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COP26 ushers in new era of ESG reporting

January 10, 2022

COP26 ushers in new era of ESG reporting

Synopsis
12 Minute Read

The creation of global disclosure standards on sustainability is being touted as the biggest change in corporate reporting standards in the last 100 years.

Leader, Consulting – Organizational Renewal

In this edition of our four-part series on ESG, we show how proposed environmental, social and corporate governance reporting standards could leave some businesses scrambling.

Table of contents

Global ESG disclosure standards established

More clarity on data and reporting

Increased regulatory oversight coming?

The data challenge

New and onerous reporting requirements

Beyond the E in ESG

Global ESG disclosure standards established

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The most recent United Nations climate conference (COP26) may have fallen short of its main objective to get countries on track to limit global warming to 1.5°C by 2050, but it did result in what some commentators say will be the biggest change in corporate reporting standards since the Great Depression era.

The creation of the International Sustainability Standards Board (ISSB) by the International Financial Reporting Standards (IFRS) Foundation, which sets accounting standards for much of the world outside the United States, means a global baseline of sustainability disclosure standards are expected to be implemented soon. These standards will be designed to meet the needs of companies, investors and other stakeholders who have struggled with myriad ESG standards, frameworks and metrics for years. While it will take time to implement disclosure standards for material ESG topics, the focus is expected to prioritize climate-related disclosures as aligned with the global agenda and urgency to address climate change.

In short, while governments may be struggling to meet carbon reduction goals agreed to in the 2015 Paris Agreement, companies and investors cannot afford to dismiss the ISSB, which has already released two draft prototypes showing just some of the data companies will have to disclose in the near future. Formalized standards are expected to be published by mid this year.

In many ways, the COP26 conference crystallized the environmental focus of the private sector, which continues to go green despite relative government inaction. It also provided a substantial boost to the broader movement toward ESG issues — and made it clear public companies will have to get on board or pay a hefty price in the eyes of stakeholders who care about such issues.

The standards will be based on the technical requirements of the Climate Disclosure Standards Board (CDSB) and the Value Reporting Foundation (VRF), including the Task Force on Climate-Related Financial Disclosures (TCFD) as well as the World Economic Forum International Business Council’s Stakeholder Capitalism Metrics. Pivotal will be the four pillars of governance, strategy, risk management, and metrics and targets from the TCFD that will provide guidance for the foundation that companies need to disclose climate-related risks and opportunities on a regular basis. The new standards should help investors and others better understand a company’s ESG commitments and track record, while helping them gauge long-term performance and value-creation prospects.

Consistent data should also help address stakeholder concerns about greenwashing — that is, companies that provide misleading information to convey a false impression their policies and / or products are more environmentally sound than they actually are. It’s an issue the International Organization of Securities Commissions (IOSCO), whose members regulate more than 95 percent of the world's securities markets, has been increasingly concerned with, given the growing market for ESG ratings and data as companies and investors try to align with both internal and externally regulated targets.

“There is a clear need to address the challenges associated with the lack of reliability and comparability of data at the corporate issuer level and the ESG data and ratings provided by third-party providers to enable the investment industry to properly evaluate sustainability-related risks and opportunities,” the IOSCO said in a recent report.

IOSCO also has concerns about the lack of regulatory oversight of ESG ratings and data, since they generally don’t fall under the purview of securities regulators. IOSCO in late November 2021 issued five recommendations that, among other things, include making sure ESG ratings and data products providers implement “written policies and procedures designed to help ensure their decisions are independent, free from political or economic interference, and appropriately address potential conflicts of interest.”

The ISSB standards should provide clarity, but various securities regulators, including the U.S. Securities and Exchange Commission and the Ontario Securities Commission, are still working on ESG requirements for issuing companies. The Canadian Securities Administrators (CSA) is also seeking public comment until Jan. 17, 2022, about the climate-related disclosure requirements it proposed in October. These requirements are formulated based on TCFD recommendations. Nevertheless, the ISSB may mandate companies disclose their current position as well as the transition mechanisms to reach their targets.

In 2021 the United Kingdom confirmed large U.K.-registered companies will have to disclose climate-related financial data from April 2022 onward, making it the first G20 country to put such a mandate into law. The Chancellor of the Exchequer, Rishi Sunak, who is responsible for fiscal and monetary policy, in November 2021 also mandated companies “publish a clear, deliverable plan setting out how they will decarbonize and transition to net zero.”

The approach is similar to many regulators’ requirements for companies to disclose the steps they are taking to diversify their boards of directors. For example, most provincial and territorial regulators in Canada require companies to have a written policy about the identification and nomination of women directors (or disclose why they don’t), as well as a summary of their objectives and the steps taken to achieve them. These diversity rules recently expanded to include a breakdown of Indigenous peoples, persons with disabilities and visible minorities, and they could eventually broaden to include LGBTQ2S+ and other groups.

Collecting data on board diversity, however, is much simpler than collecting the data likely required to satisfy ESG disclosures — something many companies have never done, in some cases because there has not been a standard methodology of doing so, either nationally or internationally. In the world of business, confusion leads to inaction, since companies don’t want to risk spending time and money on initiatives their stakeholders don’t want or need. But now that the IFRS (through the ISSB) is stepping in, the option of doing nothing becomes far less enticing. Companies need to get ready now, which starts with figuring out what data will be needed and, just as importantly, how and where to get such data — and how to start disclosing it.

As part of its mandate, the ISSB is consolidating two investor-focused international sustainability standard-setters. One is the Value Reporting Foundation, a non-profit created in 2021 by the merger of the International Integrated Reporting Council and the Sustainability Accounting Standards Board (SASB); it is home to 77 different industry SASB Standards. The other is the Climate Disclosure Standards Board, a non-profit formed in 2007 that aimed to enfold climate change-related information into mainstream financial reporting.

(There’s a Canadian connection to the new body, since IFRS offices in Montreal and Frankfurt, Germany, will support the ISSB and help coordinate with regional stakeholders.)

The ISSB has already published two reporting prototypes, one on climate-related disclosures and the other on general sustainability disclosure requirements. In the former, if adopted, companies will have to report their greenhouse gas emissions in metric tonnes of carbon dioxide (CO2 ) equivalent; the amount and percentage of their assets or business activities vulnerable to transitioning to cleaner energy sources; the proportion of revenue, assets or other business activities aligned with climate-related opportunities; the amount of capital expenditures, financing or investment deployed toward climate-related risks and opportunities; and the proportion of executive management remuneration affected by climate-related considerations.

On the last point, Canada’s Big Six banks have all stated their executive compensation policies take ESG targets into consideration, though it’s a small part of their total pay packages and the metrics used are not consistent. All those disclosures comprise just one category — “cross-industry metrics” — in a field of 17 broad reporting recommendations.

That is, in short, a lot of paperwork. But companies will also have to detail how they are responding to significant climate-related risks and opportunities. This includes but is not restricted to how they plan to achieve any climate-related targets, such as how these plans will be resourced, the processes in place for reviewing those targets, and assumptions about the use of carbon offsets in achieving said targets; how they are advancing research and development related to climate-change mitigation, adaptation or opportunities; whether they are adopting new technologies; and what direct adaptation and mitigation efforts are being undertaken.

Importantly, these disclosures address just the E in ESG. Under general sustainability disclosures, companies would also have to report a complete, neutral and accurate depiction of their risks and opportunities related to labour practices, human rights and community relations, water and biodiversity — all of which are becoming important to capital markets in assessing an organization’s current and future value and prospects. Companies will also have to give a “clear indication” of whether their targets are absolute, normalized, intensity- or activity-based, as well as the timeframe to reach the target and any milestones or interim targets. Those are just two of the proposal’s 90 recommendations, some of which will clearly be more difficult to achieve than others.

All told, the two ISSB reporting prototypes are already comprehensive and will require companies to disclose information they may never have had to before — or may not even have at hand. Meeting the standards will require a significant effort to do it correctly.

But it is also necessary, especially given the apparent fact that governments are not driving sufficient change when it comes to environmental stewardship. Private, public and government bodies will need to work together to achieve climate goals, rather than relying on government alone.

“Capital markets can have an essential role to play in reaching net zero,” Erkki Liikanen, chair of the IFRS Foundation Trustees, said in his speech at COP26 announcing the ISSB’s creation. ("Net zero" refers to a future economy that focuses on reducing GHG emissions to the lowest level possible while offsetting the remaining GHG emissions with equivalent carbon credits through tree planting, carbon capture and sequestration, or other methods.) “But that can only happen when sustainability information is produced with the same rigour, assurance of quality and global comparability as financial information.”

Investors and capital markets want and need high-quality, transparent and globally comparable sustainability data to enable them to do their jobs. That can be difficult if they have to navigate individual and voluntary reporting frameworks and guidance (although, in the absence of global standards, those efforts should be applauded even if they increase costs and complexity).

Now, with global standards on the way, the challenge is shifting toward companies themselves, whose owners and managers, if they haven’t started already, will soon have to start adapting their existing disclosures or develop entirely new ones — or face the consequences of contravening international accounting rules and alienating their investors, customers and employees.

Follow the remainder of this four-part series on environment, social and governance issues as we examine industry specific takes, and address the often-overlooked S and G components of ESG.

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