The global accounting profession has launched a single standard for company environmental, social and governance (ESG) reporting, raising expectations that the bewildering array of corporate sustainability disclosure systems will finally come to an end.
The new standard, published by the International Sustainability Standards Board (ISSB), is the product of 18 months of planning and consultation. It carries the weight and authority of ISSB’s parent organization, the International Financial Reporting Standards (IFRS) Foundation, the global organization that sets standards for the accounting profession.
By establishing a “global baseline” for sustainability reporting, the standard will “enable comparable and consistent sustainability disclosures across global capital markets,” according to ISSB.
The standard marks a frontier in corporate reporting, says Emmanuel Faber, ISSB chair and former CEO of French food products company Danone.
“We were standing till this morning on one side of that frontier,” Faber said in remarks June 26 in London at the launch of the standard. The framework will create an “accounting-based language,” he said, in contrast with existing “ESG metrics and disclosures which can be inconsistent, which can be competitive against each other, redundant, and overlapping with gaps.”
While ISSB can’t compel companies to adopt its framework (it’s a standard-setter, not a regulator), it has received widespread support, raising expectations it will be swiftly adopted by companies voluntarily, as well as securities and corporate regulators that can make the standard mandatory in their countries and regions.
Even before the standard was officially launched, it was endorsed by the IFRS Foundation Monitoring Board – which includes securities regulators around the world, including the U.S. Securities and Exchange Commission, the Financial Services Agency of Japan, and the U.K.’s Financial Conduct Authority.
“We encourage policymakers to adopt the ISSB’s new standards as this global baseline by 2025,” said Jane Goodland, head of sustainability at the London Stock Exchange.
“China is fully committed to supporting the work of the ISSB and the development of global sustainability disclosure standards,” said Zhongming Zhu, vice-minister of China’s ministry of finance, just before the launch.
The framework also received support from Canada’s 11 largest pension plans, representing more than $2 trillion in investment. “Companies have an obligation to disclose their material business risks and opportunities,” the pension plans’ CEOs said in a joint statement, strongly encouraging companies to voluntarily adopt the standard, although, importantly, they did not call on regulators to make the ISSB standard mandatory.
With an estimated 600 sustainability disclosure frameworks competing with each other, the vision of a single reporting system has been voiced at sustainable business and finance meetings for decades. The principle behind ESG reporting – what gets measured gets managed – cannot be achieved without consistent reliable sustainability disclosure.
The Global Reporting Initiative (GRI) has made significant headway over the years as the most dominant ESG disclosure system, but it is limited by its voluntary nature and focus on sustainability impacts, rather than financial materiality, which is of most interest to investors.
A breakthrough happened about 18 months ago at the COP26 climate summit in Glasgow when the IFRS Foundation agreed to form the ISSB and establish a single sustainability reporting framework. Created in 2000, the IFRS is a non-profit foundation that has become the global standard-setter for accounting principles. With ISSB, IFRS now adds sustainability standards to its accounting framework.
What will the ISSB standard measure?
The ISSB standard comprises two separate standards – S1, Sustainability and S2, Climate – although additional themes are under development.
The S1 standard requires companies to report any sustainability risks or opportunities throughout their value chains arising from their stakeholders, society, the economy and the natural environment.
Companies are required to report only if the risks or opportunities are material (if omitting, misstating or obscuring that information could be expected to influence decisions by investors or other primary users).
Those that do report will be required to provide detailed reports on their governance processes, strategy, risk- management practices, metrics and targets related to their sustainability risks and opportunities.
Companies adopting the standard are expected to start the reporting process in 2024, meaning the first reports will be public in 2025. While the standard doesn’t require verification by external auditors, it is expected that regulators and IFRS will eventually require it, similar to financial reports.
For S2, companies will be expected to report greenhouse gas emissions in line with the Greenhouse Gas Protocol (a global standardized framework), including Scopes 1 and 2 (direct emissions) and 3 (emissions by their end-users). Companies will also need to make detailed disclosures on assets or business activity vulnerable to climate risks, capital expenditures deployed to climate risks and opportunities, carbon pricing models, climate targets and whether targets affect executive remuneration.
While ISSB is starting with climate as a specific theme for reporting, it has said it wants to develop future thematic standards on biodiversity, human capital, human rights and how sustainability reporting is integrated into financial reporting.
Standard leaves door open for companies to under-report climate risks
A fundamental problem with the ISSB standard is that it is based on a financial materiality requirement for reporting, which means that disclosure of real-world impacts on people (human-rights violations, for example) or the environment (destruction of natural habitats, for instance) don’t necessarily need to be reported if they are not considered material by investors. It leaves the definition of materiality up to each company to determine, although this will likely be subject to verification by external auditors.
This could enable banks or fossil fuel companies, for example, to under-report climate risks or metrics based on an argument that fossil fuels will be needed for many years to come. This is especially true with the Ukraine war driving up oil and gas prices and demand in Europe.
Many corporations “really understate the risks of the sector that they’re operating in, and the risks of stranded assets,” says Carol Adams, an accounting professor at Durham University in the U.K. who also sits as chair of the GRI Global Sustainability Standards Board.
In an interview, Adams says that GRI is collaborating with ISSB to jointly develop a “double-materiality” framework, incorporating the impact standards of the GRI with the financial materiality standard of the ISSB.
The GRI standards are much more detailed than the relatively basic ISSB standard and cover specific themes, such as biodiversity, child labour, emissions, and labour issues, as well as specific sectors, such as oil and gas, coal and agriculture. They have been adopted through an exhaustive consultation involving NGOs and other groups directly involved in social and environmental issues. As such, they are not considered financially material by many companies, although they are welcomed by many ESG-oriented investors and other corporate stakeholders.
If GRI and ISSB agree on a joint framework for double materiality, it likely will be a tough sell to regulators in many jurisdictions, including the United States. Even making the ISSB standard mandatory in the U.S. is not under active consideration, as Republican lawmakers pressure the Securities and Exchange Commission to relent on recent climate emission disclosure proposals similar to the ISSB S2.
But with the European Union soon to adopt a double-materiality standard under its Corporate Sustainability Reporting Directive as part of Europe’s Green New Deal, companies that report under the GRI already fulfill the basic requirements of the new European regulation.
Adams is hopeful that similar impact and financial materiality reporting will spread to other jurisdictions.
“It’s going to be a challenge increasing impact reporting and also getting organizations to report fully on their risks and opportunities,” she says. “But it’s a challenge worth fighting for.”
Eugene Ellmen is a former executive director of the Canadian Social Investment Organization (now Responsible Investment Association). He writes on sustainable business and finance.
