Friday, September 24, 2021

ESG reporting: Experts advise on how to start and what’s to come

By Lene Powell, J.D.

With the ever-growing volume of information about environmental, social, and governance (ESG) issues, it can be daunting for companies to know where to start with ESG reporting. At a recent accounting conference, public company reporting experts at Ernst & Young and Bank of America offered advice on how to approach ESG reporting in a manageable way. The panel also gave an overview of current voluntary and regulatory reporting frameworks.

The panel took place September 22, 2021 at the Conference on Banks & Savings Institutions hosted by the American Institute of Certified Public Accountants (AICPA) & Chartered Institute of Management Accountants (CIMA). The panel was moderated by Dom Giuffrida, partner at Ernst & Young, and included Marc Siegel, Americas thought leader for corporate and ESG reporting at Ernst & Young, and Mike Tovey, corporate comptroller at Bank of America.

How to get started on ESG reporting? In developing an approach to ESG disclosures, Siegel said first, companies should understand they do not have to do everything, and in fact cannot do everything. It is also not an on-off switch where a company will have all its disclosures ready simultaneously. It is a journey and will take time, said Siegel.

To start, many organizations begin with a materiality assessment. Siegel explained that in this context, “materiality” is meant in a generic sense, not a legal sense. In the assessment, a company maps ESG issues to business issues to find the issues most relevant to its own business. Then the company can focus on those and not worry about the others, said Siegel.

Next, a company can decide which players to focus on in choosing standards and frameworks.

Who are the major players? In the voluntary ESG space, Siegel sees the major players as sorting into four “buckets”:
  1. Standard setters. These are organizations, mostly NGOs, that recommend disclosures for companies interested in reporting on a voluntary basis. These standards usually feature specific qualitative and quantitative disclosures. This category includes the Global Reporting Initiative (GRI) and Sustainability Accounting Standards Board (SASB).
  2. International goals and guidance. These are higher-level frameworks that usually do not recommend specific disclosures, but rather categories and corporate governance that companies might consider. This category includes the Integrated Reporting Framework, Task Force on Climate-Related Financial Disclosures (TCFD), and UN Sustainable Development Goals (UNSDG).
  3. Disclosure-based sustainability scorers. These determine which companies get into ESG indexes like the Dow Jones Sustainability Index. NGOs send questionnaires asking questions—typically a couple hundred—and the companies that score in a top tier get included in an index. Companies are inundated with these questionnaires and try to figure out which ones to fill out and which ones to disregard.
  4. Rating agencies. These entities take data both from what companies publish as well as from external sources provided by third parties. They feed all the info into a scoring algorithm and come up with a score. The algorithms are typically opaque and scores can vary between rating agencies.
Investors are starting to coalesce around SASB and the Task Force on Climate-Related Financial Disclosures (TCFD), said Siegel. These standard setters are specifically focused on an investor audience. In contrast, GRI, though extremely popular in some parts of the world, is focused on total stakeholder audience, not just investors.

One benefit of SASB is that it is industry-specific, which helps identify the issues most likely to be important to investors in those industries, said Siegel. For example, it is possible to look up different standards for different industries in the financials category, like commercial banking, insurance, investment banking and brokerage, etc.

TCFD is also popular because it links climate-related risks and opportunities to financial impact, said Siegel. He added that it looks like TCFD is going to be mandatory in the U.K.

Speaking from a preparer’s perspective, Tovey said the Bank of America uses an “inclusive capitalism” orientation that considers all stakeholders. Bank of America reports using standards from GRI, CDP, SASB, TCFD, and the World Economic Forum’s International Business Council. There’s no one “silver bullet” report that covers everything about ESG, said Tovey. Therefore, companies should ask their investors and clients what information they want to know.

In the environmental space in particular, Tovey agreed that investors are coalescing around TCFD. It is intuitive and the standards are broken down into governance, strategy, risk management, KRIs, and KPIs. SASB is also useful because the metrics can be reported on relatively easily and then compared within and across industries, said Tovey.

What is the U.S. regulatory landscape? In the U.S., most ESG disclosures so far have taken place outside of SEC filings, said Siegel. However, with the new SEC human capital disclosure rule adopted last August, companies have started reporting on that topic in SEC filings.

Siegel sees two different areas the SEC is going to focus on in the near term, which will probably end up in two different proposals, potentially before the end of the year. First, there will be a relook at the human capital disclosure rule. The current rule is mostly principles-based and did not require any new data disclosures, or metric disclosures other than number of employees. But the coming proposal will likely mandate some specific human capital disclosures, said Siegel.

While there is no clarity what the coming human capital disclosures will be, Siegel observed that SEC Chair Gary Gensler tweeted that some of the things he is thinking about include workforce turnover, which could be just a percentage of workforce turnover, and skills and development training. That could go a number of ways, but could include dollars invested in training, hours invested in training, and compensation benefits.

Another key human capital area is workforce demographics. Siegel noted that in their annual letter earlier this year, State Street said they are looking for the biggest companies in the world to be disclosing specifics on their diversity. Specifically, State Street is looking to see companies’ EEO-1 reports, a workforce diversity report filed with the Department of Labor. Although State Street is not necessarily asking for it to be filed in a 10-K, they are asking for the biggest companies to disclose the report somewhere.

Health and safety is another important human capital area, said Siegel. particularly after the last year and a half.

Turning to climate disclosures, Siegel said that climate change is huge on the President’s agenda, and the SEC will likely issue a specific proposal for disclosures. Siegel believes that Gensler thinks he has a mandate to impose climate disclosure rules, in part because 75 percent of comment letters that came in earlier this year are looking for mandated climate disclosure rules.

Siegel expects to see specifically information around greenhouse gas emissions. Likening it to the fair value framework, Siegel envisions three scopes. In Scope One, you kind of know what it is, and in Scope Two, you can figure it out. In contrast, Scope Three is “Yikes”, said Siegel, indicating lack of certainty. The disclosures could be proposed to be included in the 10-K. There could also be qualitative disclosures that mirror TCFD. As to assurances, the SEC may or may not provide a roadmap to getting disclosures assured, said Siegel.

Tovey agreed that something will come from the SEC and that it will be significant. He noted that Gensler gave information about the SEC’s direction in a speech to the Principles for Responsible Investment (PRI). Gensler compared instituting climate disclosure requirements to past seismic shifts in financial reporting, as for example when MD&A was instituted. There was pushback at first, but in time the new requirements became widely accepted. Tovey noted further that climate emissions disclosures could be challenging because the underlying science is not black and white.

The Fed is also looking closely at ESG and has joined the Network of Central Banks and Supervisors for Greening the Financial System, said Tovey.

Regarding FASB, Siegel noted that FASB has an agenda consultation out, and he is sure they will get requests around ESG. He does not think it will be a binary outcome of will FASB get involved or not, because where there are assets and liabilities in this area, FASB already is involved. They have issued an educational paper showing where under current GAAP, there might be things companies have to consider around climate change, AROs or contingencies, etc. And IASB has done the same with what IFRS requires. That said, Siegel does not think FASB will get out ahead of the SEC on ESG reporting. Rather, they will take their cue from the SEC.

Siegel observed that the IFRS Foundation is expected to launch a new global International Sustainability Standards Board. He thinks they will probably announce it with the COP26 conference in late October or early November. While IFRS is not required in the U.S., if the IFRS foundation does it right, the new board could end up getting rid of some of the current alphabet soup of competing standards, said Siegel. He does not want the new board to get ignored and have nobody send in comment letters, and then suddenly they issue standards. He advises paying attention in this area.

What about the non-U.S. landscape? In the E.U., Europe has issued a fairly comprehensive ESG package of disclosures, said Siegel. One part is the Corporate Sustainability Reporting Directive (CSRD), which would scope in not just European companies, but any non-European company that either is listed in the E.U. or has “significant undertakings” in the E.U., which could mean a company has a couple hundred employees in the E.U. This mandates ESG disclosure and also mandated limited assurance on that disclosure, and it is supposed to be integrated into the into the management report.

Tovey reported that the European Central Bank has issued a document that they called guidelines, which are embedded into an interpretation of the capital requirements directive and the capital disclosure directive. This means that if you think that climate risk is material to you, then it needs to be considered in your capital assessment processes and in your disclosures, said Tovey. The U.K. also came out with similar documents, as well as the Hong Kong Monetary Authority (HKMA), the Australian Prudential Regulation Authority, the New Zealand prudential regulator, Japan, Malaysia, Indonesia, and more.

Europe has also issued a “green taxonomy” requiring companies to produce a balance sheet classified by green assets, said Tovey. There is a very detailed set of criteria to evaluate all a company’s investments, and companies are going to have to report on a green asset ratio. This will be public in the next couple of years, but companies have to start reporting that to the regulators from the end of this year, said Tovey.

Likewise, Singapore has issued a proposal on its own green taxonomy, the U.K is thinking about one, and the U.S. will also likely see its own green taxonomy. But as with GAAP and IFRS, Tovey doubts the standards will ally, and so for companies with global operations it is going to be a “mess” to deal with.

“It's really a global tidal wave of environmental disclosure and risk management practices that have been embedded into existing risk management frameworks that prudential regulators are using,” said Tovey. “I think the point here is you cannot ignore it, because it's coming, and it's going to impact everyone.”

Advice: get started and tell your story. Siegel advised that entities should not wait for somebody to tell them what they need to do, because what is mandated is not necessarily going to tell the organization’s story.

“You might as well get started and try to figure out what does tell your story, and start working on finding the data, collecting the data and reporting the data, or even qualitative information around it to get started along that path,” said Siegel.