Bringing risks to account

As environmental issues rise up the regulatory and financial agenda, large companies are facing converging pressures to better manage non-financial information flows. Mark Nicholls reports on how they should respond

It’s an old adage of corporate environmentalism that what isn’t measured can’t be managed. But, increasingly, large companies are discovering that what isn’t measured could represent a significant opportunity cost, a major business risk or an environmental liability that might land the chief executive in jail.

The increasing financial materiality of so-called ‘non-financial issues’, such as environmental and social risks or poor governance, is beginning to drive a revolution in corporate information management, say consultants. Pressures from regulators, activists and shareholders are converging – driving an overhaul in how major companies manage their environmental information systems, with profound implications for how companies communicate with their stakeholders and even how they are run.

“Previously, strategically important issues from the point of view of the finance department may not have incuded environment, health and safety [EHS],” says Peter Walsh, the Paris-based client services director of consultancy ERM’s Information Solutions business. “Increasingly, the environment is becoming a significant issue.”

At the heart of the issue is increased, and more rigorous, regulation – whether new disclosure requirements, emissions trading schemes or more traditional ‘command-and-control’ measures. But companies are also upgrading environmental information management to meet demands from external stakeholders for more transparency – and to improve the efficiency of their own internal processes, say experts.

Perhaps the clearest nexus between the EHS department and the chief financial officer has been created by emissions trading schemes. Beginning in the US in the mid-1990s with acid rain-forming sulphur dioxide pollution, these schemes impose overall emissions targets on companies – requiring emissions to be monitored and measured – and create tradable allowances. Increasingly, the value of these allowances is being reporting on company balance sheets.

In some cases, these assets and liabilities can be worth tens of millions of dollars or euros. The recently launched EU Emissions Trading Scheme, for example, creates 6.6 billion allowances for the 2005–07 trading period, currently worth around €23 each (see Environmental Finance, October 2005, pages 18–19).

Aside from trading schemes, there is little let-up in the growth of conventional ‘command- and-control’ regulations, with similar requirements for data collection. Companies in the EU have long been subject to the Integrated Pollution Prevention and Control Directive, and forthcoming rules on the Registration, Evaluation and Authorisation of Chemicals (REACH) promise to affect a large number of firms. “These regulations require companies to answer questions about their operations in a verifiable and auditable way,” says Walsh.

But the most discussed new regulations are those that relate to corporate disclosure, following recent scandals such as Enron, Parmalat and WorldCom. The response in the US was the Sarbanes-Oxley Act of 2002. The same year saw France’s parliament introduce the Nouvelles Régulations Economiques, which require companies to report on social and environmental indicators, followed in the UK by the Operating Financial Review (OFR) this year.

Such regulations are not, primarily, concerned with environmental and social issues. But they do address business risks more broadly, which may well include material social and environmental issues. And, most importantly, they contain enforcement provisions that require senior executives to be extremely confident about the rigour of the data they are signing off. Indeed, Sarbanes–Oxley could see corporate executives going to jail if they fail to comply with its requirements.

“Sarbanes–Oxley and the OFR put a new perspective on reporting requirements,” says Dominique Gangneux, a London-based senior manager at professional services firm Deloitte. “Now, executives have to stand behind the information they put out to the external world.”

And the ratchet is tightening. US companies are now required not only to comply with Article 404 of Sarbanes-Oxley, which requires them to report on their internal control structure and procedures for financial reporting, but also to meet Article 409. This latter requires companies to report, in real time, information that has a material bearing on their operations or financial conditions. This will apply to non-US companies who are listed on US stock exchanges from next July.

Another driver, ERM’s Walsh says, is related to corporate disclosure regulations, but is more voluntary in nature. “There is a range of different stakeholders, whether investment analysts, rating agencies, NGOs or shareholders, who want to see evidence of good social and environmental performance.” The investment community is on the alert for environmental issues that may become financial problems, while NGOs want to be reassured that management is on the alert for environmental and social accidents. And for all constituencies, it is becoming ever more important that this information is credible, verifiable and accurate.

But Walsh adds that improved environmental and social information management can also meet internal demands for more efficient ways of working. “Good information management can be linked to performance management, efficiency and doing things more quickly.

“Companies are increasingly looking to differentiate themselves from their competitors – better EHS and sustainability management can become a competitive advantage in the marketplace.”

All of these pressures mean that companies are having to reassess what, in many cases, are a whole range of legacy systems, developed independently of one another, or that are hangovers from mergers and acquisitions. In some cases, these may be simple spreadsheets and e-mail systems, or even paper-based monitoring and reporting processes.

“A key barrier is the pressure of legacy point systems,” says Andrew Arends, of EHS software provider Camaxys. But, while replacing a plethora of existing systems may seem daunting – and resource intensive – maintaining the status quo can be more expensive, he says. “To monitor all of those systems, some of which may no longer be supported [by the manufacturer], can take a massive amount of resources.”

Furthermore, they may simply not be up to scratch with new compliance requirements, argues Walsh at ERM. “As well as being inefficient, they may have different collection and measurement methods, and often they provide very poor audit trails and accountability.”

The first challenge for a company is deciding what information should be collected, says George Molenkamp, a partner at KPMG in Amsterdam, and chairman of the consultancy’s global sustainability services network. “You shouldn’t turn to IT before you know what you really want to measure – many companies have really struggled to find the relevant [key performance indicators (KPIs)]. If it’s not tangible, it’s difficult to invest in the right systems.”

He also warns against developing dozens of KPIs. “Try to use risk management to focus on the issues that are really important, and focus on a few realistic KPIs. Risk management is also better understood – if you talk about sustainability, people can get a bit lost.”

“One of the big challenges is trying to address the difference between KPIs for management processes, and strategic level KPIs,” says Charles Gooderham, a senior manager at Deloitte in London. “‘Traditional’ environmental KPIs are moving towards ones that are more relevant to shareholders.”

“It’s important that companies identify what EHS and sustainability information adds value to the business,” agrees Walsh. “For some relatively sophisticated companies, it will be clear. Others will need to listen to their stakeholders.”

He notes that, for something clearly prescribed, such as an emissions trading scheme, the objectives are well defined. Managing a supply chain, however, is less straightforward. Equally, while a financial institution may have identified the metrics with which to measure its direct impacts – such as energy, water and paper use – measuring the impacts of its lending may be more complicated (see box 2).

And, while the concern from the compliance department may be that not enough information is collected, an opposite danger is that company managers become swamped with too much.

“You need software that can be configured – like your Amazon account,” says Arends at Camaxys. “The CEO, for example, doesn’t need to see all the compliance data – but if there’s an accident, he’ll get an e-mail to his desktop.”

Moreover, those responsible for collecting the information need to be factored in to the process, says Philippe Tesler, head of sustainable development at Enablon, a company which specialises in non-financial reporting and corporate social responsibility (CSR) software. “One of the key challenges is people – they can be bombarded with information requests. Questionnaire fatigue isn’t just a problem at the corporate level, but at the site level as well.”

As such, systems need to be designed with the business-level user in mind – and their benefits must be clearly communicated. “Systems should allow information to flow down and horizontally, as well as up,” he says.

For example, a system could allow the site manager to benchmark his site’s performance against similar parts of the business, or compare performance with corporate environmental objectives.

One of the buzz phrases in improving environmental information flows is enterprise- wide risk management. “Companies are trying to bring what has traditionally been a separate management system and process around the environment within a central business risk management process, which is reported up to the board” says Gooderham at Deloitte. “There may be 20 key risks to the business, one or two of which may be environmental.”

According to Hewitt Roberts, chief executive of software company Entropy International, an enterprise-wide approach to environmental and social issues provides an opportunity for companies, rather than a challenge. “Our advice to companies is, use the tools you have. Use existing risk management activities and investments you’ve made as a springboard to wider enterprise-wide risk management.”

He predicts that, over the next few years, the management of EHS, supply chain, and other material, non-financial issues will converge with that of corporate governance and traditional financial issues. “They will meet in the middle,” he says.

But most companies – and the consultants and software companies offering products and services in this area – are still at the start of the process. Many firms in the US are still scrambling to comply with Sarbanes–Oxley, and the first OFR reports in the UK have yet to be published.

“Over the next four or five years, these processes and systems will embed CSR further into business,” says Gangneux at Deloitte. “How stakeholders react over the next few years will set the pace,” he adds, predicting that environmental groups are likely to take a fine-tooth comb to corporate disclosures.

“This whole area is going to explode over the next few years,” says Arends at Camaxys. “There is such an intense focus on compliance; people will have to get systems in place to meet these new requirements, and the best ones won’t be band-aids, but wider systems that are flexible, and can grow and adapt.”

BOX 1 - Counting on the numbers

“Everything begins with measurement,” says Karl Buttiens, senior vice president for environment at Arcelor, the world’s leading steel manufacturer. “If you don’t measure you are not aware of your problems so you don’t have a chance of solving them.”

The challenge for a company like Arcelor, which came into being in 2002 following the merger of three national steel companies, Usinor of France, Arbed of Luxembourg and Aceralia of Spain, has been to develop a system whereby data can be efficiently collected, collated and distributed around the group.

Everything begins with measurement at Arcelor

Equally important for a company with 140 production sites around the world has been the need to ensure it can collect enough data, often enough, to ensure it amounts to a true reflection of the company’s environmental performance in key areas, says Buttiens.

At the end of 2002, the company took the decision to develop an environmental data management system. The system needed to be able to provide information at site and corporate level and to incorporate new requirements as they emerged. Above all, says group environmental data manager Yann de Lassat, “we needed a system that is flexible enough to accommodate change. We were previously getting inconsistent data from different parts of the group and the existing system simply wasn’t flexible enough.”

The company opted for a solution put forward by consultancy ERM Information Solutions. The chosen option – based around a specialist software product from ESP – offered easier recording and retrieval of data, more consistency, better overall results and the all important flexibility.

“We also wanted a system that could work on the web, that could be developed within the timeframes we have and that could evolve to meet new requirements as they emerged,” says de Lassat.

Particularly important is the system’s capacity to benchmark facilities against each other. “We have plenty of installations that are doing the same thing, so we have a chance to look at who’s performing better,” Buttiens says. This benchmarking will become particularly important for the small number of fully integrated steel production sites, which account for more than 80% of the company’s emissions.

In a company that employs 95,000 people in over 60 countries, its information requirements go way beyond traditional ad hoc systems, using individual spreadsheets. It is about combining automation with flexibility but also getting relevant employees comfortable with the new way of working, says Buttiens. Ultimately, “the challenge is to make the system as user-friendly as possible so people want to use it for their own reporting. Once we start to get data in a consistent format, we start to be in good shape.”

Nick Cottam

BOX 2 - Local data, from the world’s local bank

HSBC faces three particular challenges as it overhauls its environmental information management system, says its environmental advisor Francis Sullivan. First, the global banking giant has no fewer than 9,800 sites around the world – which makes tracking its direct impacts, such as energy use, water consumption and waste, a complicated task.

HSBC – collecting data from 9,800 offices

“In terms of systems, it’s very different to a big oil company – we’ve got lots of point sources. We need to find efficient ways of collecting the data,” he says. The company is in the final stages of negotiating with a software supplier that will provide a web-based system allowing HSBC to consolidate the numerous spreadsheets that it previously used to track its impacts.

“The software can be filled in, and checked online, from the different offices worldwide,” he adds. And, because the information is consolidated, it’s much easier to conduct trend analysis. “It’s useful to go back and ask,‘why are we doing this?’ It’s to manage down our environmental impacts, and having good data, with trend analysis, is absolutely critical.”

But, increasingly, stakeholders are putting pressure on financial institutions to look beyond their direct environmental footprint – and address the indirect environmental impacts caused by the companies in which the bank invests, or to whom it lends money.

“It’s very hard to know what the metrics should be,” says Sullivan. “It’s one thing here the use of the proceeds is known, such as in project finance, but when it comes to metrics for general corporate lending, or asset management, it’s very hard.”

He says that HSBC is one of the first banks to report on its application of the Equator Principles – voluntary environmental and social guidelines for project finance. It breaks down the number of project finance deals it underwrites, how many it rejects, and the Equator Principles category into which they fall. He adds that the bank is working with other financial institutions to attempt to agree common key performance indicators on other aspects of their business.

The final challenge lies in tying together the bank’s direct and indirect impacts with its philanthropic activities. “We spent $69 million in philanthropy last year. What difference did that make? We’re wondering if we can use common metrics for measuring all three,” he says.

“The danger is that we end up setting up three databases,” he concludes. “The goal is to break down the barriers between the bank’s direct impacts, indirect impacts, and our philanthropic activities.”