Examining the state of worldwide mandatory ESG disclosures
Examining the state of worldwide mandatory ESG disclosures
Institutional investors around the world are increasingly considering ESG (Environmental, Social, Governance) factors when making investment decisions. These investors rely on data-driven disclosures to identify leading sustainability-focused companies. However, a lack of reliable, consistent reporting prevents them from making meaningful, well-informed investment decisions.
To address the gap between investor demand for ESG information and supply of information by companies, several countries have enacted national legislation that makes requires public and private companies to properly disclose information on ESG issues in traditional financial disclosures or specialized standalone reports such as corporate social responsibility reports.
However, while investor pressure has pushed disclosure from "good to have" to "must-have", mandatory reporting continues to remain irregular, localized, and issue-focused.
Shortfalls of voluntary standards & frameworks
At the CERAWeek conference in March 2021, U.S. Securities and Exchange Commission (SEC) Acting Chair Allison Lee said the current voluntary standards and disclosure regime for climate and other sustainability issues in the U.S. has failed to produce the level of consistent, comprehensive, and comparable information that investors need.
This comes after the SEC issued a risk alert to inform investors of potentially deceptive statements identified during recent audits of investment firms that provide ESG products and services. "Controls were inadequate to preserve, monitor, and update clients' ESG-related investing rules, mandates, and limits," according to the risk alert documents. The staff found flaws in the policies and processes controlling the advisers', clients', or funds' ESG-related directives' implementation and monitoring.
As a result, the SEC's new Climate and ESG Task Force will begin establishing initiatives to proactively identify ESG-related wrongdoing, evaluate current ESG criteria, and begin developing a framework for climate and ESG disclosures.
To date, most voluntary reporting standards were originally designed to complement traditional financial reporting and were developed to support different types of stakeholders through their divergent focuses and definitions of materiality.
Take the reporting frameworks known as the “group of five”, which includes the Sustainability Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), CDP (formerly the Carbon Disclosure Project), the International Integrated Reporting Council (IIRC), and the Climate Disclosure Standards Board (CDSB).
SASB was primarily designed with investors in mind. As a result, the SASB standards place a strong emphasis on ESG issues that are projected to have a significant financial impact. GRI standards, on the other hand, aim to make sustainability reporting as simple and transparent as possible for businesses.
Conversely, CDP uses a question-and-answer platform that provides a popular format for corporate disclosures requested by investors. CDSB and IIRC, which joined with SASB in June of this year, are on the periphery.
In addition to these voluntary guidelines, the Financial Stability Board established the Taskforce on Climate-related Financial Disclosures (TCFD) to strengthen and expand climate-related financial disclosures.
It's important to note the difference between ESG reporting standards and reporting frameworks, though. ESG standards such as SASB and GRI provide explicit instructions on what should be reported on ESG issues, as well as information on which indicators should be revealed.
Frameworks such as TCFD, on the other hand, provide principles-based guidelines on what areas organizations should report on and how the data should be organized. As a result, reporting standards and frameworks were intended to be utilized in tandem, but this isn’t always the case. Given its complexity and the numerous reporting alternatives available, understanding the disclosure process can be difficult.
Which countries require ESG disclosures?
An ECGI (European Corporate Governance Institution) study identified 25 countries that introduced mandates for firms to disclose ESG information between 2000 and 2017, including Australia, China, South Africa, and the United Kingdom. To date, mandatory sustainability reporting has been mostly applied only to state-owned companies, large corporations, or listed companies. Here are some examples:
Under the Companies Act 2006 (Strategic Report and Directors’ Report) Regulations 2013, quoted companies in the United Kingdom are required to provide a report detailing annual greenhouse gas emissions, diversity, and human rights. Companies who have a Premium Listing of equity shares must also report on how they implement the Corporate Governance Code 2012's major principles.
The Non-Financial Reporting Directive of the European Union (EU) went into effect in all EU member states in 2018. Companies are expected to comply by revealing material environmental, social, and employee-related problems, such as anti-bribery, corruption, and human rights performance.
In the United States, the SEC adopted regulations requiring all publicly traded corporations to publish their environmental compliance costs. Listed firms must also adopt and publicize a code of corporate behavior and ethics, according to the New York Stock Exchange (NYSE).
China has seven regulations that operate as required sustainability disclosure instruments. Corporations are required to publish environmental information in accordance with regulatory standards under the Environmental Information Disclosure Act of 2008. Large enterprises listed on the Shanghai Stock Exchange are also required to submit a supplemental report that includes an environmental disclosure. Annual resource use, pollution levels, waste generation, disposal methods, and a few other factors can all be voluntarily disclosed in order to receive additional grants and public support rights.
In Indonesia, all listed companies are required to publish Sustainability Reporting starting in 2020, according to Indonesia Financial Services Authority.
What issues surround mandatory ESG reporting?
A prominent study by Carrots and Sticks in 2016 revealed the adoption of mandatory ESG reporting promotes social responsibility among business leaders. While that is a positive outcome, there are still several issues surrounding mandatory reporting. These include:
The exclusion of SMEs: The majority of mandated reporting instruments are aimed at large or publicly traded enterprises. Governments and regulators pay little attention to the practice of ESG reporting among SMEs (small and medium enterprises). SMEs, on the other hand, make up around 90% of businesses, but only 10% of reports in the GRI Sustainability Disclosure Database come from small and medium businesses.
A lack of standards: The voluntary reporting requirements that are currently available must be adaptable to businesses of all sizes if they are to become mandatory. It is nearly impossible to create such standards across all industries, and industry-specific standards are not yet well-developed or widely embraced.
Global governance incompatibility: While many nations have implemented mandatory reporting requirements, there is no way to determine whether the governments regularly and fairly check the quality of the reports. Unfortunately, high levels of corruption in poor nations can erode public confidence in the environmental impact data provided nationally and to the international community.
Finally, whether sustainability reporting should be mandated or voluntary is still a point of contention. On the one hand, mandated ESG reporting ensures that all companies are reporting in the same way. Mandatory standards, on the other hand, place undue pressure on businesses that are just beginning their sustainability journey. Many also claim that voluntary reporting is market-driven and gives reporting enterprises a competitive advantage.
The impacts & benefits of mandatory ESG disclosure
Mandatory ESG disclosure, according to the ECGI study, improves the availability and quality of ESG reporting, particularly among companies with poor ESG performance. ESG reporting is also good for a company's information environment; analysts' earnings forecasts become more accurate and less dispersed if ESG disclosure is required.
Furthermore, when mandated ESG disclosure is enforced, negative ESG incidents become less likely, and the danger of a stock market crash decreases. Mandatory ESG disclosure, according to the research, has both informative and real-world benefits.
Where we're heading: A global standard
The International Financial Reporting Standards Foundation (IFRS) announced in February 2021 that it will move forward with developing a worldwide sustainability reporting standard. The IFRS is supported by CDP, CDSB, GRI, IIRC, and SASB as the group of five collaborate to create a global standard for comprehensive corporate reporting. It is the first attempt by the five organizations to combine their existing standards frameworks to produce a common approach for reporting the impact of sustainability issues on company value.
Multiple stakeholders have expressed explicit support for the IFRS' work, including the International Monetary Fund, the UN, the Financial Stability Board, and the United States, which is looking to address ESG disclosure requirements that will support the Biden administration's climate agenda. The work of the IFRS was also accepted as an extension of the TCFD framework by G7 finance ministers.
ESG materiality assessments
With investors inquiring more and more frequently about what your company is doing in regard to responsible investment, how you treat employees and vendors, your dedication to sustainability initiatives, and other activities that fall under the ESG umbrella, it’s important to have answers to these questions.
An ESG materiality assessment empowers you to easily report on your current state and outline future initiatives while taking into consideration your business goals and risks. Download our guide to creating and extracting the maximum strategic value from an ESG materiality assessment.