ESG and sustainability regulation around the globe

In response to the Paris agreement, we have seen a proliferation of government policies aimed at tackling the climate crisis and leading to a profound shift in regulation. This accelerates the need for global common sustainability reporting standards to ensure relevant, consistent and reliable information for the capital markets an imperative. In whatever jurisdiction companies operate, they can expect to deal with the same or similar demands now and into the near future.

UK

As hosts of COP26, the UK has attempted to lead the way by becoming the first country to introduce mandatory climate reporting using the Taskforce for Climate-related Financial Disclosures (TCFD) framework.

Launched in 2017, and developed by the G20’s Financial Stability Board, TCFD guidelines though voluntary in most jurisdictions, have emerged as the de facto global standard for climate risk reporting.

Last year saw the UK change tack: Chancellor Rishi Sunak placed obligatory TCFD reporting at the heart of climate change plans. The government road map required premium listed companies and the financial services sector to be reporting with TCFD this year and next whilst all listed companies should be TCFD compliant by 2023. Consultations are underway to establish how the framework will extend further across the economy.

Implementation of the framework requires focus. Though introduced on a “comply or explain” basis, there remains an emphasis on compliance. With companies encouraged to take disclosures “as far as they are able to”, it will be a journey for most as they come to terms with developing the governance, climate change strategies, risk management processes and metrics needed to meet the demands of TCFD.

More recently the UK government has published a “roadmap” for green finance. Part of the strategy is the broadening of reporting responsibilities with the Sustainability Disclosure Requirements (SDR) for businesses and asset managers. Subject to consultation, the SDR will involve reporting with proposed international sustainability reporting standards as well as the UK Green Taxonomy.

Asset managers will have to report extensively on the environmental impact of their activities and show how sustainability is woven into their investment strategies. Corporates will be required to publish their net-zero transition plans, on a comply or explain basis. The scope, timing and particulars of the specific reporting detail will be settled in a public consultation.

The UK’s SDR relies on the work underway at the International Financial Reporting Standards Foundation (IFRS) for the creation of International Sustainability Standards. An announcement is expected to take place in November on progress made with the creation of the new international Sustainability Standards Board (ISSB).

The new board is expected to launch its work with a draft climate-related standard (likely to be based on TCFD) before following up with standards on broader sustainability factors.

The UK government is expected to create a mechanism to see them adopted and endorsed for use in the UK.

For UK directors, the warning lights are glaring. With mandatory TCFD and the planned adoption of proposed international standards into the SDR, company leaders will need to push ahead with preparation. Much needs to be done, not least ensuring that the skills and capabilities needed for implementation are at hand.

And it’s worth bearing in mind climate is not the only area of reporting under development. The UK government is also ramping up disclosure requirements for diversity and inclusion. Gender pay gap reporting is already here and a consultation is underway on proposals for ethnicity pay gap reporting. If, as expected, the new reporting requirements get the go ahead, companies should begin putting in place plans for data collection and monitoring. This will not be a one-off project. There will be an ongoing responsibility that needs to be embedded in business processes.

Elsewhere, proposals published in a white paper earlier this year suggest that assurance will be extended to cover non-financial, or ESG, information, in a process similar to auditors examining financial reporting. That remains a consultation with a long way to go before it becomes law. However, there is growing pressure from stakeholders for this kind of assurance, with companies at the top end of the listed market already including it in their published reports. It is hard to see how non-financial information can be considered beyond the reach of auditors and assurance for much longer particularly in the context of developments in the European Union where the proposed Corporate Sustainability Reporting Directive (CSRD) seeks to mandate sustainability reporting and assurance with the ultimate aim overtime of “bringing sustainability reporting on a par with financial reporting.”

Europe

In Brussels, minds are focused on the Corporate Sustainability Reporting Directive (CSRD). Though still waiting to be enacted, the document will bring forward a number of key changes that will further frame and clarify sustainability reporting requirements within the European Union (EU), a step that should lead the way on the international stage.

The consequences for European companies will be diverse. For companies already subject to its predecessor—the EU’s Non-Financial Reporting Directive (NFRD)—it is fair to say the legislation is more a “structuring evolution” than “revolution”. Despite some structural changes—including the mandatory use of European Sustainability Reporting Standards (ESRS) and assurance of sustainability information—most companies should already be prepared for what’s coming, given the ESRS are expected to build on current best practices and international frameworks and standards, such as GRI (the Global Reporting Initiative), SASB and TCFD.

That means the biggest adjustment will be for companies coming to sustainability reporting for the first time. And there will be tens of thousands of them. Currently, around 12,000 companies across EU member states fall within the scope of the NFRD; the new directive will affect almost 50,000.

Newcomers to this kind of disclosure should note that there is “no reporting without information to report”. Boards would do well to start the process of building their capability to identify and report on their sustainability impact, risks and opportunities as soon as possible. For companies without a proper sustainability strategy and governance in place, the immediate first step is to seek advice on what is required, either from peers or advisers.

The CSRD is not the only sustainability initiative underway in Brussels. Officials have also been working on rules that would introduce mandatory sustainability due diligence for supply chains.

Though the Sustainable Corporate Governance Directive has had a troubled time making progress, at first expected before the European Commission at the end of the summer, now by the end of the year, it remains on the EU’s green agenda.

The scope of the new directive has yet to be clarified so it is hard to say how far reaching its provisions will be. But it is clear human rights will not be its only target; broader social, environmental and governance-related supply chain risks will also figure. The directive will undoubtedly create a tougher regime for boards who should begin ensuring that they have a deep and detailed knowledge of their value chains.

China

It may come as a surprise to learn that China is moving on sustainability regulation too. This is driven currently by the Central Bank of China requesting the country’s big banks to identify their climate risks. Concerns have grown over the kind of economic activity the banks have financed, with observers worried that a major financial crisis is a real danger should they fail to adapt.

United States

Perhaps the jurisdiction set to go through the most high-profile conversion is the US. Far behind advances in the UK and Europe, the Securities and Exchange Commission (SEC), Washington’s most senior financial watchdog, is currently consulting on the introduction of mandatory ESG disclosures.

So far the SEC has been tight-lipped about the timing of new reporting rules, though there is speculation that COP26 could see more details emerge. And TCFD is not far from the US narrative either. During the SEC’s consultation many of the world’s largest asset managers and companies advocated strongly for introduction of the framework.

That said, those who expect the US to move only on climate reporting are likely to be disappointed. The SEC has given clear signals that new rules will embrace the whole range of ESG reporting with diversity and inclusion a key priority.

Countering the climate crisis is a global battle. The world’s largest economies are now engaged while the TCFD reporting system is gradually emerging as a global standard. That means boards can expect growing regulatory pressure on climate-based disclosures, as well as ESG more broadly, in most places their companies do business. Early preparation will be critical.

By Maud Gaudry and Alexia Perversi. Maud Gaudry is Global Co-Head of Sustainability, and Alexia Perversi a Director of Global Audit & Assurance, at Mazars.