Sustainability disclosure requirements are tightening

  • The regulatory disclosure of ESG information has accelerated in the first half of 2023 as organisations and governments propose and adopt internationally aligned regulations.
  • The EU and US are set to finalise new sustainability regulations under the Corporate Sustainability Reporting Directive (CSRD) and the US Securities and Exchange Commission’s climate-related disclosures. Meanwhile, the International Financial Reporting Standards (IFRS) released the first set of global sustainability disclosure standards in June.
  • The EU has the strictest regulatory requirements for ESG implementation, as it includes double materiality. Although most countries are strengthening ESG disclosure requirements for companies, obstacles to ESG implementation, such as political opposition, greenwashing and a lack of standardisation, will continue to undermine effective ESG reporting.

In 2022 global regulators turned up the heat to tackle greenwashing, especially in the financial services sector, and 2023 is seeing tighter sustainability disclosure requirements.

EU takes it up a notch with double materiality
The adoption of strict rules to promote sustainable activities is critical for the EU as it targets its ambitious climate goals set under the European Green Deal (EGD) in 2020. As part of its financial policy initiatives to support the deal, the EU broadly divides the strategy into three components: the EU taxonomy; the disclosure requirements under the Sustainable Finance Disclosure Regulation (SFDR) and the CSRD. There are benchmarking requirements, including the EU Green Bond Standard (GBS) and the EU Climate Transition Benchmarks Regulation. In addition, there are three key legislations proposed as part of the Green Deal Industrial Plan: the Net-Zero Industry Act (NZIA), Critical Raw Materials Act and a reform of the electricity market design, all of which aim to improve the EU’s competitiveness in the green industries.

The European Commission is finalising the first set of mandatory standards for ESG reporting under the CSRD, a piece of legislation that came into effect in January 2023 as part of the EGD. The first set includes 12 sustainability standards, also called the European Sustainability Reporting Standards (ESRS), comprising two cross-cutting standards on all sustainability matters, five standards on environmental issues, four standards on the social pillar and one on governance. About 50,000 companies are subject to CSRD and will have to incorporate disclosure requirements under ESRS in their reporting.

One of the critical materiality requirements for companies under CSRD is the double materiality assessment, which puts the EU ahead of other regions in terms of sustainability reporting requirements. The materiality assessment is a comprehensive approach that requires the company to determine the scope of sustainability reporting from the materiality perspective of risks and opportunities as well as the impact.

All EU-based large companies and listed small and medium enterprises (SMEs) are within the scope of CSRD, and these reporting requirements will be phased in depending on the type of company. It also includes non-EU companies with one or more EU subsidiaries that meet the CSRD criteria. A company is identified as a large company if it meets two of three criteria: has more than 250 employees, €40m in turnover and €20m in total assets. Starting January 1st 2024, listed companies with more than 500 employees will have to incorporate ESRS in their reports due in 2025, as part of regulatory compliance under the CSRD. All large companies and listed SMEs will have to comply with ESRS starting January 1st 2025 and 2026, respectively.

The implementation of policies proposed under the EGD will propel European countries’ ratings on all three pillars even higher in future updates of our ESG ratings. However, most of these laws are pending approval from the European Parliament and Council and are also open to modification. For instance, the NZIA was compromised in July to include nuclear power in the list of green technologies in order to reach political agreement.

Global adoption of ISSB
The International Sustainability Standards Board (ISSB), a standard-setting private body under the IFRS Foundation, released sustainability disclosure standards in June 2023. The initial two IFRS Sustainability Disclosure Standards for companies, S1 and S2, will go into effect in January 2024. IFRS S1 requires an entity to disclose its sustainability-related risks and opportunities, while S2 requires companies to disclose material climate-related information. In April the ISSB announced transitional one-year relief in S1 and allowed companies to disclose only climate-related risks and opportunities for the first year. While the standards are voluntary, several governments across the world, including those of the UK, Canada, Singapore, Japan, New Zealand, Australia and Nigeria, are planning to adopt ISSB, while US-based companies are likely to voluntarily comply with these regulations. ISSB disclosures provide a global baseline and uniformity in corporate sustainability reporting, thereby improving comparability and boosting investors’ confidence. The respective governments will decide which companies will come under the ambit of these regulations and whether they will be voluntary or mandatory.

In July the Financial Stability Board (FSB), an international body responsible for monitoring global financial systems, announced that the ISSB would take over the Task Force on Climate-Related Financial Disclosures (TCFD). TCFD is the FSB’s advisory body on voluntary climate-risk disclosures for companies. This indicates the need for further consolidation in the ESG disclosure requirements and to tackle the “alphabet soup” of complexities.

US to finalise climate disclosure rules
The US has been relatively slow in enacting ESG regulations, but the US Securities and Exchange Commission (SEC) is expected to announce the final disclosure requirements on greenhouse gas emissions and climate change risks by the end of 2023. These mandatory disclosures would require SEC-listed companies, both domestic and foreign, to disclose climate-related risks and their impact on the business in periodic reports. It includes scope 1 and 2 emissions for all listed companies as well as scope 3 emissions for large companies. Scope 1 emissions are direct emissions from a company’s operations and are the easiest to determine. Scope 2 are indirect emissions from purchased energy, while scope 3 emissions are from the entire value chain, including suppliers and consumers. The SEC may ease these requirements amid pushback from investors and politicians. The adoption of a watered-down version of these regulations will adversely affect the country’s ESG ranking in our future updates.

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