Sustainability
Private companies account for over 71% of global emissions and are a vital group in the fight to reach net zero. This article explores the trend towards uniform environmental reporting standards in a bid to incentivize firms to improve their environmental performance.
COP26 largely neglected one of the most important avenues to fight climate change: environmental reporting standards. Such standards incentivize private companies to preserve the environment and assist sustainability-minded investors seeking environmentally-friendly investments. However, a patchwork of environmental reporting standards makes it difficult for firms to clearly communicate their progress towards environmental goals, and makes it difficult for investors to ensure their investments support environmentally friendly firms. Fortunately, there are signs of standardization among disparate reporting regimes.
Challenges to Environmental Reporting
Currently, it is difficult for firms to navigate the minefield of different environmental disclosure regulations. A key reason is because different regions have unique core objectives for their environmental disclosure rules. Environmental reporting in the United States focuses on information that is “material” to investors, such as requirements to notify investors of environmental fines in excess of $300,000. EY summarizes the US environmental disclosure rules by stating that “the level of information that companies are compelled to disclose under the existing regulatory framework is significantly lower than a number of other developed markets”. This is partially due to the fact that European Union’s definition of what is “material” is far more predicated on stakeholder well-being rather than just investor support, and has resulted in a far more all-encompassing mandatory environmental reporting regime.
Additionally, different reporting standards are based off of a myriad of industry ratings agencies, such as the Global Reporting Initiative (GRI), the Sustainable Accounting Standards Board (SASB), the Climate Disclosure Standards Board (CDP & CDSB), and the International Integrated Reporting Council (IIRC). Each agency includes different elements in their definition of “environmental” issues, or have a unique emphasis on specific issues. This can result in the same firm receiving drastically different environmental sustainability scores, both blunting a firm’s efforts to improve its environmental standing, and even opening it to potential legal challenges.
Signs of Standardization
There are signs of standardization in environmental reporting standards. In the United States, FASB (America’s Financial Accounting Standards Board), is preparing to release their proposed environmental disclosure requirements before the end of 2021, with final guidance coming shortly thereafter. This forthcoming guidance is noteworthy as it may well serve as the model for future Securities and Exchange Commission (SEC) rules, as former acting SEC Chair Lee stated “…future SEC rules governing ESG reporting would likely resemble those that FASB lands on.” Additionally, Chairman Gensler has asked his staff to look into quantitative disclosure metrics surrounding issues like greenhouse gases, the financial impacts of climate change, and progress towards climate goals which would bring American disclosure rules more normatively in line with those from Europe.
The EU has already implemented the Non-Financial Reporting Directive (NFRD) and the Sustainable Finance Disclosure Regulation (SFDR), both of which bring environmental issues to the fore in corporate reporting and investor relations. Additionally, the International Financial Reporting Standards (IFRS), which provides standards for financial reporting in over 120 countries and has buy-in from numerous national and global entities such the European Securities and Markets Authority and the International Organization of Securities Commissions, also has buy-in for its International Sustainability Standards Board (ISSB) which will soon release comprehensive global baselines for environmental disclosure standards. The IFRS is well-positioned to dramatically increase regulatory harmonization in the non-GAAP world (America’s system of accounting, the Generally Accepted Accounting Principles).
Fortunately, the wild-west era of environmental reporting appears to be nearing an end as the world settles into two mega-environmental standards, an American one derived from FASB’s guidance and a global system derived from the IFRS. While it remains to be seen how standardization between these two systems may evolve, this should be welcome news in the fight against climate change.