Sustainability Disclosure Grows Up
Sustainability reporting and ESG disclosure are finally growing up. They are moving from being desirable towards mandatory. So how do you avoid the pitfalls?
Read this article to get the full story on what’s happening, where and what it means for you. If you don’t want to read the detail, here are the headlines:
- Changes in laws on sustainability reporting mean more companies will have to produce comprehensive, meaningful and consistent information.
- Changes in accounting practice are on the horizon – requiring accounting firstly for carbon impact and risk, to be followed by other sustainability topics.
- Investors are moving fast, if you are listed anywhere, you will soon be asked for more and better ESG information.
- All of these changes mean that sustainability/ESG is becoming a fundamental part of corporate reporting rather than an option or add on.
Sustainability disclosure – what is happening?
Sustainability disclosure (including formal reports, regulatory information provision, investor and sustainability rating requests) has been with us for quite a while. My experience of it extends back 20 years to dark memories of taking home 80 environment and sustainability reports to plough through as a Sustainability Reporting Awards judge for ACCA.
Things have of course moved on, now you don’t have to weigh down your bag with lengthy reports, you can access them electronically and not just in pdf form, sustainability information is finding its way across websites and into the core of Investor Relations presentations.
So, if the medium has transformed, what is happening with the content? Well, for starters, more companies are producing reports than ever (KMPG notes that 80% of companies worldwide now report on sustainability) and the information that they contain is becoming increasingly central to the perspectives and judgments of corporate practice made by stakeholders, especially investors.
However, significant challenges remain for non-financial reporting to be as reliable and useful as other types of corporate disclosure. There is a still a plethora of standards and approaches used by companies to decide what should be reported, how much should be disclosed and to whom.
Historically, while a range of policies and regulations across the world require companies to produce a variety of environmental and social information, the standards for sustainability disclosure have remained voluntary, and are expressed in the standards produced (for example) by the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB).
But now significant developments mean things are beginning to change. This article provides an overview of these developments and highlights their implications for sustainability disclosure.
EU Corporate Sustainability Reporting Directive
Now, more than ever, stakeholders would like the ability to assess and compare the sustainability intent and performance of organisations. Most significantly perhaps, this need has become central to the focus of investors.
Investors need to meet their own disclosure requirements under sustainable finance disclosure regulation. Therefore, meaningful, consistent information from their investee companies allow them to assemble portfolio-level sustainability risk and performance information.
The most significant way to ensure clear and comparable sustainability disclosure is through regulation that requires and specifies which companies should produce information, and what that information should cover. This pathway has been pioneered by the European Union, with its Non-Financial Reporting Directive (NFRD) since 2014.
In 2021 the European Commission adopted a proposal for a revised version of the NFRD, the Corporate Sustainability Reporting Directive (CSRD). The proposal for the revised version of the EU-Non-Financial Reporting Directive has come to light due to two significant challenges with the original 2014 NFRD:
- Insufficient information reported – company reporting to the NRFD often failed to include information stakeholders and investors feel is important – material that would allow them to gain a complete picture of the reporting organisations’ identification of approach to and management of material social and environmental issues. As a result, information varied too significantly in quality and completeness and fell below what stakeholders needed and wanted.
- Narrow scope of organisations covered – the NFRD covers less than 1,200 large companies and groups in Europe (‘public interest entities’ i.e., listed companies, banks and insurance companies which have more than 500 employees). The CSRD will extend the scope of organisations required to report to 50,000 private and public organisations. The commission is also looking to include listed SMEs in the new revision albeit with simpler reporting than large companies. However, these reporting requirements would be applicable to SMEs with transferrable securities listed on SME growth markets or multilateral trading facilities (MTFs).
The final legislative text has yet to be confirmed. However, the first draft of the standards is due mid-2022. If these are accepted, the new reporting standards would be adopted by end of 2022. This would mean the new standards would cover the 2023 financial year, with reports published 2024.
The International Financial Reporting Standards Foundation (IFRS) – Sustainability Standards Board
The IFRS, oversees the International Accounting Standards Board (IASB), which sets the International Financial Reporting Standards (IFRS) – these standards define and require the coverage and standards of financial information produced by companies for investors and regulators and are required use in 140 jurisdictions across the world.
The IFRS Foundation Trustees are required by the IFRS Constitution to review the strategy of the IFRS Foundation every five years. The most recent review has created the need to accelerate their focus on sustainability reporting. As a result of the review, the IFRS Foundation Trustees published a consultation paper to assess the demand for global sustainability reporting standards.
Feedback for comments on the reports was left open until December 2020. Analysis from the feedback confirmed that there was an urgent need for global sustainability standards. Between January and April 2021, the IFRS Foundation Trustees reviewed the results of the consultation paper and set out their strategy for the creation of a new international Sustainability Standards Board under the governance of the IFRS Foundation Trustees. The role of the Sustainability Standards Board is to assess and define the sustainability information that should be included in the required disclosure of companies.
This is a significant development. A standard in this area would put sustainability/ESG information on a par with conventional financial information, allowing investors to assess and analyse ESG performance consistently.
The IFRS has proposed taking a ‘building blocks’ approach to the type and coverage of sustainability-related issues to be disclosed by organisations, starting with climate.
A prototype for the climate disclosure that might be adopted by the IFRS was developed by a coalition of voluntary sustainability standard setters in December 2020.
The key elements of this prototype, and any future standard adopted by the IFRS is likely to guidance relating to how an organisation should disclose climate-specific risks and opportunities and the impact of climate change to its value creation process.
There will likely be requirements for eligible organisations to disclose information with regard to the organisation’s exposure to and approach to the management of climate change in the following dimensions:
- Strategy and risk management processes
- Quantitative targets
- Assessment of strategic resilience to climate related risked based on scenario analysis
The standard will apply to all climate-related risks (i.e., impacts that are reasonably likely to negatively affect the enterprise value) and climate-related opportunities (i.e., impacts that are reasonably likely to positively affect enterprise value).
If approved, it would allow the IFRS to secure the resources needed to create a new board. The plans for the changes and the creation of a new board will be announced at the United Nations Climate Change Conference, COP26, scheduled to go ahead in November 2021.
IOSCO Board-level Task Force on Sustainable Finance
The International Organization of Securities Commissions is an association of organisations that regulate the world’s securities and futures markets (regulators of stock and futures exchanges in more than 130 countries).
IOSCO has launched a Board-level Task Force on Sustainable Finance to identify what information is decision-useful for investors, and what kind of sustainability information falls under the purview of securities regulators, to develop a principles-based set of guidance for market regulators.
The Sustainable Task Force (STF) has been created by IOSCO due to the need to improve the consistency, comparability, and reliability of sustainability. Since April 2020 work has been progressing on securities issuers sustainability disclosures, asset managers disclosures and investor protection of the ESG data and ratings providers.
It has been brought to the attention of the IOSCO, that companies often report sustainability selectively, referencing different frameworks. The STF is continuing to work with IOSCO on three priority areas:
- Encouraging globally consistent standards
- Promoting comparable metrics and narrative
- Co-ordinating across approaches
To drive the sustainability project forward, the IOSCO has announced the establishment of the Technical Expert Group (TEG) under the STF, and it is likely that IOSCO’s focus will be on alignment with the work of the IFRS SSB.
The TEG has been established to assess refinements of its prototypes and its content which will include industry specifics. The TEG will assess whether the prototype could be used as a sound basis for development of the international reporting standard.
The new international reporting standard will have a focus on enterprise value that will include meeting three key requirements, to:
- Meet the core information needs of capital markets
- Ensure the new standard will be compatible with existing accounting reporting standards which will promote good governance of sustainability related disclosures amongst preparers
- Form the basis for the development of an audit and assurance framework.
Due to the urgent need for credible sustainable reporting, the initial assessments are required to be completed by 26th November 2021 – around the time of the United Nations Climate Change Conference.
This is important because it relates to information that companies whose shares, debt or bonds are traded on national and international markets, would be legally required to disclose about their sustainability approaches, performance, and goals, with a specific focus on climate-related information.
Consolidation in the voluntary space
In the light of this movement from regulators and formal standard setters, the organisations that produce voluntary guidance and standards for sustainability/ ESG reporting have responded in several ways.
The CDP, CDSB, GRI, IIRC and SASB produced a statement of intent to work towards a more coordinated approach to comprehensive corporate reporting of sustainability information.
These five collaborating organisations formed an unprecedented collaboration to create a complete set of standards to cover the specificaton and provision of information on corporate impact measurement, assessment, and reporting with the goal of ensuring the consistent production of decision useful information.
Alongside the intention of these organisations to work more closely together, two of them, SASB and IIRC, have announced their intention to merge to form the Value Reporting Foundation.
This brings together the two voluntary standards setters whose focus is upon sustainability disclosure through the lens of enterprise value (reporting on issues and performance that can be understood to affect directly or materially the value of a company).
The purpose of the merger between SASB and IIRC is to create an integrated reporting framework which both sets sustainability disclosure standards and advocates integrated thinking.
The framework provided by IIRC provides principles based on guidance for reporting structure and content, whereas the SASB standards provide specific metrics to help understand the financial and non-financial risks and opportunities in greater detail. Used together such reporting should allow a full understanding of the relationship between financial and non-financial performance.
After many years which have seen sustainability disclosure as at best a voluntary exercise, and at worst a chaotic wild west, we seem to be seeing a move into the mainstream, through the twin processes of accounting and regulation.
In recognition of the need to provide consistency to the market, the voluntary standard setters have focussed upon ensuring that they exhibit greater alignment and coordination so that organisations seeking to improve their disclosure face less confusion about how they should structure and disclose their performance.
As yet though, beyond the clear proposals outlines in the European Union’s CRSD, things are neither entirely finalised nor settled, and the disclosure of sustainability and ESG information is not yet a simple, clear and globally understood process.
Key takeaways – what you must get right in ESG disclosure
As ever, some essential elements are fundamental to any company’s disclosure. Use the following to guide your approach. Your sustainability disclosure should:
- Remember that reporting is a means not an end. It is a tool to tell the story of your company’s management organisation, focus, performance and intent.
- Connect to the big picture – and interpret the implications for the company. Sustainability / ESG issues often impact business intentions and present strategic risks and opportunities.
- Be strategic – your reporting should apply to the entire company, its activities, risks and related dependencies.
- Identify, explain and explore fundamental resource relationships – what do you depend upon to generate value and what is the quality of your relationships to these resources?
- Focus on material issues – the things that are important to your stakeholders and to the success of your company.
- Highlight your governance – the responsibilities, structures and processes that you have in place to assess, set and deliver against clear, meaningful performance targets.
- Be specific – allow stakeholders to see your targets and your progress to achieving them.
- Be true – to allow stakeholders to rely upon its content and be able to assess both performance and prospects – using assurance and other evidence of transparency.