The Era of Compliance: The Changing Landscape of ESG Reporting
The Basics: Where are these requirements coming from?Such demands for information are coming from internal and external stakeholders alike. Employees are seeking safety, security, and stability; regulators seek to ensure their communities are protected from contamination and competition for resources; investors are seeking “sustainable investments” and projects; and business leaders must protect and grow their organization in an ever-changing global economy.
Historically, companies have voluntarily communicated their ESG efforts to different stakeholders through a number of channels ranging from occasional press releases or blog posts, to the multitude of third-party customer and investor surveys such as the Dow Jones Sustainability Indices (DJSI), CDP and EcoVadis, or through full-fledged corporate sustainability reports aligned to prominent standards and frameworks such as Global Reporting Initiative (GRI), Sustainable Accounting Standards Board (SASB), and Task Force on Climate-Related Financial Disclosure (TCFD).
Up to this point, companies have largely been given the flexibility to pick and choose which topics to address, what boundary to apply, how to calculate data, and whether to have their information assured by a third-party. The concern, however, is how to discern if the information presented to stakeholders is a valid and true reflection of the company with so little responsibility tied to performance or communication.
This growing concern about lack of transparency, accountability, and consistency has risen to a boiling point, to the extent that we have now entered a new Era of Compliance.
Emerging LegislationThe UK TCFD-Aligned Disclosure, the pending SEC proposal, and the upcoming EU Corporate Sustainability Reporting Directive “CSRD,” are all examples of newer legislation which seeks to standardize reporting requirements around various ESG topics. Many of these new legislative pieces are leveraging existing surveys and frameworks to inform their requirements rather than introducing yet another reporting framework.
Companies that meet the conditions for these new policies will soon be legally obligated to report annually on ESG matters, with certain topics required to be externally assured – a step forward towards credibility and consistency.
Impacts of this new legislation include:
- As of April 6, 2022, certain UK-registered companies and financial institutions are now required to disclose climate-change related risks and opportunities that are material to their organization in compliance with the Task Force on Climate-Related Financial Disclosures (TCFD). The ruling is said to impact approximately 1,300 organizations. Examples of the disclosure requirements include description of governance arrangements to address climate-related risks and opportunities; process for identifying, assessing, and managing the relevant risks and opportunities; as well as actual and potential impacts of climate-related risks and opportunities
- The proposed SEC ruling has to be finalized yet; however, the rule would require registrants (foreign and domestic) to include certain climate-related information in reports such as their annual Form 10-K. Topics under consideration include climate-related risks and material impacts; climate-related risks and management processes; greenhouse gas (GHG) emissions which could be subject to assurance; climate-related financial statement metrics; and information about climate-related targets, goals, and corresponding transition plans. The SEC proposal is built upon existing frameworks such as the TCFD and the Greenhouse Gas Protocol. (Learn more about the proposed rule)
- Meanwhile, the CSRD is one of the most highly anticipated and wide-reaching regulations to emerge with regard to ESG reporting, with an expected impact on almost 50,000 companies worldwide. This new reporting requirement is set to go live in 2024.
The standard specifies that companies will be required to disclose environmental factors such as climate change mitigation (including greenhouse gas emissions); pollution; and biodiversity and ecosystems. Social topics obligated to be discussed
include equal treatment and opportunities; working conditions; and their approach to respect for human rights. Finally, the CSRD requires governance topics addressing leadership accountability; internal controls and risk management; business ethics
and corporate culture; and value chain management (e.g. customer relations, suppliers and communities affected by business activities, and payment practices)
Introducing Double MaterialityNot all ESG topics are materially relevant to all companies, even within the same industry. As a result, in each of these regulations, there remain allowances for companies to exclude certain information which has been deemed “immaterial.” So, how does a company determine which topics are material enough to be included and to what extent?
To address this confusion, the CSRD has introduced the mandatory application of “double materiality.” This concept broadens the scope of materiality beyond the direct financial impacts of business activities to also incorporate the material impact of business activities upon people and the environment.
Therefore, as a first step and as best practice, companies should begin considering double materiality as a means to evaluate their broader ESG-related decisions and prepare for new compliance requirements.