WE have reduced carbon emissions by 30% in our operations; the materials that we use are 100% recycled; our ingredients are sustainably sourced.
These may look like simple statements in an annual report, but once communicated publicly, they become claims that someone may eventually ask the business to substantiate.
This isn’t actually new.
The Malaysian Advertising Code of Practice, under Part 11 on environmental claims states that “claims such as ‘environmentally friendly’ or ‘wholly biodegradable’ should not be used without qualification unless advertisers can provide convincing evidence that their product will cause no environmental damage.”
But what happens when the evidence falls short? Volkswagen’s “Dieselgate” emissions scandal a little over a decade ago is a stark reminder of what can happen when corporate claims fail to stand up to scrutiny.
The German carmaker had promoted its diesel vehicles in the United States (US) as low-emission and environmentally friendly. But questions emerged after researchers from West Virginia University, in a study commissioned by the International Council on Clean Transportation, tested diesel vehicles under real-world driving conditions and found significantly higher nitrogen oxide (NOx) emissions than expected.
Further investigations by US regulators eventually uncovered software in certain diesel vehicles that could detect when they were undergoing emissions tests and activate full emissions controls. During normal driving, however, some vehicles emitted NOx at levels up to 40 times the US emissions standard.
The US Environmental Protection Agency issued Volkswagen a notice of violation in September 2015. Volkswagen subsequently acknowledged discrepancies affecting around 11 million vehicles worldwide.
Then chief executive officer Martin Winterkorn apologised for breaking the trust of customers and the public and resigned days later. Authorities ordered millions of affected vehicles to be recalled, while Volkswagen launched an external investigation into the scandal.
The financial consequences were substantial. Volkswagen recorded €16.2bil in charges related to the diesel issue in 2015 alone, including provisions for technical measures and recalls, vehicle repurchases, customer-related measures and legal risks.
So when does an inaccuracy stop being an honest mistake?
According to Cypark Resources Bhd operational sustainability head Nor Azah Masrom, a discrepancy alone does not establish wrongdoing, as figures can change when more information becomes available and the data is progressively verified.
“What matters is whether the assessment was made in good faith, based on the information reasonably available at the time, and supported by proper governance, verification and escalation processes,” she says.
“Where such processes were genuinely in place and followed, a later revision to the data should not retroactively be treated as negligence. The concern arises only where clear warning signs existed and no reasonable inquiry was made, regardless of whether any deliberate wrongdoing occurred,” adds Nor Azah.
The red flags
From an investor’s perspective, advisor to the Institutional Investors Council Malaysia (IICM) Bhd, Rejina Rahim, says one of the biggest red flags in a company’s ESG or climate claims is when there is a large gap between ambition and evidence.
She cites the example of a company announcing a net-zero target without clearly setting out how it plans to achieve it, the capital required, interim milestones or whether management remuneration is linked to the target.
Other red flags include changing ESG metrics, reporting only favourable indicators, altering baselines without explanation, or making sustainability claims that are inconsistent with the company’s investment decisions or business model.
“Investors also become cautious when disclosures focus heavily on activities such as the number of programmes undertaken, rather than actual outcomes or impact.
“A useful question we usually pose in our engagements is, ‘show me how this sustainability commitment changes the way you allocate capital or manage risk’.
“If there is no clear answer, we would then naturally question the substance behind the claim,” says Rejina.
If a company’s claims are found to be inaccurate or misleading, it becomes a governance and trust issue, Rejina points out.
Institutional investors may then question the strength of internal controls, board oversight and management accountability. “If one set of disclosures is unreliable, investors may naturally ask whether there are weaknesses elsewhere in the reporting framework.”
Their first response would be to seek explanations from management and the board, including how the error occurred, whether controls are being strengthened and who is accountable.
If concerns remain unresolved, Rejina adds, investors could escalate their response by voting against directors, supporting shareholder resolutions or, in more serious cases, reconsidering the investment.
“The key issue is trust. Once trust in disclosure is damaged, rebuilding it can take significantly longer than correcting the data itself.”
Where do companies most often fall short? According to Nor Azah, it is usually the data collection stage that is most common, adding that it is an industry-wide challenge and not unique to any one company.
“Typical weaknesses include inconsistent coordination across group structures, absence of standardised data templates, unclear ownership of individual data points and gaps in understanding the applicable methodologies.”
The board, she points out, needs to understand the material risks and assess whether reporting processes, systems and competencies are adequate, with any limitations properly disclosed.
“Accountability should run across operations, finance, risk, legal and internal audit, not sit with one department. The board isn’t expected to verify every data point, but it is expected to ensure the process behind the numbers is sound.”
Data assurance
Recently, the Advisory Committee on Sustainability Reporting (ACSR), chaired by the Securities Commission, deferred the commencement of mandatory reasonable assurance requirements on Scope 1 and Scope 2 greenhouse gas emissions disclosures by a year.
The decision came after a review of the first 91 Group 1 listed issuers reporting under the IFRS Sustainability Disclosure Standards found that further improvements to disclosure quality were needed.
Mandatory assurance for these companies will now take effect from 2028 instead of 2027, allowing them more time to strengthen their reporting processes, controls and data quality.
For investors, independent assurance is becoming more important as sustainability information plays a greater role in investment analysis.
According to Rejina, investors rely on audited financial statements when making capital allocation decisions. “As climate and sustainability metrics become financially material, it is reasonable to expect similar discipline around those disclosures.
“Assurance does not automatically make a company sustainable, but it gives investors greater confidence that the underlying data, methodology and controls have been subject to independent scrutiny.
“However, the scope and quality of assurance matter. Limited assurance over a small number of indicators is different from comprehensive assurance over the most financially material sustainability metrics.
“Over time, investors will likely expect sustainability information to move closer to the reliability and governance standards applied to financial reporting,” notes Rejina.
As expectations around assurance increase, so too does the question of cost.
What if businesses can’t afford it?
Full assurance can be costly, thus making it a real constraint for smaller companies.
But the starting point isn’t assurance, Nor Azah says. It is internal discipline around data accuracy, a clear process for reviewing the information and proper documentation of who prepared and verified the numbers.
“Without that foundation, assurance simply confirms the same gaps. The practical sequence is to strengthen internal governance first, then scale assurance coverage as the company grows.”
Ultimately, it comes back to how the information is used.
For long-term institutional investors, sustainability disclosures help assess a company’s ability to manage future risks, remain resilient and create value over time.
“Good disclosure helps investors assess questions such as: Is the company prepared for climate transition risk? Are there significant regulatory or reputational exposures? Are supply chains resilient? Is the company investing sufficiently for the future? And does the board understand and oversee these risks?
“Importantly, investors are increasingly looking for the connection between sustainability and financial performance.
“The strongest companies will be able to explain how sustainability risks and opportunities influence strategy, capital expenditure, cost of capital, margins and ultimately long-term shareholder value.
“So, from IICM’s perspective, where our members collectively manage over RM2.7 trillion in assets under management, ESG disclosure should not simply be viewed as a reporting obligation.
“Good sustainability disclosure is ultimately good investment information, because it helps investors understand whether a company is capable of creating sustainable long-term value,” says Rejina.
