Environmental, Social and Governance—or ESG—is the term that seems to be everywhere these days, which is largely the result of the considerable number of changes on the horizon that could impact every type of business.
Until recently, ESG (also known as “sustainability”) reporting was more of a niche. Most companies reporting this information did so voluntarily to bolster their reputations. However, this dynamic has been changing rapidly since the investment community tapped into the value of ESG data. For example, the world’s largest institutional investor—BlackRock—has threatened to vote its shares against any portfolio company that doesn’t fall in line with carbon reporting.
Now, regulators are quickly jumping in to address the lack of common reporting standards in ESG reporting. In the U.S., the Securities and Exchange Commission (SEC) recently asked for comments on 15 questions around requiring more ESG disclosures. In Japan, the Financial Services Agency (FAS) announced in January it would embark on a similar path.
And in Europe—where ESG disclosure has been required for more than five years—there are new recommendations aimed at making these reports more useful for investors.
Forecasting where all of this is likely to go is difficult. But examining some of the global trends, as well as those from ESG standards organizations, highlight five key messages that are likely to shape the future of ESG reporting, and impact companies everywhere:
1: Universal disclosures are coming—and climate will be first
The biggest frustration with ESG reports is the lack of comparability. Until now, companies have been free to choose which ESG issues apply to them and which do not. The result was a jumble of data that was not very useful, to put it kindly. The new proposals coming from Europe have focused on the concept of “universal disclosures.” Stated simply, this means regulators will pick a subset of the myriad of ESG topics and require all companies to report on them.
The universal disclosure concept has been around for a while, but recently got a boost from the International Business Coalition, a group of CEOs within the World Economic Forum. Frustrated with the poor quality of ESG data, this group proposed a set of about 20 universal ESG topics and then doubled down by agreeing to have their companies report on them. Because of their leadership, the WEF has been invited to the insider working group consulting on ESG standards with the International Financial Reporting Standards (IFRS) Foundation.
When it comes to what exactly will comprise the list of universal disclosures, there is no real alignment except for one issue agreed upon by all parties—climate change. The SEC, the EU, several APAC countries, and the standards organizations have all prioritized climate change, so it is a safe bet that reporting on your company’s carbon footprint will soon be mandatory.
2: Sector disclosures are coming next
The main complaint about universal disclosures is that one size doesn’t fit all. This concern has a lot of merit. There are ESG issues that impact certain industries more than others. For example, destruction of the tropical rainforest is a big issue for the beef industry, yet not applicable for management consulting firms. To compensate for these differences, the regulators are looking at defining ‘sector-specific’ disclosures.
Sector standards have been a core philosophy of the Sustainability Accounting Standards Board (SASB) since the organization was founded. This and other attributes have made the SASB standards popular with investors. Now that it appears sector-based standards will be required, SASB is picking up support from IFRS and others.
3: Materiality is being redefined
This word—materiality—is one of the hottest topics in the ESG community, as it defines how companies select the topics they will report. Again, this company-by-company determination of which issues to report is a main reason that ESG has foundered. In essence, materiality is the enemy of comparability.
The new proposals coming out of Europe will minimize this approach. Rather than companies making these decisions, the regulators and standards setters will decide. This will definitely help with data comparability from company to company.
With financial matters, materiality is based on judgment of what could affect investors in the company. With ESG issues, the debate is over whether sustainability concerns should be added to investor interests—this has been called “dual materiality.” For example, poor working conditions in a company’s supply chain may not be financially significant, but would be material when looked at through the lens of sustainability. This is dual materiality.
The outcome here is less clear. The EU will go with a dual materiality approach for its ESG reporting policy and odds are the U.S. will stick with using solely investor interests to define materiality.
4: Regional laws show the way
If California were a nation, it would be the world’s fifth largest economy. For decades, California has pioneered environmental policies that create a blueprint for national laws—this holds true with climate reporting.
Today there are a number of ESG-related bills working their way through the California legislature. Notable among them is SB-260, championed by Senator Scott Wiener, which would make carbon reporting mandatory for roughly 5,000 companies that do business in the state.
And California is hardly alone. A number of cities and states throughout the U.S. are pushing forward their own similar laws, as are municipalities throughout the world. And, as more businesses are covered by regional and local policies, the pressure will build to drive globally consistent disclosure.
5: Convergence will be a struggle
A complaint about the ESG reporting world is the lack of consistency. There are several organizations providing overlapping reporting standards, which adds confusion and results in inconsistent disclosures.
Recently, the IFRS has taken the lead in driving convergence to a single internationally accepted reporting standard. However, the Europeans, for now, seem to be intent on developing their own version of ESG reporting standards. A positive development has been that the existing standards organizations are making a concerted effort to work together toward a converged future. The wild card is China; there have been signals that they will also jump in with their own set of ESG standards.
Sadly, today the convergence of ESG standards remains an elusive goal despite the need for a global common language for measuring these important issues.
The pace of change in ESG reporting in 2021 is already unprecedented, and there is more to come. Company leaders need to stay well informed and lay the groundwork for these changes now, because it’s clear that yesterday’s ESG playbook won’t work in the future.
Tim Mohin is the chief sustainability officer for Persefoni AI. Formerly, Mohin served as chief executive of the Global Reporting Initiative; he also held sustainability leadership roles with Intel, Apple, and AMD and worked on environmental policy within the U.S. Senate and Environmental Protection Agency. He is the author of Changing Business From the Inside Out: A Treehugger’s Guide to Working in Corporations.