Increased pressure from investors and stakeholders for regulators to streamline ESG disclosure standards is starting to bear fruit.

By Paul A. Davies and Michael D. Green

As 2020 draws to a close, it is clear that standard-setters have made significant progress in harmonising environmental, social, and governance (ESG) disclosure frameworks. The launch of new initiatives in recent months shows that stakeholders recognise both the value of streamlining ESG disclosures and the importance of consolidating such disclosures as soon as possible. Organisations are also keenly monitoring developments. For example, the Basel Committee on Banking Supervision is actively tracking the initiatives outlined below in an effort to leverage its work and facilitate information-sharing across parallel initiatives.

A timeline of notable initiatives

In June 2020, the Investor Advisory Committee and Asset Management Advisory Committee of the US Securities and Exchange Commission (SEC) drew attention to the growing need for action on ESG. The two Committees, which were created to advise the SEC on its regulatory priorities, recommended that the regulator update its reporting requirements to incorporate material, decision-useful ESG considerations. A resounding theme was the need to ensure consistency in the way that companies report ESG data, risk and, opportunities. Additionally, the Committees made pleas for companies to put ESG data into context and be mindful of its role in their business plans.

In August 2020, the Chartered Financial Analysts Institute (CFA Institute) launched a consultation on ESG disclosure standards for investment products to establish a standard in describing and understanding the ESG financial products on the market. The consultation paper noted the concern of several market participants with respect to consistency and variation in the use of ESG terms. As a response to this perceived problem, the CFA Institute established an ESG working group to develop proposals for a voluntary global standard that would allow investors to understand the features offered by a particular product and to make comparisons.

In September 2020, a group of standard-setters signed a pledge to collaborate on comprehensive corporate reporting. The group includes the Carbon Disclosure Project (CDP), the Climate Disclosure Standards Board (CDSB), the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC), and the Sustainability Accounting Standards Board (SASB). As the pledge emphasises, research now shows a correlation between sustainability performance and drivers of enterprise-value creation. In this context, both companies and investors / asset managers would benefit from a better understanding of sustainability-related risks. Greater clarity in ESG reporting can, in this group’s view, be delivered through reporting that is more consistent and reliable. As a consequence, this group aims to develop a comprehensive reporting system that meets the needs of a variety of users.

Also in September 2020, the World Economic Forum’s International Business Council, in collaboration with Deloitte, EY, KPMG, and PwC, published a white paper aimed at establishing consistency and comparability for companies reporting on ESG performance. Using existing ESG standards, the paper establishes a number of core and expanded metrics and disclosures that map the UN Sustainable Development Goals. The paper encourages companies to report on ESG performance as a way to consider the impact of their operations on the planet and in society, at all levels of business. The paper builds on an earlier document by the World Economic Forum, entitled “Toward Common Metrics and Consistent Reporting of Sustainable Value Creation” and published in January 2020.

In October 2020, the International Financial Reporting Standards Foundation (IFRS Foundation) launched a consultation in an effort to assess demand for global ESG standards. The consultation recognises the use of sustainability reporting in value creation and risk mitigation and that a set of comparable and reliable standards will allow businesses more transparency and greater assurance. Based on the consultation, the IFRS Foundation would like to establish a Sustainability Standards Board, a new standard-setter that would work with existing initiatives.

Also in October 2020:

  • The UK’s Financial Reporting Council launched a consultation on the future of corporate reporting. The consultation discussed how the current reporting systems are ill-equipped to deal with investors’ increasingly broad interests and to cater to multiple audiences and purposes. The proliferation of parallel reporting regimes translates into companies offering fragmented content on non-financial information and meaningful comparisons between peer companies become extremely difficult. In an effort to alleviate those issues, the consultation proposed the creation of a network structure, under which companies will release a mandatory business report, financial statements, and a dedicated public interest report, the latter disclosing non-financial information.
  • The International Association of Insurance Supervisors published a consultation paper on the supervision of climate-related risks in the insurance sector. The consultation is aimed at providing examples of good practices and does not establish new standards.
  • The French Development Agency launched a new SDG Bond Framework, under which it will also issue climate, social, and sustainable bonds. The eligibility criteria under the Framework focus on the contribution, and not only the label, of the issuer towards achievement of SDG goals. Crucially, the Framework envisions continued reporting obligations for the life of the bonds, namely in relation to the allocation of bond proceeds and environmental and social impact indicators. In June 2020, the European Commission also published a consultation on the establishment of an EU Green Bond Standard, which seeks to implement mandatory reporting on the environmental impact of projects.

What the future holds

The willingness to embark on and also commit resources in order to create a global ESG framework is by no means a small feat. As Erik Thedéen, Director General and Chair of IOSCO’s Task Force on Sustainable Finance, announced during his speech delivered on 30 September 2020, the five CEOs of CDP, CDSB, GRI, IIRC and SASB have for the first time committed to work closely with IOSCO and the IFRS Foundation in establishing a global standard.

However, many problems and questions remain. There are still areas where further improvements are needed:

  • Stakeholders need to be able to rely on ESG data and disclosure. The initiatives discussed above clearly show willingness to address this issue, but more needs to be done. There is still fragmentation in ESG reporting, which translates into a lack of consistency and comparability. Consultation papers are a necessary step, but the real challenge lies in devising a standard ESG framework.
  • The risk of greenwashing is still present. Misleading disclosures, incorrect product labelling, and questions concerning the reliably of ratings fuel greenwashing. The concern is that this undermines initiatives aimed at furthering ESG objectives.

Moreover, industry leaders identify that defining materiality is another hurdle in setting a global ESG standard. Materiality can be defined with a view to society or in relation to investors’ interests. The EU’s notion of “double materiality”, where both aspects matter, is one potential solution. Nonetheless, devising a set of standards that encompass what is material for different audiences will be challenging.

Notwithstanding all of the above concerns, the recent launch of new initiatives suggests that there is a level of commitment to devising a global ESG standard. At the same time that companies and investors are expressing confusion about the number of different frameworks and standards, sustainability is becoming mainstream, partly in recognition of the inextricable link between ESG disclosure and value creation. As such, continued pressure from investors and stakeholders is likely to lead regulators to further harmonise all the disparate initiatives currently running in parallel.

Latham & Watkins will continue to monitor developments in this area.

This post was written with the assistance of Sabina Aionesei in the London office of Latham & Watkins.