Globally, there has been an uptick of landmark regulations forcing companies to address sustainability issues like climate change, and to disclose the work they are doing to address these issues. On July 31, 2023, the European Union (EU) adopted the European Sustainability Reporting Standards (ESRS) and published them as “final rules” for the Corporate Sustainability Reporting Directive (CSRD), the most far-reaching set of disclosure requirements companies have to comply with, covering 12 environmental, social, and governance (ESG) standards. CSRD will affect large US companies that have over 250 employees in the EU, and €40 million in net revenue or more than €20 million in total assets. For the first wave of companies affected, sustainability reports will be required as soon as fiscal year 2024.
In parallel, the U.S. Securities and Exchange Commission (SEC) is in the process of finalizing climate related disclosure requirements. These requirements will likely mandate publicly traded companies to disclose their greenhouse gas (GHG) emissions footprint, climate-related goals, and progress, as well as climate-risk related financial impact and expenditures. These disclosures will need to be filed as part of the company annual 10-K statements, potentially as soon as the 2024 fiscal year if the final ruling is published by October 2023 as currently expected.
Moreover, the International Sustainability Standards Board (ISSB) released the final versions of its first two global sustainability disclosure standards for financial reporting (the ISSB Standards) at the end of June 2023. These standards have wide support and are expected to be adopted by a significant portion of the countries and jurisdictions that follow International Financial Reporting Standards (IFRS) across the world.
These proposed regulations and standards represent a significant shift from today’s largely voluntary climate disclosures, requiring companies to adhere to regulated disclosures. For example, the regulated disclosures could be anything from estimates around Scope 3 emissions, to investor-grade data. In many of these cases, the outcome could be no assurance to limited assurance and then reasonable assurance over time.
While most companies have historically published annual Environmental Social Governance (ESG) reports long after their annual financial statements, it is likely that the SEC will require companies to disclose ESG data with financial statements. The process will accelerate the pace at which ESG data will need to be collected, verified, and incorporated into these financially material investor disclosures. Similarly, the ISSB and CSRD requirements, if adopted by member countries, will require sustainability disclosures in American multinational companies’ authoritative financial filing for those countries.
Key challenges in meeting Sustainability disclosure requirements
For most companies today, meeting this wide range of requirements will force accelerating the maturity level of ESG data quality, data management, and governance controls, as well as streamlining the ESG reporting processes to ensure auditability. This is because the proposed regulations mandate a higher level of (a) Transparency, (b) Analytical and Process Rigor, and (c) Assurance, than most voluntary reporting frameworks have required to date.
CSRD requirements are based on “double materiality,” meaning that any covered company must report both on how its business is affected by sustainability issues and how its activities impact society and the environment. In 2021, the EU stated that the CSRD proposal “aims to ensure that companies report reliable and comparable sustainability information needed by investors and other stakeholders.” Similarly, when the SEC announced the proposed regulations in 2022, SEC Chair, Gary Gensler indicated that the intention of the regulation was to “provide investors with consistent, comparable, and decision-useful information for making their investment decisions.” The regulations mandate a level of transparency and consistency that will build upon what is only sometimes reported on in today’s ESG reports, including disclosing the level of total emissions, before offsets, as well as disclosing any offsets. Additionally, the SEC proposal requires any company that has announced climate-related goals to disclose the scope and structure of the goal. This includes discussions on how the company intends to meet its goals, whether progress has been made and if not already in place, plans to meet stated goals.
The overall recurring theme in these regulations is that companies can no longer pick and choose what they disclose or use ESG disclosures to paint the company in the best light. It is about accountability and driving comparability for real impact. Companies will therefore need to ensure constant data hygiene and data management controls to enable visibility and transparency for investors, sustainability activists, raters and rankers. Moreover, they will need to disclose ESG current state as well as committed future state, with traceable progress.
Analytical and process rigor
The high level of analytical rigor required by the various regulations has increased from previous standards. For CSRD, ISSB and SEC, this is especially apparent in the requirements to assess climate-related risks and related business resilience. For example, the SEC could require companies to describe any analytical tools, such as scenario analysis, that they use to assess the impact of climate-related risks on their business and consolidated financial statements. They would also need to disclose processes for identifying, assessing, and managing climate-related risks and whether any such processes are integrated into their overall risk management system or processes. Furthermore, companies would need to disclose the price and rationale for internal carbon prices. To add to the complexity, different regulations may define boundaries differently, which means emissions and other sustainability impacts from direct and indirect business relationships will need to be analyzed and reported differently for these regulations.As such, there is a need for companies to ensure they utilize strong analytical skills and tools, as well as streamlined processes to address climate risk assessments and other sustainability disclosures.
Both the CSRD ruling and SEC proposal mandate some limited assurance to begin with, moving to reasonable assurance after a period of time. Today, sustainability information may be rife with human error, mostly driven by the complexity of data calculations (e.g., for emissions inventories) and the multitude of data that needs integration and conversion. To move to limited then reasonable assurance, companies must be ready to subject their sustainability data and processes to extensive testing of controls, data verification, assumptions validation and analytical methodologyscrutiny.Companies must therefore move towards more automation, streamlined workflows and systems integration. This will quickly combine and transform source data, and ensure traceability while eliminating human error in reporting, therefore enabling attestation.
How to address the reporting challenges
It will be critical for companies to establish systems and processes that enable high quality data, continuous data hygiene and data management with embedded quality controls and governance. At IBM, we have been helping companies prepare for the upcoming regulations by beginning with an inventory of existing data, systems, and disclosures. We then perform a gap assessment to help clients understand the processes, data, automation, and systems integration changes needed to meet the many regulatory requirements based on the scope of their operations. Lastly, we help clients create and execute data and process automation and integration roadmaps to enable investor-grade, accessible and usable ESG reporting.
Common challenges our clients face at the beginning of this journey include siloed data and processes with different owners in the organization, inadequate ESG expertise and staffing, as well as the cost of adoption. As a leading systems integration company and a leader in sustainability services, we are helping our clients automate processes and integrate ESG data systems. This provides clients with our ESG expertise backed by decades of experience across the globe and helps them minimize the costs to change by accelerating insights and speed to value. Preparing for global disclosure requirements is a core imperative in future-proofing the business for increasing regulatory as well as investor and customer-driven ESG disclosures. More importantly, it enables companies to join peers and competitors in addressing the real risks posed by climate change, social issues and other sustainability initiatives to business resilience and continuity.
Americas Geography Leader, Sustainability Services, Consulting
Sarah Thuo, Global Sustainable Sourcing and Managed Services Leader
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Published at Fri, 15 Sep 2023 14:00:00 +0200