very obvious, is it?

On the other hand, digitalisation and robotics are changing the way we work, changing market needs and demands and employability and, silently but firmly, reshaping the way we live. Sadly,  fibre optics and silicon aren’t drinkable, not yet at least, and over a billion people currently struggle to get something as basic as water. In addition, global uncertainties fed by geopolitical tensions, mass migration and climate change, are issues plaguing the decision-makers minds.

To tackle these issues, there are global initiatives already put in place. With 17 Goals and 169 targets, the SDG’s focus is to end poverty, protect the planet and ensure prosperity for all. It integrates into the 2030 sustainability agenda that governments, civil society organisations and corporates have developed.

The role corporates play in making SDGs happen is becoming more prominent. Indeed, they are catalysts to achieve the SDG goals. Corporates have a social responsibility towards the SDGs. They can align their corporate responsibility agenda with the SDG goals to position themselves as key players on the road to a sustainable future. That road, however, isn’t straight, nor is it free of shadows, so trust and stakeholders accountability are the compass to sustain the initiatives.

One way to build trust and stakeholder accountability, is by including non-financial performance reporting to the widespread financial performance that we’re used to, which allows businesses to add legitimacy to the role they play in within the sustainability agenda.

One way to amount trust and stakeholder accountability is including non-financial performance reporting to the widespread financial performance that we’re used to, which allows businesses to add legitimacy to the role they play in within the sustainability agenda.

As we previously mentioned in our ESG article, investors, and the market demand for sustainable products, are growing. For companies to attract and retain investors, clients and talent, they need to add the variables “people” and “planet” to the profitability equation. That’s when the audit function takes a whole new dimension: the balance sheet game evolves, and equity is no longer a financial liability thing, but a social and an environmental one, too.

To know more about this fractured world, the growing importance of non-financial reporting and how it will impact the future of the audit industry, we had a warm talk with our sustainability expert, Valérie Arnold, our Corporate Responsibility and Sustainability leader. This article summarises what we’ve learnt from our exchange.

Repairing the fractures: what’s been done so far?

Problems on a global scale call for a global team and collective solutions. Although progressing slowly, global initiatives to deal with the challenges of our fractured world are gaining traction. Until now, the preeminent international agreements have been the Paris Agreement and the 2030 Agenda for Sustainable Development.

On one hand, the result of the Conference of Parties (COP21) in 2015, addresses climate-related issues, asking countries to take measures and finance projects that reduce green-house gas emissions. As of March 2019, 195 countries have signed the agreement, including the European Union.

On the other hand, the Agenda for Sustainable Development  – a plan of action for people, planet and prosperity – has 17 Sustainable Development Goals (SDGs) put in place by the UN. They cover a wide range of social, economic and environmental development issues.  

However, goals and agreements cannot be left on the shelf of good intentions. The Earth needs us to take action. Valérie Arnold, PwC Sustainability Leader at PwC Luxembourg, reminds us that:

The UN and Paris agreements settled the latest framework [but] it’s up to us, societal players, public authorities and businesses to do our part. In the civil society, goals and priorities of participating entities have to be aligned. Corporate objectives have to serve both the public and private good of their shareholders.

At PwC Luxembourg we are convinced that we also have a role to play. Following the lead of the PwC Global Network, we have taken part in the SDG Reporting Challenge. This survey is an analysis of whether companies are addressing SDGs while reporting on their business strategy, and if they’re approaching the SDGs with the appropriate KPIs necessary to achieve these Goals.

This year, we sampled 114 of the largest companies in Luxembourg, out of which 18 explicitly report on SDGs – a leap compared to zero companies that reported on the Goals last year (SDG Challenge 2017).

After this experience, we concluded that while SDGs are gaining recognition among enterprises in Luxembourg, we still have room for improvement in the field of non-financial reporting. Commonly, companies choose and prioritise SDGs that are more relevant to their business strategy and their activities, without deep diving into the 169 targets, leaving a reporting gap.

It’s precisely this gap what we and the PwC Global Network are trying to address and close. If the gap isn’t filled, companies won’t be unable to report on quantitative information their stakeholders and interested parties often demand.

What of the role of business in all of this?

While the term CRS – Common Reporting Standards – is anything but new, it has evolved over time, much like the importance of our planet for governments, businesses and individuals alike.

The 50s was the era of ethical design, when businesses had the moral responsibility to protect the well-being of their employees, their families and their communities. In the 70s, 80s and 90s, things changed a bit. Social performance of both individuals and organisations joined business profitability. By doing good, businesses could nurture their corporate identity, improve their reputation and continue to build trust among their stakeholders. It was called the era of utilitarianism.

Nowadays, we live in the era of sustainability. It requires businesses to help address the challenges and risks that our planet and humanity as a whole faces. Businesses want to consider the impact they have on society and the environment, and be accountable for the consequences of their actions. Indeed, addressing environmental and societal issues is increasingly part of the business agenda. Valérie points out:

Ultimately, their goal is […] to generate shared value that creates a secure future in a sustainable world. They owe it to society, to play an active role and produce for the common good.

Non-financial reporting: a milestone on the sustainability road

As we briefly mentioned in the introduction, and pointed out through the SDG Reporting Challenge, the non-financial reporting trend will continue to grow as stakeholders and investors increasingly demand more information on corporates’ social and environmental impacts.

To ensure information transparency, it’s essential for companies to provide reliable and detailed information. In the near future, having, or not having, non-financial reporting will no longer be the question; it will rather be how companies choose to meet the needs of their stakeholders and comply with the regulatory frameworks. And that’s when audit comes in.

To facilitate this task, the Global Reporting Initiative (GRI), the first global standard for sustainability reporting was launched in 1997. On this regard, Valérie elaborates:

It [the GRI] enables companies to assess the environmental impact of their activities, and those of their supply chains. Today, 92% of the world’s companies with the highest market capitalisation report on their non-financial performance; 74% of them do so according to the GRI.

Auditing the data

Investors see corporate governance practices, business’ societal goals and environmental targets as important. To them, these issues are more and more an integral part of the value of the companies in their portfolios. The financial performance-only mindset is indeed shifting to a new one whose drivers are long-term value creation, sustainable business models and non-financial KPIs.

On the other hand, the rise of artificial intelligence-based technology in various industries is already changing the way we work. The digital age is, let’s face it, overwhelming. It’s challenging our ability to keep up with the speed of technological changes, our capacity to consume content, and to understand the amount of data we’re bombarded with, every single day.  

Both business stakeholders and shareholders want timely and reliable information. Because the era of a tech-driven world has only started, the information flow we see passing by is meant to increase, as well as our dependence and attachment to technology. The audit function, also powered by big data, is meant to play a pivotal role in the analysis and understanding of this information.

Auditing both internal and client financial reports is still a manual process. Auditors review a large amount of unstructured data and code it into a system. Tedious and time consuming, this procedure has an expiration date, as automation and machine learning – an application of AI –  get more sophisticated. For instance, software powered by machine learning is already able to analyse large sets of data and detect patterns in real time. As audit is fundamentally a data-driven service, we can predict, although timidly, how the function will evolve, because the real power of artificial intelligence is yet to be seen.  

The role of the auditor, then, will evolve. AI will turn auditors into analysts, who will have to verify the final product.

Audit powered by machine learning still has a long way to go before tackling the challenges of non-financial reporting.

Is non-financial reporting the future of audit?

What exactly is non-financial reporting, after all? It’s the disclosure of a company’s environmental, social and human rights information, also known as Environmental, Social and Governance information (ESG). According to the European Commission, the existing EU rules on non-financial reporting only apply to large public-interest companies with more than 500 employees. Currently around 6,000 businesses including banks and insurance companies are subject to non-financial reporting. They have a major impact on the economy, society, the environment and the different local communities across the EU.

But while non-financial reporting isn’t generalised yet, we believe that, with certain nuances, reporting will be extended to companies of all sizes.

Non-financial reporting is evolving and the information is gathers nowadays won’t be the same as AI, blockchain-based technology, data privacy regulation, etc. change over time. Because it tackles human and business behaviours and activities that are still the subject of warm discussions among societal actors, audit is still catching up with them. The same applies to any AI-powered software or technology that will support the audit practice.

Non-financial reporting can improve risk management, social, environmental and financial performance and competitiveness. It brings the transparency that investors, stakeholders and shareholders are increasingly demanding, and reinforces the’ responsible behaviour of business.

What we think
Valérie Arnold, Corporate Responsibility and Sustainability Leader at PwC Luxembourg and Krisztina Szenci, Corporate Responsibility and Sustainability Manager

A sustainable global economy is not a luxury, it’s an Earth imperative. Businesses need to understand their impact on the environment, on people and on society. Non-financial reporting is crucial to keeping track of those impacts and how they link to any organisation’s activities. We live in a fractured world. It’s time to start bringing the pieces together by being transparent, increasing the confidence of current and future stakeholders. Earth is a gem, a shining dot in a vast, deep blackness. It’s time we stop taking it for granted, consider its fragility and our dependence on it.

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