ESG, the SEC, and the IFRS Foundation

From the IFRS Institute – August 27, 2021
 

The Environmental, Social and Governance reporting landscape is rapidly evolving. Companies are advancing their voluntary reporting amongst a myriad of standards and frameworks, while at the same time governments, regulators and supranational organizations are imposing or expanding mandatory requirements. Against this backdrop and with widespread support, the IFRS Foundation is moving forward with the creation of a new International Sustainability Standards Board that would develop a set of baseline disclosures that countries and jurisdictions could build upon. In this article, we explain these developments from the perspective of preparers in the US following IFRS® Standards.

What’s at stake for preparers?

The ESG reporting landscape has developed organically over many years, with companies largely determining their own reporting needs and following one or more of the numerous frameworks and standards available. In recent years, mandated reporting has become more common, most notably in the European Union under the Non-Financial Reporting Directive.

KPMG has been surveying sustainability reporting trends since 1993. Our first survey showed 12% of the 100 largest companies in 52 countries reporting on sustainability. In the latest 2020 survey, that number was 80%.

Usually a discussion about standard setting is based on where a company has reporting obligations, and for dual preparers that means a discussion about IFRS Standards versus US GAAP. However, ESG reporting is different. Yes, one aspect is about reporting obligations; a company listed in both the EU and the US will be concerned about the potential need to collect and report two different sets of ESG metrics.

But ESG reporting goes beyond a company’s traditional financial reporting boundaries and obligations. As companies seek to establish their ESG strategies and report robust and timely metrics, they are increasingly seeking assurance along all elements of their supply chain and into their customer base. While not the only factor, a fractured landscape of reporting requirements adds to the uncertainty as companies seek clarity about what is expected of them.

Existing ESG reporting frameworks or standards have been developed largely independently – some designed for the benefit of investors and some designed for a broader group of stakeholders. The related organizations increasingly recognize the need to work together for a common purpose. For example, leading global ESG reporting organizations have published a prototype for an approach to climate-related disclosures¹, and the US-based Sustainability Accounting Standards Board has merged with the International Integrated Reporting Council with the intent of simplifying the corporate reporting system.

While we welcome all efforts aimed at closer cooperation between organizations that would reduce diversity in reporting, we believe that a codified effort under the umbrella of a single standard setter would achieve a faster and more consistent reporting baseline. This is why the IFRS Foundation’s initiative to create a new International Sustainability Standards Board is so relevant.

About the International Sustainability Standards Board

The proposed ISSB would be based on the following principles.

• Investor focus. Standards would be designed to provide decision-useful information for investors and capital markets, and not broader stakeholders (e.g. customers, employees, local communities).
• Climate first. Working within a broader sustainability remit, the ISSB’s initial focus would be climate-related disclosures.
• Building on existing frameworks. The ISSB would seek to build on the mature work already done by leading ESG organizations. In particular, the ISSB would consider the work of the Task Force on Climate-related Financial Disclosures (TCFD) in developing proposals related to climate; a working group is currently looking at further developing the climate prototype published by leading global ESG reporting organizations.¹
• Building blocks approach. The objective of the IFRS Foundation Trustees is for the ISSB to develop “a globally consistent and comparable sustainability reporting baseline, while also providing flexibility for coordination on reporting requirements that capture wider sustainability impacts.” This approach would allow national and regional jurisdictions to build on that global baseline to set supplemental standards that serve their specific jurisdictional needs.

The proposals have received widespread support, including from the Financial Stability Board, G20 Finance Ministers and Central Bank Governors, and the International Organization of Securities Commissions.

The last step in the process to facilitate formation of the ISSB is changing the IFRS Foundation’s constitution; the comment period on proposed amendments closed at the end of July. Following finalization of those amendments, the creation of the ISSB is expected to be announced ahead of the UN Climate Change Conference (COP26) in November.

How the ISSB intersects with ongoing regulatory developments

As the ISSB heads toward formation, some countries and jurisdictions are moving more rapidly. The SEC is expected to issue proposals for comment in the final quarter of 2021, while the EU issued a proposal for expanded ESG reporting in April 2021. For preparers in the US following IFRS Standards, this raises understandable questions about how the ISSB intersects with regulatory developments and what this means practically.

SEC guidance released in 2010 highlighted climate-related matters that may be relevant when considering various Regulation S-K disclosure requirements; in February this year, the SEC announced that the staff would review the extent to which registrants address the topics identified in the 2010 guidance. In addition, principles-based disclosures about human capital came into effect in 2020 as part of the SEC’s modernization efforts.

The SEC has indicated that it will issue specific proposals in three areas: climate change, human capital (in particular, diversity) and cybersecurity risk governance. As input to helping the staff develop proposals, then-Acting SEC Chair Allison Herren Lee issued an informal request for public comment in March. Comments closed mid-June, with over 550 unique comment letters received.

From a review of comment letters and specific to climate change, our overall impression (across all constituents) is that the TCFD climate disclosures are most favored. SEC Chair Gary Gensler spoke to this in a recent speech, noting support for the TCFD disclosures and their endorsement by leading ESG organizations. He noted that he had ”asked staff to learn from and be inspired by these external standard setters” but cautioned that the SEC should write rules and establish a disclosure regime appropriate for US markets.²

Although the SEC may be moving more quickly than the ISSB with its 2021 regulatory agenda already published, and with a focus clearly on US markets, this does not necessarily signal a lack of support for the work of the ISSB. In particular, consideration of the work of the TCFD is clearly in the thinking of both the SEC and the IFRS Foundation, which could mean that climate-related disclosures converge over time with a global baseline emerging.

Developments in the EU have also been at a faster pace, with the proposed Corporate Sustainability Reporting Directive effective for financial years starting on 1 January 2023 or during calendar year 2023 – covering an extensive range of ESG topics and based on information that is material to ‘other stakeholders’ as well as investors (so-called ‘double materiality’).  In addition, limited assurance over the disclosures would be required on the first report.

The proposal requires the Commission to take account of other standards and frameworks for sustainability reporting in adopting standards, while also considering additional Europe-specific needs and public policy objectives. In that regard, the European standard setter is actively liaising with leading ESG organizations, including the IFRS Foundation trustees, and in July signed a statement of cooperation with the Global Reporting Initiative; one of the headline messages in the press release was “Working towards international sustainability reporting convergence.”³

Similar ESG reporting developments are happening in other countries. For example, all UK premium listed companies are required to report on the TCFD climate disclosures (on a comply-or-explain basis) from 2021, and the Australian Prudential Regulation Authority has issued proposals that align with the TCFD disclosures.

The takeaway: Act now

ESG reporting, and in particular climate-related disclosures, is inevitable if not already in place. Although many companies are reporting on sustainability, our survey shows a significant drop-off when looking specifically at climate risk; and only 20% of companies reported in line with the TCFD recommendations.

We are monitoring proposals. In our view, without a global framework, disclosures will be less consistent and comparable; companies operating across jurisdictions (not least through their supply chains and customer bases) will have less clarity as to what is expected of them; and achieving reliability will be more costly because of the lack of standardization.

However, companies should be formulating their ESG reporting strategy now. The TCFD climate disclosures are clearly emerging as the frontrunner and our view is that companies should not wait. Start by understanding the concepts underpinning the TCFD recommendations: risk, opportunity, governance, reporting.

While standards may evolve, it is better to have a strategy and make tweaks than to wait and start from scratch. An effective strategy is led from the top, is embedded in operations, and involves stakeholders across the organization – and it takes considerable time to understand, set a strategy, get buy-in throughout the organization and then implement.

Don’t wait.