ESG reporting standards and taxonomies

Sticking points & challenges

The regulatory drive to introduce ESG reporting standards and establish sustainability taxonomies is providing significant momentum to improve the availability, relevance, and understandability of ESG data. As of today, however, ESG data continue to exhibit limitations with respect to quantity, quality, consistency, timeliness, ease of access & use. Moreover, interpretations continue to diverge on what constitutes a sustainable activity and investment. There are several reasons behind these challenges:

• First, while jurisdictions are increasingly introducing mandatory reporting, this is not the case across the board.
• Even where mandatory reporting is in place, there is typically partial coverage with only a subset of corporates mandated to report and reporting requirements introduced with phase-in periods.
• Furthermore, there needs to be more consistency in reporting conventions and standards. For example, whether the scope of reporting is on climate change or covers additional environmental and social challenges, whether the emphasis is on financial or impact materiality, and whether there is a requirement for assurance (external audit).
• Disclosure regimes are, moreover, still evolving. For example, the anticipated launch of the TNFD (Taskforce for Nature-related Financial Disclosures) framework in September is expected to form the basis for improved reporting on biodiversity loss.
• Moreover, there are multiple taxonomies at different stages of development and with different nuances, for example, regarding the scope of sustainability topics and the range of economic activities and sectors covered.

Alignment

Greater alignment of ESG standards and taxonomies is likely to improve the consistency, comparability, and understandability of ESG data.

There is a gradual emphasis on accounting principles, such as relevance, which may be supplemented by a requirement for external audits. A lot more however must be done to bring sustainability reporting to a comparable level of integrity and completeness as financial reporting.

Alignment of standards is taking shape with an emphasis on reporting information material on enterprise value creation, especially on general governance and risk management, and in the context of climate, where the TCFD (Taskforce for Climate-related Financial Disclosures) framework is a standard reference.?

Launching the two ISSB standards will likely accelerate the trend toward alignment. The UK and several other countries have indicated it will consider the two ISSB standards for endorsement, and the SEC has indicated it may adjust to better align its proposed climate disclosure requirements with those of the ISSB. A likely endorsement of the standards by IOSCO (International Organization of Securities Commissions) could pave the way for broad adoption of the standards across its 130 or so members.

The recent launch of the first set of draft ESRS, considered – according to the accompanying announcement by the European Commission – "intensive and constructive technical discussions" with the ISSB and the GRI " to ensure a high degree of interoperability" with those global standards.

Alignment across sustainability taxonomies is likely to move at a slower pace. Being a first mover, the EU taxonomy established cornerstone concepts, such as substantial contribution, adverse impacts, and minimum safeguards. Substantive differences are driven by a focus on addressing regional needs & priorities, the choice of metrics, and performance indicators. Initiatives to develop regional taxonomies (e.g., in Asia and Central America) may drive alignment in the future.

Practice

For financial firms the utilization of ESG standards and taxonomies depends on many factors, such as where they are based, where their clients are based, where they invest and what their sustainability ambitions are.

Financial firms may take a strict compliance approach, focusing on the availability of required ESG data points and risk controls. Alternatively, they may adopt a broader mindset, looking broadly across the growing span of ESG data and taxonomies as a source of information and insights to be leveraged in forming conviction on sustainability challenges, mobilizing capital to address them, reporting and communicating on the material impacts of investee companies to investors and other stakeholders.

ESG standards and taxonomies are far from being a silver bullet, but they can present an opportunity to better align portfolio holdings with the sustainability preferences of investors and advance the SDGs. The regulation increase is accompanied by a growing body of academic research on sustainable finance and multiple professional networks and associations that can support practitioners in deepening their knowledge base, sharing and leveraging best practices, and exploring partnerships.