Basel Institute on Governance
The Basel Institute on Governance is an independent, international non-profit organisation dedicated to preventing and combating corruption and other financial crimes and to strengthening governance around the world.
The debate about whether companies have moral responsibilities as firms themselves, or whether this is only something individuals can exercise, continues to shift. Nowadays many believe that the so-called responsibility deficit means that a company’s obligations must go beyond its fiduciary duty to shareholders, and extend to a wider group of stakeholders. More broadly, sustainability has become a conventional governance topic. It is shorthand for a wide range of risks, standards, and interests with a scope that covers the economy and society. Companies failing to meet these standards have been at the centre of public scandals, with legal liability for individuals and companies.
Sustainable investment through impact investing or the more common approach based on environmental, social and governance (ESG) analysis, are becoming more widespread. ESG indicators allow investors to gain a better understanding of the companies in which they invest and their risk exposure beyond financial risk. In generic terms, this means investment portfolios combine traditional financial performance indicators with non-financial indicators.
In parallel, governments have been establishing new guidelines and legislations to incentivise companies to limit their potential negative impacts on people and the planet. The European Union Non-Financial Reporting Directive requires companies within scope to report non-financial indicators. It held a public consultation in early 2020 as a starting point for possible revisions to the Directive. A closer look at supply chains of corporations has also been at the forefront of the legislative agenda. This trend is on the rise, with Switzerland, Germany and the European Union among those looking to introduce new regulations on due diligence. France implemented a Corporate Duty of Vigilance law in 2017, and in 2019 the Netherlands passed its Child Labour Due Diligence law.
Regulatory bodies and standard setters have also started requiring companies to disclose non-financial indicators and be more transparent about their business operations and supply chains. The UN Guiding Principles on Business and Human Rights and its Working Group on Business and Human Rights are one example. Another is a new guide by Business at OECD (BIAC) and the International Organization of Employers (IOE): “Connecting the anti-corruption and human rights agendas: A guide for business and employers’ organizations.”
In summary: the evolving regulatory landscape and increasingly complex jigsaw of standards and guidelines is putting pressure on companies to rethink their compliance and sustainability functions.
There are several reasons behind the lack of consistency in non-financial reporting indicators. One is the challenge of defining materiality. In traditional financial reporting, the International Accounting Standards Board, the independent accounting standard-setting body of the International Financial Reporting Standards Foundation, defines the term “material” as follows:
“Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity.”*
When it comes to sustainability and non-financial indicators, the concept of double materiality predominates the discussion. In a recent consultation paper on the review of the European Union NonFinancial Reporting Directive, the European Commission defines double materiality as, “not only how sustainability issues may affect the company, but also how the company affects society and the environment”.** The Directive imposes disclosure “to the extent necessary for an understanding of the development, performance, position and impact of [the company’s] activities.”*** Double materiality arises when the company’s effect on society and the environment is included in the assessment.
Looking through the lens of double materiality, one challenge in risk assessment is the overlap of these risks. An example of this can be seen in corruption, which remains a serious corporate compliance risk for companies around the world and across all sectors and industries. Corruption exposes companies not only to reputational, legal and financial risks through penalties and blacklisting but its negative effects also extend to investors and business partners. It also undermines economic efficiency, disadvantages compliant companies and is detrimental to shareholder value. Corruption underpins other risks such as breaches of human rights and environmental risk. Corruption emanating from the private sector can lead to a public official facilitating illicit activities, resource exploitation or non-enforcement of laws and regulations, which in turn impact local communities.
The typical response for such a broad type of risk is often to address each aspect of the risk individually and not as a whole – potentially leading to a compliance programme that has overlaps and duplications since risk ownership is often siloed within a corporation. These potential overlaps and duplications are not limited to risk assessments but also extend to due diligence processes and grievance mechanisms. Breaking down silos and reducing these duplications requires a more cooperative approach between compliance, legal and sustainability functions.
Looking at due diligence with a corruption and human rights lens, for instance, requires a logical and coordinated approach, especially in industries with complex supply chains that include numerous third parties. For risk assessment specifically, the audit and compliance functions possess the knowledge and skills and can therefore support the team addressing broader sustainability issues. In the same way, matters related to sustainability, such as human rights and the environment require specific skills and knowledge that compliance experts do not necessarily possess. Internal grievance mechanisms and whistleblowing hotlines are often integrated for all issues relating to potential breaches of the corporate Code of Conduct. The investigation and remediation of issues connected to these topics could also benefit from greater cooperation between business functions.
These challenges are not limited to a single company, and the compliance concerns within an industry are usually common to all players. A collaborative approach to leverage synergies, such as collective action, is a potential response. Collective action involves multistakeholder collaboration as it can bring together different combinations of private and public sectors as well as civil society and international organisations. For the private sector, active participation in collective action offers the advantage of tackling challenges pragmatically, such as developing good compliance, sustainability and human rights practices through constructive exchanges with peers and other stakeholders. Additionally, the collaboration of peer companies within a collective action initiative mitigates the risk of an individual company being outperformed by a company with lesser ethical standards. Collaborative approaches to the joint agendas of sustainability and anti-corruption compliance could also lead to tailored guidance or self-regulatory standards within these dual agendas in certain industry sectors.
“For the private sector, active participation in collective action offers the advantage of tackling challenges pragmatically, such as developing good compliance, sustainability and human rights practices through constructive exchanges with peers and other stakeholders.”
If we take the voluntary involvement of a company in a relevant anti-corruption collective action initiative as an indicator of its commitment to addressing corruption and bribery risks, the same might be said for companies that engage in collective action to address human rights and corruption risks together. The GRI Standards, as a matter of fact, include a company’s involvement in collective action as a recommended disclosure in the field of anti-corruption, focusing on the strategy of the collective action activities as well as the main commitments of these initiatives. Disclosure of the commitments and activities under such initiatives in the public domain lead to a greater understanding from the investor community as well as to greater accountability. The same can apply to dual-purpose collective action initiatives that cover both anti-corruption compliance and sustainability.
This approach is not just about better understanding the data that arises from compliance and sustainability functions and collectively addressing challenges, valuable as those are. It’s about pushing the sustainability and compliance agendas forward in ways that work for companies and their stakeholders.
* IFRS. 2018. Disclosure Initiative - Definition of Material (Amendments to IAS 1 and IAS 8).
** European Commission. 2020. Consultation Document, Review of the Non-Financial Reporting Directive.
*** Directive 2014/95/ EU of the European Parliament and of the Council of 22 October 2014, Article 19a.
Private Sector Specialist, Basel Institute on Governance