ESG Focus: Merger Heralds Global Disclosure Regime

ESG Focus | Dec 14 2020

FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future:

-Push to create unified, standardised global ESG reporting standards
-The quest for financial materiality gathers pace
-World governments may finally be on the same page
-Corporations can be held legally liable for ESG reporting accuracy 

By Sarah Mills

Just weeks after the election of Joe Biden, it has been announced that the Sustainability Accounting Standards Board and the International Integrated Reporting Council (IIRC) will merge into one global organisation called the Value Reporting Foundation (VRF).

The merger is expected to create the most comprehensive corporate global sustainability framework to date and will be completed by mid-2021.

Backed by international legislation, it will cast social disclosure nets around the world to ensure that the massive covid stimulus and ESG dollars being directed towards investments that support environmental and social aims is finding its mark; and to battle "greenwashing" and “social washing”.

Announcing the merger, IIRC CEO Charles Tilley said: “Our focus is in on ensuring businesses have effective governance over enterprise value creation factors and that investors are able to fulfill their role as stewards.”

The VRF will be headquartered in London and San Francisco and will not only integrate SASB and the IIRC, but will advance the work of the Climate Disclosure Standards Boards (CDSB).

In time, the VRF may also subsume the CDSB, the CDP Charity, the Global Reporting Initiative and even the Taskforce on Climate Disclosure (TFCD).

A rose may not always be as sweet by any other name

The foundation aims to simplify sustainability disclosure by creating a single, unified reporting framework for sustainability metrics globally.

At present, there are many different reporting frameworks and few provide meaningful information to investors. 

– There is voluntary disclosure, in which corporations can pick and choose which metrics they report on, and whether they report at all.

– Many are familiar with narrative disclosures, in which a corporation tells a story about its sustainable progress but, similar to voluntary disclosures, they lack specificity and have gaps.

– Under various reporting requirements, companies can disclose measures taken to improve sustainability but not the outcomes of those measures.

– There are various quantitative and financially material disclosures but these are often based on divergent methods and criteria from nation to nation.

Other problems associated with ESG reporting include the fact that companies report on different topics; and that disclosures are located in different formats, often on company websites, and outside of the exchange and tax frameworks. So there is no one-stop shop to find information, let alone standardised reporting.

A final issue is that of different audiences. In an era of stakeholder capitalism, corporations are expected to report on issues relevant to all their stakeholders. But this information may be very different to the financial materiality required by investors.

Capital markets require transparent, evidence-based data upon which to base their decisions and the case for financially material ESG reporting has been gaining momentum.

In its 2021 US Equity Outlook, Goldman Sachs bemoans the lack of quantitative data in the ESG space.

“Policy intentions rather than quantifiable metrics continue to dominate the majority of available information and disclosures across companies are not standardized,” says the analyst. 

“Although the availability of numeric metrics has risen in the past few years, they still comprise only 25% of the criteria used in most ESG analysis.”

The establishment of the global VRF represents a significant and welcome (at least by large investors) step to improve this state of affairs.

The IIRC framework and SASB standards are complementary. Integrated reporting describes all relevant value creation topics and the approach to integrating them in corporate thought and reporting. SASB provides the precise definitions of the data that should be reported for these topics in each industry. 

Hence it is hoped the merger will create a reporting requirement that will provide transparency through the financial materiality of sustainability and into value creation.

“Capital markets are hungry for information linked to enterprise value creation but they cannot easily digest what comes from a fragmented reporting landscape,” SASB chairman Robert Steel told IR magazine. “This merger is an important step towards businesses and investors communicating with clarity and ease about the issues that matter most to financial performance.”

As part of the merger, the VRF has appointed senior advisers around the world.

The Australian situation

The VRF has appointed Ernst & Young’s Partner for Climate Change & Sustainability Services, Terence Jeyaretnam, as senior adviser to Australia. 

“Until recently, SASB has been very US-focused, but that is changing,” says Jeyaretnam in an online interview.

“As part of efforts to increase its reach, the organisation earlier this month [November] appointed me as senior adviser in Australia, as one of a new global network of specialists. SASB standards help investors and companies drive performance through comparable, reliable, and decision-useful information.” 

It is probably too early for the issue to have garnered much attention from the Australian Tax Office or Treasury.

FNArena contacted the Australian Council of Superannuation Investors (ACSI) on the issue but received no response, leading this writer to assume they perceive the announcement to be a low priority at this point in time.

Given the merger will not be completed until mid next year, it appears that major domestic news regarding the integration of SASB metrics into tax or ASX reporting is unlikely to arise in 2021.

But the ASX and ACSI provide ESG reporting guidelines for corporations, and given these were broadly adopted by most major ASX-listed organisations in 2020, it is fair to assume the appointment of Jeyaretnam means corporations can expect significantly more activity on this front over the next two years.

The international rollout

Mandatory ESG disclosure is expected to become a global norm. 

The international rollout of SASB industry standards is proceeding, with French, German, Japanese and Spanish translations expected to be published in early 2021 for the organisation’s 77 industry standards.

Janine Guillot has been appointed Global CEO of the merged entity.

Europe has introduced a taxonomy to standardise the way in which sustainability metrics are integrated into financial systems. 

This year, the European Securities Market Authority (ESMA) rolled out a Sustainable Finance Strategy that builds on ESG disclosure frameworks for transparency around sustainability factors and risks. 

European governments are also implementing the European Commission’s Non-Financial Reporting Directive. It provides guides to embedding key topics and metrics into core management and reporting functions, deciding where to disclose, determining how to use SASB Standards alongside other standards and frameworks, and assessing materiality and readiness to report.

Financial and securities regulators or stock exchanges in more than 80 counties are working on standardising ESG information for investors. At least 12 exchanges require listed companies to report on ESG information.

IR Magazine reports that the IIRC guidelines have already been well received in France, the United Kingdom and Australia

The magazine notes that out of 454 companies that have reported SASB metrics (a US organisation) up until the end of October, 42% are domiciled outside the United States – a 288% increase in the year to October 31, 2020. This highlights that one of the biggest obstacles to developing standardised ESG reporting, to date, has been the United States.

The Trump Administration has been pushing back aggressively on the rollout of ESG legal and regulatory reporting frameworks that have been in inception since the 1970s. But this is expected to change under President-elect Joe Biden, pending bipartisan support in the Senate.

The Republicans have particularly resisted the incorporation of the SASB standards into the 10K tax filing forms, often backed by key US governing bodies.

The Securities and Exchange Commission’s (SEC) chairman Jay Clayton was quoted in Forbes in May as saying:

“I have not seen circumstances, where combining an analysis of E, S and G, together, across a broad range of companies, for example, with a ‘rating’ or ‘score’, particularly a single rating or score, would facilitate meaningful investment analysis that was not significantly over-inclusive and imprecise.” 

Indeed, many in the US are against the broadening of reporting frameworks, critics claiming that ESG reporting can obfuscate poor financial performance. They site gaps and inconsistencies in reporting that limit their usefulness and comparability.

They also complain that asset managers can charge higher fees for ESG funds in the US, which creates an incentive for funds to jump on board – although this appears to be a weak argument. 

But much comes down to the fact that many in the Land of the Free also associate the standards as an attack on sovereignty from those pesky Europeans, and would happily toss ESG standards, along with the tea, into the Boston Harbour (or in this case, the Hudson River).

Hence, voluntary uptake of SASB standards in the US has been weak, with only 30 major organisations adopting them voluntarily. Even those that choose to adopt them can engage in selective reporting: only reporting on metrics that cast them in a favourable light, which does little to enhance transparency.

Yetas mentioned above, a Biden Administration may well alter this state of affairs.

And it appears the SEC may be succumbing. On May 14, 2020, a subcommittee of the SEC Investor Advisory Committee recommended the SEC start a process to update reporting requirements to include “material, decision-useful, ESG factors”.

Those in favour are pushing ahead

Bloomberg, meanwhile, has developed ESG stock benchmarks based on the SASB metrics, laying the foundations for further integration of SASB into the reporting landscape. Bloomberg’s founder, Michael Bloomberg, plans to encode standards in federal regulation. 

He says he would urge the US Securities and Exchange Commission (SEC) to adopt a rule “requiring companies to publish information on the racial and gender composition of their boards, senior executives, hiring, pay and procurement,” as well as “climate risks”, according to The Wall Street Journal.

SASB, meanwhile, is licencing its metrics, topics and technical protocols. 

FNArena called the ASX to determine the exchange’s position on the SASB standards but the organisation was unable to reply before this story went to print. 

Institutions pressuring companies.

Until legislation is in place, institutional behemoths such as Blackrock, Vanguard and State Street are pressuring companies to adopt SASB and TFCD frameworks “voluntarily”. 

SASB reports that institutions managing US$30trn in assets back sustainability reporting.

Blackrock has asked companies in which they invest to publish in line with SASB and TCFD by December 2020. Blackrock will deem failure-to-comply as indicative of poor management of ESG risk.

Blackrock has said that for now, companies can disclose similar data sets in a manner relevant to its business – this year. The ante is expected to rise over 2021.

State Street, meanwhile, has developed its R-Factor score, a reporting roadmap that draws on “multiple data sources and leverage[s] widely accepted, transparent materiality frameworks from the SASB and corporate governance codes to generate a unique ESG score for listed companies”.

The “too big to fail” financial organisation has indicated that it will take voting action against board members at companies on major indices that lag on R-Factor scores, and who cannot articulate how they planned to improve their scores.

Massive challenges for corporations

Given the astounding acceleration in ESG adoption in the past two years, and the flurry of green and social stimulus, it is possible that many corporations will start to view the standards as less of an impost, particularly if they wish to position themselves as stimulus recipients and candidates for the US$59trn of institutional investment flowing into 21 countries.

But there are considerable hurdles for companies to overcome, the most significant being the costs and liabilities associated with material reporting.

The Harvard Corporate Governance blog discusses the feasibility of implementing adequate internal controls over ESG and points out that ESG disclosure may contain liability risks if materially inaccurate or misleading:

“There is a legal liability associated with an issuer’s ESG disclosure; there are likely to reputational consequences for any material inaccuracies or failures to comply with the issuer’s publicly stated ESG commitments,” says the Harvard blog.

It advises companies to ensure their ESG statements are feasible and that they can meet their commitments. “This requires robust control procedures as with any public disclosure,” says Harvard. Corporations will have to deal with many other complications.

Companies with international operations, for example, may be subject to jurisdiction specific disclosure requirements going forward, such as in the European Union. Corporations may also find themselves subject to reporting requirements under some material contracts, particularly with governments. 

The green bond market is likely to prove another minefield. 

Green bonds usually require borrowers and issuers to measure and report on agreed metrics that determine, in part, the interest payable under the bond. Sometimes ratings agencies set these standards and they must be met.

ESG-linked indices such as the Dow Jones Sustainability indices, and exchange-traded funds also have their own metrics and standards for inclusion, and issuers will have to weigh up the value of such inclusions and may be forced to adapt their disclosures. 

These “complications” mean that simplification and standardisation will be critical to the successful adoption and incorporation of meaningful sustainability metrics into company accounting software, processes and procedures.

That is the task of the Value Reporting Foundation – no mean one at that.

FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future:

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