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Impact of Stricter ESG Reporting Requirements in the U.S.
A Market update on where Regulators and Industry Participants stand regarding ESG reporting and disclosure regulations in the US. The main focus is on recent comments and announcements from regulators such as SEC & FRB with an analysis of market participants' sentiments.
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ESG reporting and disclosure regulations in the US
In this article, we provide a market update on recent developments specific to ESG reporting and disclosure regulations in the US. Our main focus was on the recent comments and announcements from U.S. regulators such as the SEC and FRB specific to anticipated regulatory changes surrounding ESG reporting and disclosures. We analyzed the financial services industry sentiment on stricter regulatory requirements from current clients and open comments provided via Open Comments in response to the SEC proposed rulemaking on ESG disclosures. We also provided background on existing frameworks from which US regulators may draw from in rule drafting. We conclude this article by sharing insight into how Sia Partners recommends financial services prepare for anticipated stricter ESG reporting and disclosure regulations, etc.
“Now more than ever, investors are considering climate-related issues when making their investment decisions. It is our responsibility to ensure that they have access to material information when planning for their financial future.” – S.E.C. Acting Chair Allison Herren Lee
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Global Context for ESG Requirements
The use of environmental, social, and governance (ESG) factors in investment analysis has grown rapidly over the past decade. Recent statistics from the OECD reveal that the amount of professionally managed portfolios with integrated key elements of ESG assessments now exceeds USD 17.5 trillion globally. Also, the growth of ESG-related traded investment products available to institutional and retail investors exceeds USD 1 trillion and continues to grow quickly across major financial markets. While ESG data played a more informal role in the investment process before, a more systematic approach to ESG integration is now becoming invaluable. However, the ESG investments ecosystem is still relatively a new concept. The complexity of measuring ESG performance due to issues such as greenwashing (fraudulent claims that deceive investors into believing that a company's products are environmentally friendly) and a lack of common ESG standards has investors and investment professionals calling for more guidance on ‘what’ is green. That is why financial regulators globally are developing various guides, regulations, and standards with ESG as the central theme, aiming to certify and promote ESG integration into the investment process. An example of such regulations is the development of a national green taxonomy by regulators who seek to “green” their countries financial systems.
The EU’s green taxonomy is starting to provide the first standardized classification tool for sustainable investments which will strengthen ESG practices in Europe, which may also pave the road for other initiatives globally and help combat greenwashing. Meanwhile, Canada’s Transition Taxonomy will complement the EU’s green taxonomy and support Canada’s transition to more sustainable business practices and to a net-zero carbon economy by 2050.
For Canadian investors and investment managers, the most impactful recent policy developments on sustainable investments would be the EU taxonomy for sustainable activities (also called green taxonomy) adopted by the European Commission earlier last year and the Canadian Transition Taxonomy that is in its cusps of being published by the Canadian Standards Association. CSA Group’s Technical Committee for Transition Finance
The United States is lagging behind both the EU and Canada when it comes to reporting ESG disclosures, leaving businesses unaware of how to disclose information about their climate-related risks in a digestible way to stakeholders. As investors and customer’s behavior is changing, the demand for standard reporting is increasing. SEC Acting Chair Allison Lee has announced that the SEC is in the process of developing a “comprehensive framework that produces consistent, comparable and reliable climate-related disclosures”. In her public statement, she created an open comments period to discuss advantages and disadvantages of the TCFD, CDSB, and SASB frameworks . These frameworks are described in detail below.
SEC Sustainability Frameworks At-A-Glance
The SEC Public Statement on Climate Change Disclosures listed three main disclosures frameworks for consideration: The Taskforce on Climate-Related Disclosures (TCFD), Climate Disclosures Standards Boards (CDSB), and Sustainability Accounting Standards Boards (SASB). The below table summarizes the objectives, global scope, background, and high-level details into the methodology of the disclosure framework
| Taskforce for Climate-Related Disclosures (TCFD) | Climate Disclosures Standards Boards (CDSB) | Sustainability Accounting Standards Boards (SASB) | |
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| Objective | Industry-led initiative created to develop a set of recommendations for voluntary climate-related financial disclosures | To promote and advance climate change-related disclosure in a mainstream report through the development of a global framework | To develop standards for use in corporate filings to the U.S Securities and Exchange Commission (SEC), so investors can have comparable of non-financial. |
| Scope | Established in 2015 by the Financial Stability Board (FSB). SCope of over 1000 supporters globally as of 2020 | Established in 2007 by the World Economic Forum (WEF). Scope usage by over 300 companies, 32 countries across 10 sectors as of 2017 | Established in 2011. Scope covers over 598 reporters and 727 mentions in 2021 |
| Background | The TCFD has developed recommendations for companies to focus on to create more transparent disclosures around climate-related issues. When following these recommendations, stakeholders are more informed around their investment, credit and insurance underwriting decisions | The CDSB provides companies with a framework for reporting environmental and climate change related information that complements already existing financial reporting. It allows companies to provide investors with environmental information through a standard corporate report to aid in decision making. | SASB developed these standards in order to answer the increasing demand from investors are allowed to compare performance on critical ESG issues within an industry |
| Methodology | Disclosures recommendations structured around four thematic areas that represent core elements of how organizations operate: Governance, Strategy, Risk Management, Metrics & Targets | 12 reporting requirements while aligning with TCFD elements include: Governance, Management's environmental policies, strategy & targets, Risks and opportunities, Sources of environmental impact, Performance and comparative analysis, Outlook, Organizational boundary, Reporting policies, Reporting period, Restatements, Conformance, and Assurance | Available for 77 industries internationally. Companies are rated according to five ESG dimensions: Environment, Social Capital. Human Capital, Business Model & Innovation, and Leadership & Governance |
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Where are Regulators heading?
A major announcement at the Glasgow COP26 summit was the International Sustainability Standards Board (ISSB), from the International Financial Reporting Standards Foundation. The ISSB is a consolidation of the Value Reporting Foundation (consisting of the Sustainability Accounting Standards Board and International Integrated Reporting Council), and Climate Disclosure Standards Board. The ISSB is working to align with progress towards focus on standardized regulation and monitoring of climate risk at a global level. Specifically, the ISSB is set out to develop a comprehensive global baseline of high-quality sustainability disclosure standards to meet investors’ information needs. From a U.S. perspective, Allison Lee has commented that the SEC, through IOSCO and other international work streams, is involved in the efforts of the ISSB and hopes to use their guidelines as a baseline for the Commission’s climate disclosure proposal. The SEC is working intimately with the comments received in the open comments period and has announced there will be another open comments period, once a proposal has been made, for the public to react to the specifics and help inform any final rule.
Market sentiment surrounding proposed stricter regulations
Methodology
To better understand the industry’s response to the SEC’s Public Statement’s request for comments for the design of climate related disclosures regulations, our US Sia Partners team (a) leveraged our banking expertise and client network in our 10 US locations and (b) conducted a literature review of the open comments feedback. From our engagement with the industry and analysis of the open comments feedback, we have identified some trends which would reflect the future design, implementation, and challenges of an SEC regulated climate-related disclosure.
Public Input on the Design of SEC Climate Change Disclosures
Although each type of responder had included nuances in the comments and there was no unanimous framework for the future-state of SEC climate related disclosures there were some significant common trends among the significant market players that responded. Below are some of the trends identified in the comments regarding the design, implementation, and challenges of future SEC Climate Change disclosures.
Design
- A common reporting standard for climate-related disclosures would provide more consistency and reliable comparability. Both investors and the markets would benefit from standardization and enhanced guidance on addressing material sustainability issues.
- The SEC should leverage existing international standards whether it be from the private sector or non-profit. For instance, the TCFD framework could be a core foundation for the future SEC climate-related disclosures, while other international standards such as SASB, CDSB, GHG Protocols, and IFRS could assist with industry specific disclosure requirements.
- Climate-related disclosures should be conducted in a similar format to existing SEC financial disclosures. Some recommendations noted disclosures could be incorporated into the 10K or entirely within its own form (S-X).
Implementation and Challenges
- New standards should gradually be implemented in phases to give companies a transition period to deal with associated costs and operations. Organizations of different sizes will need time to comply with new regulations, so many believe that any new disclosures should gradually be phased in over time, allowing the SEC to refine the set of standards over time.
- There are opposing views on whether or not ESG disclosures should be mandatory or follow a “comply or explain” model. Some companies believe if the disclosures are not mandatory, companies will default to explaining and leave investors with no reliable or consistent information. Other companies argue that time, labor, and cost for compliance will make it difficult to comply with all disclosures. Considerations that need to be made are operationalization and adoption activities for client-facing resources.
- The SEC is also faced with the decision whether to have industry specific disclosures or a standard set of disclosures for all industries. Having industry specific disclosures will make it easier for investors to compare standards across companies within the same industry, but makes it difficult to analyze across industries. Some companies argue that there are idiosyncrasies within certain industries that do not need to be accounted for across all industries. The topic of having a twofold method was also presented for consideration. This would allow companies to provide information common to all firms and also information specific to their industry.
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Next Steps
Given the SEC’s increasing focus on climate-related disclosures, it is important for financial institutions to be prepared for potential stricter disclosures requirements and regulatory scrutiny. The preparatory steps highlighted below are just a small sample of the key activities organizations should be conducting as they prepare for U.S. regulatory changes.
How to prepare for upcoming changes?
Educate
- Internal - Familiarize your organization with existing ESG and climate risk disclosure frameworks, how those frameworks synchronize with the company’s overall ESG and climate risk strategy, and how your clients may be impacted.
- External - Develop an external communication plan for clients and investors to inform them on new ESG and climate focused products.
Govern
- Establish new or align existing governance structures and resources to upcoming ESG and climate risk disclosure changes at an enterprise and line of business level.
Assess
- Use existing frameworks as a guide to assess current ESG and climate risk reporting and disclosure capabilities across people, processes and technologies at the enterprise and line of business level. Consideration should be given to both the organization's ability to disclose progress against commitments (such as net-zero) as well as sustainable finance commitments (client and product strategies).
- Identify gaps in operational readiness and create a high-level readiness plan to address such gaps and the impact to overall ESG strategy and governance frameworks as well as ESG commitments made to date. Include opportunities to close gaps between internal and U.S. based entities. This should include leveraging enhanced ESG and climate risk capabilities from abroad for U.S. entities as well as ensuring U.S. based regulatory requirements are considered and met by foreign entities.
- Assess impacts to existing ESG transaction taxonomies as well as the enterprise and line of business’ ability to adjust taxonomies based on potential regulatory changes and expectations.
- When assessing your carbon emissions (operational or financed), determining your carbon accounting methodology, and setting net zero and/or sustainable financing commitments, ensure flexibility in reporting and disclosure strategy to account for any changes standardized by upcoming regulations.
How Sia Partners’ Can Help
Adapting to new disclosure requirements and integrating these new standards within your company’s current reporting processes will require strategic planning and transformation. Sia Partners brings perspective from decades of experience helping companies transform their organization to comply with new and rapidly evolving regulatory requirements. In addition, Sia Partners is well positioned to support the emerging challenges associated with ESG due to our deep ESG and climate expertise through our Climate Analysis Lab.
From Strategy to Operations, Sia Partners capabilities in Green Finance and Climate Risk can help organizations prepare and implement the necessary organizational changes to comply with stricter requirements from U.S. Regulators.
To learn more about how Sia Partners could help your organization address regulatory change associated with ESG and climate risk disclosures, please reach out to our ESG and climate risk focused consultants using the form below