Saving the SEC’s XBRL Program

Some years ago I promised myself that I would not write about XBRL again. I’m breaking that promise. eXtensible Business Reporting Language was a major conceptual breakthrough when it was first developed in 1998. But that was over 20 years ago, and XBRL has progressed little beyond a regulator-demanded user-unfriendly standard with little (voluntary) uptake by report producers, and less evidence that anyone actually consumer and uses native XBRL. There are financial analysts in university (and possibly beyond) who were not born when XBRL was developed. 

At the heart of displeasure with the SEC’s XBRL program at the core of XBRL, the “eXtensible” concept, or as the XBRL community liked to sell the concept, “tell your story, your way”. Thankfully there is a “simple” fix that will save the SEC’s XBRL program, save filers time and money, enable to (almost) pain-free expansion of the program, and increase the likelihood of uptake by consumers of financial information.

Unfortunately, the complexity of XBRL has been a problem from day one. My all-time favourite condemnation of XBRL goes all the way back to 2008 when someone said that XBRL was “using a dinosaur to crack a walnut”.

But first some background:

There are uses for XBRL and XBRL-type reporting technology, but if you are considering going down that route, beware.

The idea was simple; each piece of information in a financial statement/report could be tagged in such a way as to enable the machine to machine communication of financial and business information. The use of a common taxonomy of elements ensured that a piece of data (a “fact”) tagged would mean the same thing to any consumer of that piece of data. Anyone producing financial or business data that was to be shared would be able to ensure that the consumers of that data would know exactly what they were consuming.

Soon, the FDIC (Federal Deposit Insurance Corporation), the US banking regulator, had incorporated XBRL into the Call Report process, ensuring as early as 2004 that all reporting banks in the United States were reporting using a common taxonomy.

All “successful” XBRL implementations share one key factor; they use “closed” taxonomies and do not allow filers or providers to add extension elements.

Today, around the world, XBRL is required by various regulators are the standard for data tagging of financial statements. And in virtually all of those implementations, from the UK to Singapore to Japan and the Netherlands (to name a few), financial statements are provided to the accountant or service provider who then converts Excel into XBRL and then submits that file to the regulator. The regulator then gets to convert the XBRL back into Excel for analysis. Why? Because XBRL is complex and resource-hungry, where the equivalent benefit can be achieved from a spreadsheet.

In the US, the SEC (Securities and Exchange Commission) requires that financial statements in the 10Q, 10K and a range of other filings, be filed in HTML and in an XBRL version. The SEC is also moving to require “Inline-XBRL” filings. Unfortunately, the SEC’s XBRL program remains a burden for which there has simply not been adequate, or even partial, buy-in from the producers or the consumers of companies SEC filings.

Fundamentally the SEC’s XBRL program has been a failure.

Producers of filings to not like it, and consider the production of XBRL to be costly and time-consuming. Don’t take my word for it, read the recent article following the SEC’s roundtable on short-termism from July 2019.

In listing the bullet points from the discussion of how to improve the 10Q process, the final bullet point stated: “And then, what about XBRL? (It was noted here that many issuers find XBRL expensive and very time-consuming and highly doubt its usefulness, not to mention that the SEC has just increased the XBRL burden for companies. Another panellist quoted an issuer as describing it as the “worst part” of the process.)” (emphasis mine).

The SEC itself is a lukewarm user, and if they have ever announced that it was the XBRL that allowed them to spot a case of fraud or financial misstatement then I missed that announcement. 

Data providers such as Yahoo Finance do not bother to provide a “download XBRL” button, and if you want the data, download it in Excel. If you want to XBRL, you’ll need to go to individual filing companies’ websites and download the files from their Invest Relations page, or you will need to go into the SEC’s EDGAR system and search on the company and download the XBRL from the SEC’s site.

While iXBRL (inline-XBRL) will be a boon to consumers of XBRL, at least those reading documents through their eyes, and wondering if the XBRL-tagged facts actually match the information on the printed form, this does little or nothing to solve the main problem; the difficulty of producing the XBRL in the first place.

The “FIX”

The US GAAP Taxonomy, the “dictionary” of allowable tags for financial statements contains over 18,000 elements. Or, as the AICPA said, “The US GAAP Taxonomies contain over 15,000 elements representing commonly reported financial concepts for US GAAP financial statements”. That was a number of years ago. But really? 15,000 “commonly reported”. And this number does not include the plethora of company-specific extension elements that are created every year. 

Fundamentally, every significant implementation of XBRL for the past 15 years (as long as there really have been any implementations of XBRL) has been based on a “closed” taxonomy in which filers are not able to create company-specific extensions.

To fix the SEC’s XBRL program, they should consider the following:

1. Create a limited-set US GAAP Taxonomy. The original estimate was that at fully functioning IS GAAP taxonomy could be created with 4500 elements. While that number clearly is low, it should be possible to create a taxonomy that allows companies to report all “common” concepts in under 10,000 elements.
2. Where companies cannot find the “perfect” fit element, they should use the closest element, and/or revise their reporting to ensure that they are reporting information that is common to their industry of to US GAAP principles.
3. Encourage the development of “templates” for reporting. This will enable companies and service providers to produce XBRL as standard output, saving time and cost, especially for smaller filing companies.

Yes, this sounds simplistic, and it probably will not happen. 

Why not? Unfortunately, there are drivers for the retention of the complex system of company-specific extensions. Simply put, too many jobs are on the line. 

The FASB maintains a team whose job is the “maintain” the US GAAP taxonomy. This includes the annual release of an updated taxonomy in which new elements are added to cater for “common” company-specific extensions. Companies providing software will see their market disappear if the reporting process can be simplified. And of course, if XBRL is actually simplified, then it will become clear that almost anything that can be done with XBRL should be possible with learning engines and (gasp) Excel.  

After all, XBRL has been around for 20 years. That is 20 years of Moore’s Law improving the speed of processes, 20 years of improvements in systems and analytic capabilities, and 20 years in which IA and learning engines have, if not matured, then at least become mainstream.

It is time to fix the SEC's filing program. Fix it, or abandon XBRL.

Will Interest Rates kill the recovery?

In my "103 Months" post last week, I specifically mention seven areas that could bring about the end of the Bear market, and result in the end of this business cycle. First on the list was Interest Rates. I also specifically stated that none of the seven areas could take sole credit for a fall in the markets (and flow on negativity and economic contraction), and that each may be impacted by others, and impact others. Which will come first, an Interest Rate hike generated collapse in house sales, or a collapse in house sales spreading uncertainty resulting in an interest rate spike?

Markets exist to facilitate the effective application of capital. As such, capital will flow to the markets in which capital can be expected to deliver the greatest return to the owners of the capital. Capital will flow to assets with the greatest probability or generating the highest risk-weighted return. And while markets do not get this right all the time, generally markets sense where returns will be achieved, high or low, and move capital to those asset classes. The result has been capital allocation distortions. (It was interesting to write that first sentence, then to google the exact words - first place returned was the SEC) 

The mythical Rational Market Hypothesis tells us that open access to information ensures that capital will flow efficiently. This or course does not and cannot happen, as there is not free and open access to all information relevant to investment decision making. Different players have and always will have access to market moving information that is not available to all investors. In addition, a range of human and even algorithmic factors will ensure a different weighting of information by different market participants, ensuring a less than efficient market.

What does this have to do with interest rates?

Each time the Fed or the BoE talks rate hikes, the markets pause (for milliseconds sometimes) and asks if the higher rate will have a negative impact of economic activity, and thus on market value, or if Treasury Bills will deliver a higher capital growth, and therefore, is it time to leave one market and enter another (leave stocks, enter treasuries or other bonds). Business and investors have become so numbed to ZIRP (Zero Interest Rate Policy) that they have come to see any hikes as potential speed bumps on the economic highway.

Continued ZIRP has resulted in behavioural distortions, with a new set of assumptions, including current market reactions reinforcing self-delusional assumptions of market rationality. In the middle 2000s we were convinced that we had become expert at managing risk, now we believe in the power of monetary policy to ensure ever-expanding market value. This cannot end well.

In the UK, the change in the "Ogden rate" (the discount rate applied to large insurance claims, predicated on the assumption that large claims will be invested in the most conservative manner) in early 2017 provides a wonderful example of a political decision designed to reinforce the "end of boom and bust" narrative. A change in a long term discount rate from 2.5% to -.75% both boosted insurance pay-outs and imposed massive loses on the insurance industry (The rate is now under review). The political nature of the decision was in effect a reiteration of the UK government’s assumption or expectation that interest rates would remain in the ZIRP range for the foreseeable future.

ZIRP ensured a limiting of the range of options for capital, be effectively removing treasuries, US, British Gilts, Japanese, from the portfolios of available return generating assets.

The end of ZIRP has seen a steady increase in the retail cost of money. At some stage, that increase will be perceived as reaching a point at which users of credit will begin to make decisions to not invest, or not spend. Owners of capital will begin to ask if the markets will therefore continue to increase at a rate significantly higher than "safe haven" investments.

So what is that interest rate number that will move the markets?

Only this past week the Chairman of the Federal Reserve presented to Congress for the first time, with his upbeat assessment of the US economy having quite a strange impact. The Wall Street Journal reported: "On Tuesday, Mr. Powell made his first Capitol Hill appearance since taking over as Fed chief this month, where he underscored the improvement in economic prospects, which many investors took as a suggestion that the central bank will lift borrowing costs four times this year. “It now looks more likely that the Fed is going to tighten more quickly,” said Peter Elston, chief investment officer at Seneca Investment Managers."

The markets seem to be at a point where positive economic news itself causes concerns about interest rates, upsetting the fragile balance between shares as the probably area of best return on capital, and fear that shares will fall resulting in negative returns.

That fragility could tip either way, although the messaging would suggest a greater probability of a negative shock. Bad economic news (such as the reported fall in new housing starts) could hint at a slower pace of rate hikes while at the same time undermining confidence. Alternatively, stronger economic news could cement more rate hikes sooner, again undermining confidence in the markets as the source of future capital appreciation.

Further, that fragility is all about perceptions and perceptions of perceptions. Will rates increase? If rates increase, will shares fall? If shares fall, will that force rates higher, or will a continued fall in shares erase gains. Should gains be "locked in" by selling now and putting the capital into "safe" options, and ride out a fall in share values, while earning more interest on the bonds / treasuries?

The Fed rate after all flows through into mortgage rates, auto loan rates, student loans, and credit card interest rates. All of these have a direct impact on individuals' economic behaviours and choices.

So if we game this situation, it looks something like:

1. Fed increases interest rates, reaching an eye-watering 2.5% by mid-2018.
2. Following a Fed rate rise event, markets expect reduction in mortgage lending, increase in credit card interest, reduction in auto loans.
3. Market data is released showing a drop in new mortgage applications.
4. Home builder and real estate stocks hit.
5. REITs drop on expectation that housing prices will stabilize or fall.
6. Contagion across industries creates further falls in equities.
7. Holders of capital determine that treasuries will provide a "no loss of capital" position and that shares have created a "capital at risk" situation.

As the "rational" market distributes and creates information with an inequitable and non-transparent distribution, individual market participants reach widely different conclusions, ultimately coalescing into a consensus that the stock markets are no longer the best place to hold or invest capital for a time long enough for stable bottom to be found.

In this way Interest Rates may provide one of the catalysts for a substantial and sustained drop in market values. This is only one of the seven situations that I discussed last week. Next week we'll look at another of the seven.

What remains clear is that in a world with so many potential contributors or drivers of a change from Bull to Bear, there is no single non-interconnected economic or political situation that will be "the cause" of the coming end of this expansion. The big question will be which, through the lens of history, will carry the "blame".

Telling your story, your way - Or why extensions are here to stay

There has been quite a bit of discussion about the idea that XBRL filings should be comparable, and if they are not, that somehow is a surrogate indicator of lower quality XBRL. Yet this flies in the face of one of the key promises of XBRL - "Tell your story, your way".

Companies are different, and after years of attempting to create one-size fits all reporting. The SEC tried, and IFRS continues to think they have a one-size fits most (except SMEs). It remains clear that it is what is different about companies that enables them to be successful.

Three Motivations to Create Extensions

For years the example used was that of a major computer manufacturer and service provider, which included a negative expense line for 'IP expense'. The expense was negative because the company was bringing in over a $1 billion in revenue from patent licenses. The problem was that the data aggregators consistently aggregated (well, it is in the name) would combine all of their expenses into one 'other expenses' line, thus distorting the company's position, and message. They were (are) proud of their portfolio of patents, and reflect that in their business reporting.

We also see the example of the giant Zombie banks. Looking at their XBRL we see extension rates well above 50%. They are telling their story, their way - by intentionally making it difficult for simple Zombie to Zombie comparisons to be run. Difficult in fact, for anyone to perform automated analysis, including regulators.

There are also companies that have limited resources to spend on their external reporting, and XBRL has added to their burden. Sometimes creating a new extension is simply faster and easier than digging through 16,000+ elements, reading detailed definitions, and wondering why their exact concept is missing. Equally, as the US GAAP taxonomy evolves year on year, how many companies are reviewing their extensions, confirming that an extension created in a prior year is still required.

Three examples, three motivations, one outcome: more extensions.

1. Transparency if wonderful. We are different, and we want the investing community to know that we are different. We have unique line items and footnoted facts because we want to demonstrate why we are the better investment.

2. We'll happily pay for opacity. We are different, and exploitation of our differences enables us to be successful. Enabling easy comparisons between us and our 'peers' actually will reduce our ability to exploit our unique advantages - whatever they are. Transparency helps regulators and competitors, not us.

3. We are too busy and with no benefit from investing limited resources in XBRL, we'll get this done a quickly and cheaply as possible. If we can produce XBRL that passes the SEC's validation checks, then that is good enough for us.

One example uses XBRL to improve the quality of available information and increase transparency. The other harnesses the power of XBRL to protect their opacity. "Our 'black box' is what keeps us profitable, reduces competitors ability to match us, and keeps the regulators in the dark (without appearing to want to keep regulators in the dark)". The third simply does not have the resources to waste on XBRL, there's real work that needs doing.

They are not going away

There is simply too large a need for extensions, and too many different motivations. There are also over a million extensions already created. These are not going away. Some, possibly most, are either duplicates or are so similar as the make if difficult to differentiate. Yet these are not going away. If anything, expect the total number of extensions to continue to rise.

After all, even if the SEC, the FASB, the IASB, or any group, attempts to analyse extensions to identify a reduced set of new taxonomy elements, the three motivations outlined above will act as a 'headwind' to companies migrating off their extensions. 

So while we should see fewer 'errors', we will not see significant drops in extensions that are there specifically to influence comparability or reduce the 'auto consumption' of financial and business information. Controlling the message is what business reporting is all about, not providing transparent reporting. 

Only once they have driven down the number of errors will the SEC have the energy or resources to drive down the number of extensions - and for each one, the SEC will need to demonstrate that the filer did not, in the filers' view, have an adequate justification for the extensions created and used. 

Implications of XBRL on Audit firms

The growing requirement for companies to produce financial statements in the XBRL format is now beginning to impact auditing firms. Audit firms need to plan for the coming wave of additional effort required to provide assurance over XBRL documents, and need to be building the cadres of skilled individuals who will provide such support to audit teams. The phase-in periods are quite different by jurisdiction, as is the expected total additional effort.

Audit and assurance firms should be exploring the potential impact and planning exactly when and how they will build the skills and acquire the tools that they will need to provide assurance over XBRL documents produced by clients.

The potential cost of audit could have a negative impact on market acceptance of XBRL. We must be looking beyond the depth of the pockets of Megaconglomacorp, and understand the impact of XBRL audit on smaller filers and smaller (non Big-4) audit firms.

Go to Non-Sequitur to learn more about Megaconglomacorp: http://www.gocomics.com/nonsequitur/2010/07/21

XBRL is not a "new" standard and is being used around the world, primarily by regulators, to improve the quality of data collected, and to improve the quality and efficiency of analysis of that data. In some cases the information is converted to XBRL by the regulator, and in other cases the reporting companies produce the XBRL. It is company produced XBRL that will be audited.

Challenges

As with any "new" technology or process, audit firms will face challenges as they come to terms with new audit requirements. Certainly an initial challenge will be deciding if and when to develop a cadre of skilled individuals with the knowledge to be able to audit XBRL. Too early and these skills will not be required, too late and the rush will impact operational efficiency. Yet moving beyond the simple “do we / don’t we” question into a time when audit of XBRL is performed, there are three challenges that audit firms and the audit profession needs to consider.

Resources

As we know, the resource requirements of the audit process are not "smooth" through the year - there are clearly definable peaks of resource requirements, falling at quarter-ends and annual reporting events. These peaks vary from country to country depending on the distribution of financial year-ends and the amount of audit activity that gets squeezed into short periods of time.

I use the image of a wave moving toward the beach - the total resource required at any time represents the sea, and the increased time sensitive resource represent the wave. Consider how that wave approaches the shore (the mandatory reporting event) and the way the resource wave grows as it approaches the shore. At that last moment before breaking on the shore, the wave reaches its highest point - the most resources are being applied in that final short moment to ensure a final report.

XBRL reports are, in most cases today and for the coming three to six years, produced "after" the primary report is finalized, as an additional output format. This means that the audit of the XBRL (at least the "final" XBRL) report represents an additional set of highly specialized skill sets added to the top of that resource wave.

Software

Of course auditors mitigate the total resource required through the use of sophisticated software tools. Certainly in the XBRL space, tools are now available that help reduce the total incremental effort, and these tools are evolving quickly. Today however, most software is an extension to validation software and requires the user of the software to be an XBRL "expert".

Standards

Finally there is the problem of auditing standards. As yet there are no standards for the auditing of XBRL. There is guidance (from the American Institute of CPAs - AICPA) for the performance of "Agreed Upon Procedures" (AUP) examinations and reviews of XBRL documents. This assurance however remains "negative" assurance and for internal use only. The XBRL International Assurance Working Group continues to discuss issues around provision of assurance, but does not have the remit to produce an auditing standard.  It is probable that the AICPA's AUP guidance will form the base of any future standard for providing assurance over XBRL.

The lack of an international auditing standard for XBRL will not remove the need for auditors to provide some level of assurance over the XBRL being produced. Audit firms will need to consider their own thresholds of tolerance when providing assurance, and should be lobbying the IAASB and IFAC to fast-track the development of an auditing standard for XBRL documents.

Costs

While my purpose is not to suggest how Audit firms perform assurance, or to indicate the effort involved, it is worth noting that in the United States, AUP engagements for provision of assurance over XBRL documents have resulted in total auditor time of between 50 and 100 hours for the first basic "block tagged" XBRL (tagging of financial statements), and significantly higher for "detail tagged" XBRL (tagging of all financial information throughout the financial statements and notes to the financial statements). Subsequent quarterly "reviews" will take take, but should not require the full 50+ hours. Expect the total hours to quadruple for "detail tagged" XBRL.

The primary cost drivers are the time required to perform the engagements, and the software used in the engagement.  Subsequent engagements should see the total time commitment reduce, and enhancements in XBRL audit software over the coming few years should also reduce the total time required.

The Market and tolerances

This may seem simplistic, but I think it is fair to say that the average auditee will not lightly accept an additional 50 - 100 hours of audit time added simply to audit the XBRL. Those in the XBRL space that are focused only on the Fortune 1000 or FTSE 100/250 do not see this as an issue - these hours will simply be folded into the already thousands of hours and many millions of Dollars or GPB that makes up the total audit cost.

But we must look beyond the depth of the pockets of Megaconglomacorp, and try to understand the cost to the vast majority of other businesses. These are the companies, public and private, that will be paying first to create XBRL and then paying to have the XBRL audited. Therefore we must be looking for ways to reduce the incremental cost the cost of production and audit of XBRL. While process improvements and reductions in reporting time will reduce the cost of producing XBRL, the additional cost of auditing XBRL must also be reduced.

I fully expect software to audit XBRL to improve significantly over the coming couple of years, to the point where the total complexity and cost can be brought down to 'reasonable' levels. Of course, "my" reasonable and an auditee's reasonable may or may not be the same thing.

What will not change will be the need for auditors to gain a working understanding of XBRL, and the need for audit firms to have this additional expertise available.

What to audit in XBRL

Some (but only some) of the XBRL audit issues include:

• Use of extensions – if allowed, why were they created, and is there already an existing element?
• Confirmation that the information is the "same" – This covers more than simply “are the numbers the same”.
• Parentheticals – is all the information appropriately tagged, including information include within labels.
• Calculations – are all calculations appropriately constructed
• Dimensions/Tuples applied
• Label over-rides – have the taxonomy standard labels been used, or company specific labels, and do all labels match the non-XBRL documents
• Taxonomy selection – obviously the correct taxonomy must be used

The list goes on...

What is XBRL

XBRL (eXtensible Business Reporting Language) is an open standard for the interchange of business information between computer systems, by mapping information to entries in logical dictionaries (taxonomies) of business terms, thereby ensuring that the provider and recipient of the information share the commonly accepted meaning of each piece of information. XBRL also allows the creation of custom dictionary entries (extension elements and taxonomies) to allow the reporting or provision of company specific information.

In effect, XBRL allows a “wrapper” of information to be placed around any business "fact", be it a number, a date, or text. In XBRL terminology, this is called "Tagging", or to "Tag" a piece of information. That “wrapper” then ensures that the provider and recipient are referencing the same definition of the information, significantly improving the usability of information by reducing potential errors and confusion over the meaning of any individual piece of information.

Is CO2 material?

Let me set the context for this question - CO2 released into the atmosphere is the primary cause of global Climate Change, which is real, and is primarily being caused by human activity.  The question - "is CO2 material?" asks about the materiality of CO2, if priced, to the average corporation. Here of course I'm taking the view of "materiality" frequently used by the auditing community to mean of an amount or value that will materially impact the companies performance or reported results. Frequently this level is, somewhat arbitrarily, set at 5% of revenue.

So in this context, is CO2 "material" to the average business, and what are the implications of any answer? Very probably not. In fact, considering the range of inputs (and outputs) for virtually all services based companies, CO2 (as a product of energy use) will be negligible from a financial materiality perspective.

First, for something to be "material" it must have a price. So an associated question is, at what price per ton of CO2 does it become material to a business?

Clearly for some businesses, primarily energy companies, extractive industries, transportation industries, and primary producers such as steel factories, the raw energy inputs (and consequent CO2 content) increase the probability that CO2 is material to their business, if a price is placed on the CO2.

Also, any suggestion that CO2 is "not material" is not the same as saying that there does not, desperately, need to be limits (be they market driven or regulator imposed) on the production and dumping of CO2 into the atmosphere. After all, I cannot imaging cyanide ever being "material" to a person when measured by the 5% definition, when something very far less than 0.1% would kill that person.

The question becomes important when auditors look at a company's financial statements, and when the company (if publicly listed on a US exchange) has to produce their MD&A (Management Discussion and Analysis) as part of their filing with the SEC. In these cases, the "materiality" threshold becomes important, that where CO2 falls below that threshold, there is no reporting requirement.

So there are two key barriers today to mandated reporting of CO2 by companies.

1. There is no price for CO2. Until there is a price, it cannot be "material". So, CO2 must have a price, through a Carbon Tax or through a Cap & Trade. Of course, the benefit fo a Cap & Trade system would be to allow the markets to create a price. The alternative benefit of a Carbon Tax (a sort of Tobin Tax) would be to create a revenue stream for governments that could be used to support "green" technology and infrastructrue investment - but I dream.
2. The concept of "material" in relation to CO2 must be modified to be closer to what would be a "material" level of cyanide in a person, than the 5% level used to determine that something "material" financially.

Certainly the SEC released additional guidance earlier this year on reporting of CSR (Corporate Social Responsibility) and Climate Change related information. Unfortunately the nature of that guidance was simply a reminder filers that they must report "known trends" and "uncertainties". Sadly I expect that guidance will be inadequate.

SEC's Climate Change reporting guidance released

Last week the SEC commissioners voted to release an interpretive guidance on companies including Climate Change issues in their files (annual reports to the SEC and investors).  The release is entitled "Commission Guidance Regarding Disclosure Related to Climate Change".

The guidance includes discussion of reporting requirements for US listed companies and for Foreign companies that list in the US and report to the SEC. That includes thousands of companies around the world.

You can read the guidance here: http://sec.gov/rules/interp/2010/33-9106.pdf

Yes, Climate Change does matter, says the SEC

On January 27th, the SEC commissioners voted to approve an interpretive release requiring companies to discuss the potential impact of Climate Change related legislation on their business. This is a very important announcement by the SEC, but falls short of anything that should cause any concern to any reporting company. This release by itself certainly should not create or cause additional work. From the SEC's point of view (and I certainly agree) companies should already be providing this information.

In her opening remarks, Chairman Schapiro said:

...the Commission is not making any kind of statement regarding the facts as they relate to the topic of “climate change” or “global warming.” And, we are not opining on whether the world’s climate is changing; at what pace it might be changing; or due to what causes. Nothing that the Commission does today should be construed as weighing in on those topics.The Commission is also not considering amending well-defined rules concerning public company reporting obligations, nor redefining long-standing interpretations of materiality. These rules and interpretations have served investors well for decades, and provide both the framework and flexibility necessary to apply to changing facts and circumstances. If something has a material impact on a company then it is something that needs to be disclosed — that has always been the case.

What is most important here is that she has said that the SEC is not taking a position on climate change, that is for the scientists and politicians. The SEC is simply reminding companies of their responsibility to provide full disclosure of risks to investors. She went on to say:

It is neither surprising nor especially remarkable for us to conclude that of course a company must consider whether potential legislation — whether that legislation concerns climate change or new licensing requirements — is likely to occur. If so, then under our traditional framework the company must then evaluate the impact it would have on the company’s liquidity, capital resources, or results of operations, and disclose to shareholders when that potential impact will be material. Similarly, a company must disclose the significant risks that it faces, whether those risks are due to increased competition or severe weather. These principles of materiality form the bedrock of our disclosure framework.

Again, reinforcing that this is the type of reporting and disclosure that companies should already be making. While I would have liked to see something much stronger, such as mandating reporting along the lines of the CDP (Carbon Disclosure Project), or even a variation on the GRI (Global Reporting Initiative) G3 standard, this is a good first step to providing investors with information that is important and relevant, with a Climate Change perspective in mind.

It remains my view that Reg S-K already provides the basis for requiring significant additional reporting on Climate Change risk, and in fact on the range of Sustainability issues. The requirement already exists to discuss all "known trends" and "uncertainties" that could impact liquidity or operations. Climate Change and Sustainability issues, regardless of one politics or belief system, are accepted by enough scientists, politicians, governments, companies and individuals to rise to the level of being a "known trend". If however an individual simply says "No, I do not accept that...", then those issues rise, due to the otherwise wide acceptance, to the level of an "uncertainty" and therefore must be discussed.

In his statements, Commissioner Louis Aguilar said:

Over two years ago, the Intergovernmental Panel on Climate Change concluded that it is "unequivocal" that the Earth's climate is warming. In October of last year, 13 federal agencies and departments published a coordinated annual report to Congress that reached the same conclusion. It is expected that climate change, if unchecked, will result in severe harm to ecosystems and people around the world.

Finally, Commissioner Aguilar also said:

As the Supreme Court has explained, doubts about materiality will be "commonplace," but these doubts should be resolved in favor of investors. Similarly, previous Commission MD&A guidance clearly requires disclosure of known trends, events, or uncertainties where materiality is uncertain.

It is great to see the SEC take the first step, now hopefully this will allow and encourage them to take the next.

The SEC talks Climate Change: 27 January 2010

Yesterday in the notice of upcoming meetings, the SEC (Securities and Exchange Commission, the US regulator of listed companies) announced that they would be talking Climate Change. Well, actually they said they would be talking about two items, and Climate Change came in second.

The SEC says that:

Item 2: The Commission will consider a recommendation to publish an interpretive release to provide guidance to public companies regarding the Commission's current disclosure requirements concerning matters relating to climate change.

This could be very big news, or it could be very bad news. No question that the results of this meeting will be seen as good by some and very bad by others. The notice can be found here:

http://www.sec.gov/news/openmeetings/2010/ssamtg012710.htm

My hope is that they will determine that indeed Climate Change does rise to the standard of a "known trend" that will have a direct impact on businesses, and therefore companies will be required to specifically comment in their Management Discussion and Analysis (under Reg S-K).I believe that Reg S-K already provides adequate justification to require such reporting, and have written such before. A detailed discussion can be found here.

So, I'm looking forward to next week with anticipation.

Who is Your Audience (CSR/ESG reporting)?

This article is a response to an online e-mail discussion askingIs there any point putting together a CSR report?" The resounding answe ris "Yes, provided you communicate with your intended audience"

It is all a matter of defining your audience, and in particular, the audience for you CSR / sustainability / ESG report, which I'll collectively refer to as the CSR report.

Lets think about a few primary audiences, because each has different needs:

1. General public / retail customers
2. Supply chain partners
3. Investors
4. Employees
5. Regulators

1. General public / retail customers

There is a growing and general acceptance that retail customers will purchase based on the perceived social conscience / "green" credentials, as long as the produce is also competitively priced. That is especially true today. This means that it is important for a company to burnish its CSR credentials through any medium possible, and that include the CSR report.

There is also the need to be seen to be pro-active, just in case they are "caught out" by some bad PR. When (if) that happens, the company is then ready to pull out all its good works, and make the appropriate noises about how they are doing everything to make certain is does not happen again.

2. Supply chain partners

This includes both their customers and their suppliers. Customers want to know that the company is following sound business practices, acting in a sustainable manner, and fundamentally reducing risks that may travel upstream. After all, when the bad stuff hit the fan, it get spread far and wide. So CSR / Sustainability / ESG reporting that provides comfort to commercial customers focuses in demonstrating how the business is also protecting its customers from potential PR risk. It also demonstrates that sustainability practices are being applied to drive down costs, thus being able to deliver future cost advantages that competitors may not be able to deliver.

Equally, effective reporting sends messages to suppliers about expectations, and gives suppliers key messages about what might endanger the existing business relationship, especially any potential situations in which a suppliers PR problems might impact the company. Clearly stated supplier CSR policies put suppliers on notice that they will need to maintain the highest CSR standards themselves in order to retain their position as suppliers, or to gain an advantage by becoming preferred suppliers. WalMart's actions recently are a great example of establishing expectations in their supplier community.

3. Investors

Investors, including the actual shareholders (the owners) and the investor community (those that advise existing and potential owners) are a legitimate audience. They want metrics; detailed information that will support and enable investment decision making. They want comparative information that is multi-year, and that can provide insights into the company's performance against other key players in the same industry. Frequently reports that focus on the first two audience groups fail to provide adequate information for this audience, and are dismissed as "fluffy bunny bullshit" by the analysts. Analysts want tables of information that span multiple years, and that clearly show future objectives and how those objectives will be achieved.

Recently the DVFA (the German Institute of Investment Analysts) release a set of KPI (Key Performance Indicators) for ESG. This set of KPIs is broken out by major industry groups, but also contains a core set of KPIs that that they expect to see regardless of the industry.

4. Employees

Sometimes the primary audience is right there in front of you, the employees of the company. CSR / Sustainability / ESG reports for employees are and should be focused on what the company is doing, and the role of employees in individually making it happen. There reports are motivational, and should serve to bring employees together for the effort. They also provide an opportunity for communication of changes that might otherwise be buried in a staff bulletin, or not communicated at all. A classic example was came from the results of the "Talk Back" process at New Zealand Post some years ago. One mail centre specifically spoke about the quality of lighting. This lead to a review, and improvements in overall lighting, improving both performance, quality of work environment, and costs.

5. Regulators

Finally companies communicate with regulators, both directly and indirectly through public messaging. The use of the CSR / Sustainability / ESG report to communicate support for and compliance with various standards is one such way. Reading the CSR reports for the building industry tends be like reading a prose version of how the reporting company is ensuring compliance with various health and safety legislation, or preparing itself for compliance with incoming GHG emissions standards.

In in the United States, the ability to demonstrate a strong legislative compliance program, complete with effective risk management processes, can be used as mitigating factors in sentencing for any crimes that the organization might be accused of being involved in. Communication of these programs in CSR reports is one way that companies, in effect, are using CSR reporting to communicate indirectly with regulators.

Summary:

Before judging a company's CSR report, consider what primary audiences are being addressed. As a company, before creating a CSR report, carefully consider who you want to be speaking to, and what are the key messages that you want that audience to take away. Finally, companies might consider creating multiple CSR reports, targeting specific audiences.

I hope this is helpful in addressing the question in the subject line of this e-mail stream.