Let’s start with some background. Shortly after the 2008/2009 global financial crisis, G20 members endorsed the creation of an international body chartered with monitoring and reforming international financial regulations. The Financial Stability Board (FSB) was born. Members sought a robust, stable global financial system. Over subsequent years, the scope of FSB expanded to include standards setting and, in a major move in 2015, FSB established a Taskforce on Climate-related Financial Disclosures (TCFD). TCFD tracks and advises updates as US, EU and Asia reporting regulations change and remains the model for voluntary climate disclosures today.
Businesses have a vested interest in environmental stewardship. The inclusion of environmental, social and governance issues, whether material or immaterial to financial performance, is a worthwhile disclosure. In the EU, ESG reporting is a regulatory requirement. In the US, it’s not mandatory but widely viewed as an opportunity to communicate company ESG initiatives and results.
The global movement to capture sustainability information from publicly traded businesses is well-underway led by the EU’s European Financial Reporting Advisory Group (EFRAG). In the US, it’s the Security Exchange Commission (SEC). Elsewhere, the International Sustainability Standards Board (ISSB) drives that initiative. By far, the EU disclosure rules will be the most demanding of the three and for multi-national companies, the reporting challenges will not be insignificant. According to Refinitiv, a global provider of financial market data, more than 10,000 foreign companies will be subject to the forthcoming EU rules. Of that figure, 31 per cent are US based and 13 per cent Canadian.
What will US and Canadian companies need to disclose? A KPMG assessment from November 2022 describes it best as a 3D matrix: four reporting areas x three reporting layers x three distinct topics.
• Reporting areas: Applies to all companies and includes: governance/strategy/impact, risk, opportunity management/metrics and targets
• Reporting layers: Varies by sector with one or more applying: sector-agnostic disclosures apply to all companies/sector-specific disclosures apply where relevant/company-specific disclosures apply to situations not covered by standards
• Topics: Applies to all companies and includes: environmental/social/governance
Of the 82 EU sustainability draft standards published in November 2022, 80 per cent are environmental and social topics. The 20 per cent balance covers general and governance issues. Adherence to the new reporting rules begins as early as 2025 while some have until 2029 to comply.
As for the US side, the SEC is not yet aligned with the rapid developments in Europe. That is not to say the SEC is content with voluntary ESG disclosures. Quite the contrary, the SEC has proposed making ESG reporting mandatory using the TCFD framework for public company reporting. The SEC is also endorsing the Greenhouse Gas (GHG) Protocol as the accounting standard. In the SEC’s current draft, companies will need to report their own GHG emissions and that attributable to their suppliers and customers. This could be incredibly burdensome particularly for manufacturers of goods.
Perhaps the WSJ said it best: “Multi-national businesses could face a patchwork of requirements, if the mandatory climate reporting standards vary significantly between standard setters.”
Avoiding duplicity and contradictory disclosures will be tricky. At the very least, new compliance systems and potentially third-party auditing will be needed. Since the data captured from disclosures will be massive, is the next step thresholds, conformance timelines and penalties? Speculation…. pure speculation on my part and that may be the coming challenge of sustainability reporting.