Alphabet soup or acronym salad? The main meal is yet to come...

Alphabet soup or acronym salad? Either way, the main meal is yet to come…
26th October 2020 Judy Kuszewski
Judy Kuszewski
In Insights

It seems, among many unexpected things 2020 has brought, the time of ESG may be upon us. Or at least you would be forgiven for thinking so, what with the non-stop parade of announcements, consultations and initiatives over the past few months, mainly in the world of sustainability reporting.

The most substantial development, at least in my view, is the announcement by the European Commission at the beginning of the year to revise the Non-Financial Reporting Directive (NFRD) with the aim to create European sustainability reporting standards and mandate their use by businesses operating in the EU. I could easily write a whole series of articles on this alone, and the effort has only just begun.

But Europe isn’t the only place where you will find action on ESG. We’ve seen the World Economic Forum join the fray, alongside not one but two separate announcements on collaboration from the big sustainability reporting standards-setters and frameworks. Investors and governments alike are stepping up support for reporting against the Taskforce on Climate-related Financial Disclosure (TCFD) recommendations. And, most recently, the IFRS Foundation, responsible for the oversight of globally-mandated financial disclosure requirements, has opened a consultation on a possible future role for IFRS in sustainability reporting.

According to some observers, there is already too much activity in the reporting world – the obvious ‘alphabet soup’ metaphor has been rehearsed at length recently. Yet there is also frustration with the overlapping, parallel worlds of reporting, third-party accreditation, commitments frameworks and ratings agencies (among others), which may all be applied inconsistently or piecemeal, or may take the same company disclosures and turn out vastly different analyses from one another, rather like a tossed salad of different ESG ingredients, not all of which work well together.

This picture may not exactly whet your appetite, and it is certainly fair to say it’s a lot to keep up with (these goings-on have even given rise to a new and very ‘specialised’ satirical Twitter account, although one imagines its audience is still fairly limited).

So I’d like to give you a bit of analysis and my own opinion on what’s really on the menu, and what’s still in the oven.

  1. The ‘plethora of reporting initiatives’ is less than it seems. There is no alphabet soup – only two major standards-setters and a small handful of frameworks comprise the vast majority of the sustainability reporting world. Firstly, the Global Reporting Initiative (GRI), whose standards cover a wide range of ESG topics, which issuers select from based on their relevance to the business, boasts some 8,000-10,000 reports issued globally. Next is the Sustainability Accounting Standards Board (SASB), whose sector-specific metrics are intended to describe only the sustainability issues that are judged to have a specific financial impact, and which are followed by some 300 reporting organisations at present, but this number is growing. Alongside these two sit the Integrated Reporting <IR> Framework, the Climate Disclosure Standards Board (CDSB), and the CDP (formerly Carbon Disclosure Project); altogether these five are considered the major players.
  2. On the other hand, it is fair to say there is a plethora of questionnaires and ratings to which companies may be subject, and here lies a significant degree of proliferation and inconsistency. The highest-profile of these include the questionnaires developed by MSCI, Sustainalytics, RepRisk and Moody’s among many others. Their purpose is to aggregate ESG performance data for thousands of companies at a time for use in investment analysis. Perhaps unsurprisingly, these questionnaires all differ, and vary from one year to the next, which in one sense is fair enough – after all, investors don’t all want the same things, and they don’t all take the same philosophy or approach to get there. They require significant effort from companies and are very often confused or conflated with the sustainability reporting standards in the landscape. This confusion afflicts companies and investors alike.
  3. Reporting suffers from problems with consistency and quality of information. Report issuers have discretion to use sustainability reporting standards and frameworks as they see fit, and this often results in uneven efforts across business. The answer to this isn’t to create a new framework, it’s to ensure consistent and appropriate application of the ones we’ve already got. The lack of consistent application of existing reporting regimes is driving the EU’s NFRD efforts to a large extent – it reflects frustration with inconsistent, cherry-picked reporting that lacks transparency and does not facilitate the sustainable transformation of the economy. To this end, the stated intention is that any resulting European reporting standards would be based on the best-established global standards, but would be mandatory for businesses operating in Europe. The assumption is that this would level the playing field, increasing consistency and comparability of information.
  4. The TCFD is making a big impact, at least in terms of commitment. Large numbers of businesses and investors are expressing their support for this central bank-led initiative, the aim of which is to reduce climate-related risk in the economy. For the time being, however, there is very limited actual reporting against the TCFD recommendations. This is to be expected for now, as there is a clear first-mover disadvantage to identifying and putting a monetary value on climate-related risk to a business, when the competition is not doing the same. Additionally, the first-movers will need to come up with mechanisms and reference points for reporting, which are likely to result in further inconsistency. At least some jurisdictions will introduce mandatory TCFD reporting requirements in the near future, following New Zealand’s
  5. Recent collaboration commitments announced by the five major players are still emerging – the most tangible outcomes we can expect to see at this point are limited to education materials that aim to make it easier for reporters to use several sets of standards at once. While this may be welcome, it will not be sufficient: what reporters really want is fewer frameworks – not mapping exercises or theoretical best-practices. They want to meet as many different expectations as they can with the limited resources they have available for reporting. We will have to see more serious efforts toward formal convergence of standards, at the very least reducing their divergence and increasing their practical interoperability, but ultimately fewer standards must be the result.

Moving forward…

Real convergence is not yet happening, but there is reason to hope that it will. The GRI has committed to taking a leadership role in the convergence of standards and frameworks by building-in ‘harmonisation’ with all relevant standards and frameworks as an explicit deliverable and modus operandi of their standards development work going forward, and is pursuing funding and collaboration to this end on its proposed priorities for 2021.

Meanwhile, the IFRS path forward is unclear, but worth watching. The IFRS financial reporting standards are mandatory in over 160 jurisdictions, and extending this scope to sustainability reporting would be an immediate game-changer. However, doing so would require a huge change in IFRS at a basic governance level, and it remains unclear whether or to what extent they seek to expand their scope into non-financial realms. The chairman of the IASB (the IFRS technical standards board), Hans Hoogervorst, recently expressed the view that there must necessarily always be a role for sustainability reporting alongside financial reporting; that the IASB can create financial reporting standards when the financial impact of sustainability issues is known. But, he notes, these issues may well be material for investors long before that point. I find I agree with this viewpoint, and expect that we will be seeking the best ways for financial and sustainability reporting to coexist, rather than merging or overtaking one another.

Taken altogether, it sounds like a lot of new activity on the reporting front, but so much is yet to come. What is clear is that eyes are on the sustainability reporting world like never before, and the expectations on companies to be transparent and accountable to markets, regulators and the public are only going to become more challenging. Many of our clients have been active reporters for many years, but we are all having to do more with less – a situation made all the more challenging by the increased attention it is gaining. We expect this to be a key feature of our client work in the months to come.

If you would like to discuss your approach to sustainability reporting, or what all the changes in external standards and reporting frameworks mean to you, please email judy.kuszewski@sancroft.com.