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It should come as no surprise that preparing to adapt and comply with each of the SEC, CSA, CSRD and ISSB will require significant time and resources. The ISSB proposals in particular are evolving quickly, and ongoing monthly Board meetings are making progress in clarifying topics and providing transparency in response to comment letters and stakeholder concerns. The results of these Board meetings will further inform the final CSA, CSRD and SEC rules.
Historically, ESG reporting has been housed within sustainability and communications teams, but we are seeing a shift as the CFO group is now expected to play a more active role. The CFO will be responsible for integrating climate risk in not only the financial statements, but also the MD&A and even standalone ESG reports to the extent that they are being used for compliance with regulatory or standard-setting requirements.
In any event, with a shift from voluntary to mandatory reporting expected in the next year, several steps will need to take place—from enhancing governance models to elevating systems, processes and controls. It is becoming increasingly critical for organizations to start planning and identifying their priorities to mitigate their exposure to not only the regulatory risk, but also environmental and reputational concerns.
Easy as one, two, three
Historically, companies release their ESG reports months after the financial statements. However, evolving regulatory requirements necessitate alignment with financial reporting timelines. We therefore anticipate an increased use of estimates and proxies to calculate certain sustainability metrics—such as Scope 1, -2 and -3 emissions—as actual data may be unavailable with these new timelines. (For the uninitiated, Scope 1 emissions are those that a company produces directly. Scope 2 are those that a company produces indirectly, for instance the energy they purchase to power their offices or other facilities. Scope 3 emissions encompass everything that can be traced up and down a company’s entire value chain.)
Regulators are also generally requiring companies to report on topics consistent with the recommendations of the Financial Stability Board’s Taskforce on Climate-related Financial Disclosures:
- Qualitative disclosure around the governance of climate-related risks
- The actual and potential impacts of climate-related risks and opportunities on the company’s businesses
- Strategy and financial planning, where material
- How the company identifies, assesses and manages climate-related risks.
How are these requirements being applied within each proposal?
- Scope 1 and 2 emissions: The SEC, ISSB and CSRD draft proposals all contemplate the requirement for disclosures on Scope 1 and 2 emissions. Meanwhile, the CSA currently presents a “comply or explain” option within its proposal to disclose Scope 1 and 2 emissions.
- Scope 3 emissions: The variability in Scope 3 emissions disclosure requirements across regulators reflects the current challenges in quantifying these types of emissions. The ISSB has also stated that it will consider a phased implementation, allowing for Scope 3 emissions to be disclosed at a later date.
- Third-party assurance: While assurance has not explicitly been included in the CSA proposal, this may change—especially in light of what other regulators have released. The SEC proposal requires limited assurance over Scope 1 and 2 emissions for select companies, and the CSRD requires limited assurance over emissions as well as broader sustainability information. Both the SEC and CSRD proposals have an end goal of phasing into reasonable assurance.
- Impact to financial statement line Items: The SEC, ISSB, CSA and CSRD all require disclosure of climate impacts on financial performance. However, the SEC proposal considers changes such as increasing the trigger for disclosure depending on the financial item in question and increased disclosures in the notes to the financial statements.
- Double materiality: The CSRD is leading the path forward on this front as it is the only proposal to take “double materiality” into account. Double materiality refers to two dimensions of materiality: (1) financial and (2) impact on people or the environment, over the short-, medium- or long terms and resulting in far more comprehensive disclosure requirements.
Learning the new vocabulary
Going forward, ESG reporting will need to be developed with the same level of rigour as financial reporting. Furthermore, ESG risks are increasingly viewed as business risks no different from any other. As discussed above, these new regulatory reporting requirements are therefore also of increasing importance for CFOs, who will need to ensure that robust risk and control processes are in place.
As a first step, companies will need to complete a gap analysis against the applicable requirements, including system and data concerns, processes and controls, as well as skills missing within the workforce. This analysis should be used to inform management and those charged with governance on how to develop resource capability, ensure the necessary tools are available and recognize metrics to report on in the future. All of this should culminate in an operational roadmap to ensure compliance with future requirements in advance of expected effective dates.
When it comes to identifying metrics and topics to be reported, the ISSB, SEC and CSA proposals provide specific guidance on what should be disclosed. However, companies that fall under the requirements of CSRD may need to perform a materiality assessment to identify, refine and assess any sustainability issues that could materially (financially or otherwise) affect the business and/or stakeholders. This will be an important activity in determining which topics and metrics should be in scope of the reporting. Companies may be able to conclude that information is immaterial either on the level of a topical standard, on the level of an individual disclosure requirement or even on a single data point.
Lastly, ensuring that the information you report is accurate, robust and credible will become a greater focus and assurance will have an important role to play. Companies should consider undergoing an assurance readiness assessment to determine where systems, processes and controls on sustainability information need to be improved and where metrics may be ready for assurance.
The regulatory requirements discussed above and progress from standard setters signify a fundamental shift in ESG reporting. The ground is shifting quickly, and it’s important for companies to start considering what page they’re on and act now—before they find themselves having to go back to school.
