ESG disclosure standards as the silver bullet to solve the climate crisis?
Why can’t we solve ESG reporting if we could solve financial reporting?
The reporting space is frantically searching for the right standard to use for “sustainability-reporting” and has to date not accomplished much more than numerous statements of “intention of alignment with each other” by the big players in ESG reporting like EFRAG and the EU Regulator, the WEF-IBC, the “Alliance of ESG standard setters” (CDP, SASB, GRI, CDSB, IIRC), the FSB via the TCFD and the IFRS to just name a few. While the process of alignment and standard perfection is continuing, we are failing to reach our international climate goals, and the investment community is still utterly confused and pained by greenwashing. Why is it so hard to agree on the right standard?
Let’s have a look at standard setting for financial reporting. After the stock market crash in the 1930s, it became clear that the “art form” of financial accounting had to lose its creative freedom which was to be replaced by transparency and comparability. The New York Stock Exchange and the American Institute of Accountants took to creating accounting principles that were later enacted in the Securities act of 1933 and set the fundamentals for the US GAAP. The rest of the world followed suit by first coming together under the International Accounting Standards Committee (IASC) in 1973 which later formed the current International Financial Reporting Standards Foundation (IFRS) and is today adopted by approximately 166 jurisdictions.
Today, most of us have a solid comfort level with the utility and limitations of financial reporting standards that we are used to (e.g. the IFRS or the US GAAP). The principle based IFRS as well as the rule based US GAAP leave some room for interpretation (you might even call them loopholes), but there is a general consensus in the stakeholder base that they provide a decent level of transparency and comparability when it comes to evaluating an organizations value and economic health, especially when audited by an independent third party (let’s not focus on scandalous outliers for the moment).
With the ever increasing importance of non-financial aspects — you could also call them ESG, Sustainability or Corporate Social Responsibility matters — the importance of evaluating and comparing company ESG performance has also increased. Amongst the ones demanding this additional transparency are former Bank of England Governor Mark Carney, Black Rock CEO Larry Fink the EU Commission, the IOSCO and even the SEC with the main focus to increase investor transparency and ensure that private sector assets are channelled into sustainable investments (or rather NOT into unsustainable ones).
The approach seems logical: companies disclose (ESG) information, stakeholders have transparency, asset owners invest sustainably, we save the planet. Over the last 3 decades, there has been plenty of non-financial reporting in accordance with various sophisticated standards (e.g. the CDP much of which has focused on climate related issues (greenhouse gas emissions). However, we have not even come close to reaching any of the goals set and agreed upon by the Kyoto Protocol, the Paris Climate Agreement or the UN 2030 Agenda, to just name a few. Again, why is it not working this time?
What’s wrong with the standards?
Many argue that the reason for the lack of achievement towards our climate goals is the multitude of standards for mandatory (e.g. the SFDR, NFRD, EU Taxonomy in Europe) and voluntary (e.g. CDP, SASB, GRI, CDSB, IIRC, TCFD) reporting that confuses the stakeholder base. Others argue that we have not yet defined or agreed on what sustainability actually means and that we are working with the wrong standards altogether. There are claims that the existing standards are too detailed like the EU Taxonomy, too high level like the Integrated Reporting standards (IR), incomplete like the taxonomy, the TCFD, CDSB and CDP, too flexible with too much weight on intentions rather than results like the TCFD or the IR, focused on only one type of materiality (environmental and social or financial) like SASB and GRI, that they lack context like the EU Taxonomy or SASB, that they give too much leeway in deciding what to disclose on like the TCFD, the IR and GRI…. The list goes on.
The search for the “best standard” — does the EU approach work?
Going down the same rabbit hole I decided to see if there was a consensus amongst the subject matter experts in the field of ESG disclosure. In order to increase the chance of a viable outcome I decided to reduce the scope from “all things considered ESG on the planet” to “mandatory carbon disclosure in the EU” and asked the question if the EU Taxonomy together with the NFRD and the SFDR would bring us to the point where the standard would provide us with not only transparency, but also (at least close to) perfect comparability between disclosing entities and therefore help us to reach our goal of channelling private sector assets into green investments.
What do the experts think about the EU approach to climate disclosure?
Well, apparently I am not allowed to tell you until I have completed my degree… so stay tuned.
