(This transcript has been edited for clarity)
Total time: 19:15
Jessica McHugh: In today's podcast, we're going to talk about the technology sector and some of the financially material sustainability issues identified by the Sustainability Accounting Standards Board, otherwise known as SASB. I'm Jessica McHugh, Director of Marketing here at Sage. And today I'm talking with the lead analyst at SASB, Anton Gorodniuk. You know, within the technology sector, are there instances in which a disclosure topic might be included by SASB that would not necessarily be included by the Financial Accounting Standards Board? And could you provide an example of that?
0:37
Anton Gorodniuk: Yeah, this is actually a pretty interesting question. Well, in general, I think the FASB structures its topics around understanding of the elements of financial statements, while SASB’s topics in their scope are structured around environmental, social externalities. So, there are some fundamental differences there. And conceptually, some of the most interesting issues that SASB includes in the technology and communication sector are recording and managing a global and skilled workforce, material sourcing, which is related to sourcing and efficient use of critical materials, and environmental footprint of hardware infrastructure, which discusses balancing of energy and water resources. But the two frameworks can also interconnect. So, for example, if we look at the material sourcing topic, the way companies may be managing risks associated with critical materials, supply constraints, or environmental risks, such as water supply shortages for their data centers, is through investing in research and development. So, for example, the use of alternative materials, recycling and reusing initiatives, take back programs, improving efficiency of hardware, and so on. So, SASB’s metrics would be capturing performance on these initiatives through amount of resources used, recycled, reused, amount of energy and water consumed, and so on. But to financially account for these R&D initiatives, companies will have to follow the FASB guidance. And I think that guidance is covered by the topic 730, for example. So that's how I see the differences between FASB and SASB, and also how the two frameworks interconnect in a way.
2:18
Jessica McHugh: Okay, so, you know, it would be captured in their financial statement under R&D. But they wouldn't necessarily break it out for FASB.
Anton Gorodniuk: Correct, they would look at, you know, how the actual initiatives hit their financial statements. It's about journal entries and more like traditional accounting in that sense. And SASB is a little bit higher level. Okay, so that's how it hits financial statements, but in terms of externalities, and environmental or social issues, what are those actual initiatives? And what are the additional metrics that can connect you to the financial metrics? And that, I think, also is interesting, how SASB’s, you know, approach to the financial materiality plays out because when we do that analysis, we really want to make sure that the topics are financially material, and metrics are decision useful. So, you can always kind of think, through the lens of sustainability, but also thinking about this from the financial value drivers’ standpoint, where those impacts are.
3:20
Jessica McHugh: Okay. And you mentioned materiality. So, in terms of the materiality map, you know, when we look at environmental issues that are most important to the technology sector, energy management and waste management look to be the two most important from a financially material standpoint, in terms of how many industries it affects. A lot of these technology companies have factories outside of the U.S. in countries that might vary on what is required in terms of waste and energy management, but also in their reporting standards of those two things. So, did SASB find that those two issues were being widely reported by companies already, and what sort of standardization did SASB create for reporting on those two issues?
4:03
Anton Gorodniuk: Yeah, sure. So firstly, I would like to say that the materiality map does not actually suggest what topics are more important from a financially material standpoint. In other words, there is no like relative ranking of topics. It shows what topics are likely to be material just in general, but then it's up to investors to make their judgment about which topics are more material than others. And those opinions can actually vary, but SASB in that kind of situation stays as an independent standard setter. But in terms of the frequency of occurrence of the topics in the technology and communication sector, it's actually I think, energy and water rather than waste that are most commonly occurring environmental issues. And these issues are actually relevant to both manufacturing and non-manufacturing industries, which I think is interesting. And for non-manufacturing industries, the issues address environmental impacts of hardware infrastructure. So, for example, data centers, and those data centers usually consume a lot of water and energy to operate. And from the standpoint of reporting on these issues, we do actually systematically analyze disclosures from companies. For example, every year we screen through thousands of companies’ filings using artificial intelligence and machine learning, and include the findings in our disclosure intelligence app, which is available through the SASB navigator. And what the data shows is that more than half of companies in non-manufacturing industries do not discuss these issues in their SEC filings - that's for the technology and communication sector. And then in the manufacturing industries in the technology and communication sector., quality of disclosure is better, and has been improving over recent years, yet only a small share of those companies provides quantitative metrics, which really hinders comparability for investors.
5:58
Jessica McHugh: Okay, but does SASB, you know, recommend that these companies be reporting on energy and water.
Anton Gorodniuk: Yes, absolutely. So, the issues are included. As I said, it's the issue around environmental footprint of hardware infrastructure. So again, we identify the fact that there is lack of disclosure, especially from non-manufacturing industries in the technology and communication sector, but evidence research suggests that these topics are definitely financially material. And that is also indicated by feedback that we received from companies and investors. So SASB does suggest companies to disclose on these matters.
Jessica McHugh: Okay, and did you come up with a sort of a framework, or metrics by which they can start measuring and reporting?
6:54
Anton Gorodniuk: Yes, absolutely. So specifically, in this case, as I said, since the topic is around, kind of balancing water and energy consumption for data centers, because it's kind of a trade-off between, you know, for the cooling purposes it was really challenging to kind of separate the two, it's really about the balance. So, we look at both energy and water consumption related data for these companies. As well as some more discussion related metrics around, you know, planning for data center needs, and how companies more strategically approach this issue. Also, in terms of where they place their data centers, and kind of to help investors understand from the standpoint of geographic exposure to water shortages, potentially, why their companies exposed or not.
7:47
Jessica McHugh: So, there's a few issues in the technology sector that were designated on the materiality map as issues that would be material for more than 50% of the industries in technology. These issues include energy management, data security, customer privacy, employee engagement, diversity and inclusion, and competitive behavior. You know, what are the key characteristics of the technology sector that make the financially material attributes differ from maybe some other sectors.
8:18
Anton Gorodniuk: So, I think one of the interesting characteristics of the technology and communication sector is that it includes companies in almost every stage of value creation, so from semiconductor manufacturers, to electronic manufacturers, to hardware manufacturers, and then also it includes software and service providers. That makes material sourcing or supply chain management issues relevant for most of those industries. And also, the technology sector is the only sector where the customer privacy issue is financial material to half of the industries. And companies operating in these industries collect and use personally identifiable information from millions of consumers. And therefore, companies that fail to prudently manage the use of data for secondary purposes, may really expose themselves to financial risks. And I think it's also interesting to know that issues such as energy and water management, as we discussed, would traditionally be included in industries involved in manufacturing. So those industries where cost of these resources really represents a substantial share of a company's total costs, which means resource efficiency measures could result in meaningful impact on margins. But the technology sector is unique in that sense, where even in such non-manufacturing industries, as internet, media, and services and software and IT services, as well as telecommunication services, SASB found these issues to likely be financially material. And as I was saying, that's largely due to the fact that you know, there is a growing amount of content and services offered by these companies, and heavy reliance on cloud-based services, and companies in these industries own and operate or rent increasing more data centers, and other hardware. And these data centers, you know, they need to be powered continuously and disruptions to the energy supply can have a material impact on their operations. And therefore, companies fade, you know, this also trade off, as I said, between like energy and water consumptions due to data center cooling needs.
10:38
Jessica McHugh: So, would you say the majority of companies that you find in this sector, do have data centers, so that, you know, you mentioned customer privacy, and are you finding that a lot of them own, at least, one or two of their own data centers, if not all of them.
10:56
Anton Gorodniuk: I'm not sure. I’m not really familiar with that much data on ownership versus how much is rented. But just in discussions with companies, it's definitely the case that they are reliant on data centers. It's always even interesting for example, I had a conversation with one of the companies in the software and IT services industry and they were really trying to better understand our approach to this issue of energy and water. And in their case, I think especially for the data centers that they don't own, where there is maybe a lack of control in terms of where electricity is coming from, whether it's grid, how much is renewable, they really wanted to better understand. But it just also highlights the fact of how unique companies can be. And regardless of whether they own data centers, or rent data centers, or co-own data centers, these issues may still be material. But just the approach to managing the risk could be a little bit different.
12:08
Jessica McHugh: So, are you saying when you were having your discussion, they were maybe wondering where the responsibility lies, if they own versus rent?
Anton Gorodniuk: Yes, they wanted to better understand in terms of discussion, if the metric would apply, and what type of discussion they would need to provide to investors. So, it's not the differences in the quantitative information, but more, I would say, the strategic approach to managing the risk. And they were providing us some recommendation on how our standards from the technical standpoint, could reflect that in the future iterations. So that, again, kind of highlights how our standards and market informed and the feedback from companies is really valuable.
12:55
Jessica McHugh: So, going back to the materiality map, you know, the technology and communication sector is the only one among the 11 sectors for which competitive behavior is a financially material issue for more than 50% of the industries in technology. How did SASB determine was the best way to measure and report on how technology companies are kind of balancing this intellectual property protection while also respecting fair use?
13:24
Anton Gorodniuk: Yeah, this is a really good question. So, maybe I'll start a little bit higher level here. So, the way SASB determines how to measure performance on disclosure topics in general, is guided by criteria for metric selection discussed in our conceptual framework. So, these principles include fair representation, usefulness, applicability, comparability, verifiability, completeness, alignment, neutrality, and distributiveness. So, SASB’s end goal is to provide information helpful to investors to make informed investment decisions. So, all these principles together, ensure that accounting metrics fulfill this goal. And the approach to it identifying specific metrics includes two parts. So, the first part is research, which includes analysis of corporate disclosures to see what metrics companies already disclose that are relevant to the topic. Then analysis of sell side reports to understand what data points investors identify as relevant analysis of more technical documents, which includes regulatory documents that may address some topics or specific elements of the topics.
14:33
And then the second part of this is consultation with companies and investors. SASB really aims to balance views of investors and companies to identify the minimum set of decision-useful metrics. So, for this topic specifically, the intellectual property protection and competitive behavior, it was actually pretty challenging to identify metrics that would be forward-looking and useful to investors. And that actually tends to be the case for many of the topics that relate to such issues as management of business ethics and other regulatory environment issues, such as competitive behavior in this case. So, in general, such topics include metrics that measure amount of losses as a result of legal proceedings. So, if you look across multiple industries, in our standards. So, although this metric is actually backward-looking, it was still found to be a useful indicator by investors, as it could be used as a proxy to the future performance on this issue. And additionally, on top of this backward-looking indicator, the guidance to our standards suggest companies to provide discussion of their strategy to manage protection and fair use of their intellectual property. So, in the context of this discussion, a company’s year-to-year performance on the amount of monetary losses, the first quantitative metric, could help investors quantitatively assess how successful the company's strategy to manage the risk actually was.
16:05
Jessica McHugh: And in terms of materiality for the technology sector, what are sort of maybe core issues versus issues that are undergoing continued evaluation?
16:18
Anton Gorodniuk: So, I would say that data security and customer privacy, which appear in most industries in this sector, those two received a lot of input from companies and investors during our qualification process. These topics were commonly commented also in other sectors. Some companies raise concerns related to balancing useful disclosure to investors with the ability to you know, not disclose proprietary information, which could expose them to even more cyber risks. And investors suggested several additional indicators. And as a result of that feedback, we included elements of disclosure that relate to a number of customers impacted in data breaches, as well as percentage of operations certified to third-party cyber security standards. And inclusion of these metrics in several industries across our standards improve their usefulness to investors. In terms of the continued evaluation and research, although the standards are codified, we will definitely continue their maintenance to ensure their relevance and usefulness to investors. That includes also the issue of data security and customer privacy, especially considering the rapidly evolving regulatory environment around these issues, as well as more general trends in society and perception of privacy versus security, and some other technological developments, you know, such as blockchain and other technologies. And so therefore, we're always open to feedback from companies and investors, so they should feel free to reach out to me or other analysts with any recommendations and feedback.
18:03
Disclosures:
Sage is a SASB Alliance Member. Alliance Members share the belief that today’s capital markets need standardized sustainability disclosure and effective ESG integration into investment practices for the benefit of both companies and investors.
Sage Advisory Services is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. This podcast is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results. For additional information on Sage and its investment management services, please view our web site at sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.
