How we can move forward on unified sustainability reporting

Corporate reporting is one of the fundamental building blocks of a sustainable global economy. It enables companies to monitor their progress against targets, build trust with stakeholders, and hold themselves to account for their environmental, social and governance (ESG) strategies. And it helps them to better understand the risks of the shift to a net-zero world, as well as the opportunities that shift can bring to create value for their business.

Until recently, the capacity of corporate reporting to help build a more sustainable world was constrained by the lack of a commonly agreed approach. That situation has changed markedly thanks to several developments, not least the launch of the International Sustainability Standards Board (ISSB) at the COP26 climate change conference in Glasgow last year.

To mark COP27 – which is now underway – as well as the first anniversary of the ISSB, I want to reflect on the progress made to date with common sustainability reporting standards – and what must happen next.

Global developments

The past year has seen a series of important developments in ESG reporting, but three stand out for their potential to move the needle on sustainability – draft standards from the International Sustainability Standards Board (ISSB), US Securities and Exchange Commission (SEC) and the European Financial Reporting Advisory Group (EFRAG) that is developing the European Union (EU) standards. And at COP27 CDP, the organization which runs the Global Environmental Disclosure Platform for corporations, announced that it will incorporate the ISSB climate-related disclosure standards.

The ISSB is finalizing its draft climate and general requirements standards with a final release expected in early 2023. These standards are intended to serve as a “global baseline” – a set of sustainability reporting standards that provide investors with comparable, globally consistent, sustainability information.

In the US, the SEC released a climate disclosure proposal early in 2022 and a new human capital disclosure proposal is expected soon. The former, received thousands of responses by the time the comment period closed in June 2022. Under the climate proposal, all SEC registrants would be required to make Scope 1 (direct emissions) and Scope 2 (indirect emissions from purchased energy) disclosures. Larger registrants would also be required to make Scope 3 disclosures if the indirect emissions from upstream or downstream activities in their value chain are material, or if they have set a greenhouse gas emissions or reduction target that includes Scope 3 emissions.

The third significant development is that the European Parliament has now formally adopted the Corporate Sustainability Reporting Directive (CSRD). The CSRD, will replace the EU’s Non-Financial Reporting Directive, and will impact more than 50,000 large companies in the EU. Member States will soon begin the process of bringing the directive into national law. EFRAG plans to deliver its first set of standards to the European Commission in mid-November, with adoption by the Commission in June 2023.

While these processes represent important steps forward, the level of alignment we are likely to see in the eventual standards remains in question.

There are some key differences between the three approaches I’ve outlined, that could make it harder to compare reporting between jurisdictions.

One example of these different approaches is that they define ‘materiality’ differently and would apply a materiality threshold differently to various disclosures. The ISSB’s definition of materiality focuses on the primary users of the financial reporting information (e.g., investors, creditors) and, unlike the materiality definitions used in the SEC and the ISSB proposals, the ESRS materiality definition considers both affected stakeholders (e.g., employees, customers, vendors, the community) and other users of the sustainability reporting information (e.g., investors, creditors). In other words, the focus being on financial impact (in the ISSB and US rule) or social and environmental impact (societal value in the EU rules).

The differences also include whether disclosures are included in financial statements or not, and how they align to international climate agreements such as the 2015 Paris Agreement. Notably, the SEC and EU proposals both call for some level of assurance around reported sustainability information.

From words to action

It’s great that we have seen so much progress over the past 12 months. At last, we are moving away from an ‘alphabet soup’ of voluntary standard-setters toward globally aligned, mandatory sustainability reporting. Yet while it’s important to acknowledge where we’ve come from, what really matters is where we go from here.

With climate change happening at a faster rate than we initially expected, it’s crucial that we act quickly and decisively. So, we need the ISSB, the SEC and the European Commission to finalize their interoperable standards and for these standards to be rapidly implemented. The sooner we all use a framework that represents a global baseline and achieves interoperability between the proposed sustainability-related reporting regimes in different jurisdictions, the sooner we will be able to identify those companies that are genuinely making the transition to a low-carbon economy.

Companies should start preparing now for this momentous change, by strengthening their processes, systems and governance around ESG reporting. They also should invest in their talent, upskilling their existing teams and possibly hiring people with the right experience and skills in sustainability and ESG reporting.

In addition, audit firms have investments to make. They need to equip their auditors with climate-related risk skills and training to ensure they can provide a comprehensive assurance process for sustainability reporting.

What’s disclosed should be what matters

Finally, it is important to remember that reporting is just a means to an end. It is not an end in itself. Ultimately it is action, rather than words, that will enable the transition to a low-carbon economy.

As the latest EY Climate Risk Disclosure Barometer highlights, although businesses are getting better at reporting on their climate risks, they still aren’t taking the concrete action needed to bring about decarbonization. For instance, nearly two out of five companies surveyed (39%) had not disclosed either a specific net-zero strategy, a transition plan or a decarbonization strategy. And less than a third (29%) included climate risks in their financial reporting.

Corporate reporting can help to build a sustainable global economy – that is beyond doubt. But only if companies use it consistently and intelligently to set and monitor targets, and to inform decision-making, strategy and capital allocation. Disclosure is hugely important, if we are going to see real progress any time soon, definitive action needs to come hot on its heels. ?