Mark Mellen, Director of ESG Enablement at Workiva, outlines how new disclosure rules will fuel demand for ESG reporting and help increase business value in several key areas.
With ESG disclosure from a variety of stakeholders, as well as the US Securities and Exchange Commission’s proposed climate-risk disclosure rule and the EU Corporate Sustainability Reporting Directive (CRSD), companies are preparing for an ESG reporting revolution – and investors should be following suit.
The SEC’s proposed rulings are of seismic importance to companies’ ESG efforts and cover numerous aspects of business, including climate-risk disclosures and rulings on cybersecurity risk management and human capital disclosures. Each will create a watershed moment in the industry, forcing organisations out of the status quo to meet the expectations of investors, regulators, and boards.
Similarly, the EU CSRD was proposed by the European Commission in April 2021 as part of the European Green Deal by the European Financial Reporting Advisory Group (EFRAG). The CSRD aims to establish a single set of sustainability reporting standards for companies operating in the EU, as well as non-European companies with a significant presence in the EU. The regulation sets out ESG reporting requirements for companies. It significantly expands the scope of the Non-Financial Reporting Directive (NFRD), both in terms of who needs to report and what needs to be reported.
Although regulation is necessary, in a recent survey commissioned by PwC and Workiva, almost all business leaders (96%) said they would seek assurance for ESG reporting regardless of whether it was included in the SEC’s final ruling. More than that, the SEC proposed rulings and EU CSRD highlight the global momentum of integrated financial and sustainability reporting. By integrating reporting practices, companies can reflect a cohesive and consistent way of working. To attain integration, many companies must reassess their team structures and collaboration methods, as well as their technology.
According to the PwC and Workiva survey, 85% of executives are concerned their company does not have the right technology in place, despite almost all (97%) anticipating technology will play an important role in meeting the new requirements.
The specifics of how approaches will be implemented will look different depending on the size and individual needs of a company and stakeholder expectations. While there is no ‘one-size-fits-all’ approach, it’s imperative companies – and their investors – lay the foundation for integrated ESG reporting now.
Building the foundation
More and more investors and stakeholders are judging organisations based on how well they build ESG into their portfolios. Although preparations have already begun for the ESG reporting revolution – it is clear that there is still work to be done. Investors face a challenge in evaluating and comparing ESG information as there is currently no standardised framework for ESG reporting, coupled with the lack of skills, tools, and resources required to comply with impending regulations.
In a joint study by Workiva and CeFPro, investors said they struggle to find ESG data, and what they do find is often too superficial to inform investment decisions. By building a credible and transparent relationship with investors, organisations can create a trusting relationship that allows each side to understand the importance of ESG reporting and which aspects are most important to keep the business viable and successful.
ESG disclosure standards and frameworks provide a familiar and systematic approach to evaluating ESG factors in the investment process, offering a set of criteria and metrics for measuring and comparing the ESG performance of companies across industries and sectors. The standards and frameworks allow investors to assess ESG risks and opportunities of their investments more objectively and consistently, which helps support more informed decision-making.
The SEC’s proposals are expected to have an impact on standardised ESG disclosure, especially in regard to climate-related risks, governance, financial impacts, as well as GHG emissions, including Scopes 1, 2, and 3. The ruling is expected to increase the demand for additional standardised, consistent, and comparable metrics that organisations can use to measure and report on climate-related risks and opportunities. This, in turn, will lead to increased scrutiny of ESG reporting by investors or other stakeholders. Investors will likely use the new requirements as a basis for evaluating the risks and opportunities of organisations in their portfolios. They will likely demand greater transparency and accountability for potential investments beyond the climate disclosures required by impending regulation.
To prepare for this, organisations must act proactively and engage with their stakeholders, including investors, to discuss and further understand expectations going forward. This will help inform their approach to the proposed rulings and a broader ESG disclosure strategy. By engaging with stakeholders, organisations can enhance their credibility, build trust, and ensure they meet all stakeholders’ expectations ahead of regulations on ESG reporting.
While preparing for regulation may seem like a one-off process, companies must recognise that sustainability is a continuously evolving field, with adjustments and changes needed as time goes on. Companies can improve performance over time by consistently evaluating, enhancing, and further integrating sustainability and reporting practices.
Understanding current capabilities
Organisations can evaluate their current performance through a materiality assessment, which allows them to identify what ESG-related risks and opportunities are most impactful to their organisation, as well as set goals, timelines, policies, and procedures to meet potential SEC rulings and stakeholder expectations.
These assessments allow organisations to ask whether ESG issues are important enough to influence a stakeholder’s decisions in relation to the business. By identifying the most material ESG issues, companies can provide more relevant and meaningful information to investors, customers, employees, and other stakeholders, allowing them to create a long-term ESG strategy.
Materiality assessments are also vital to investors as they help them understand the most significant ESG issues that could impact a company’s financial performance or reputation. They ensure that a firm’s reporting method focuses on the issues most likely to impact the organisation significantly. This can allow investors to make better-informed investment decisions by providing information about the most significant ESG issues that could impact a company’s financial performance and how it made those determinations. Organisations must regularly reassess ESG materiality as regulations, market conditions, and stakeholders’ demands evolve.
ESG rating agencies are also a crucial source for investors and companies looking to further understand their ESG performance. ESG rating agencies are specialised firms that provide information to investors and other stakeholders about a company’s sustainability and responsible business practices. For example, MSCI ESG Ratings can measure a company’s management of financially relevant ESG risks and opportunities. MSCI uses a rules-based methodology to measure a company’s exposure to long-term, material ESG risks and its ability to manage them. Not only do ESG rating agencies measure a company’s resilience to long-term, financially relevant ESG risks, but the ratings can also be used as a pulse on stakeholders’ perspectives for what is most material when it comes to ESG risk and opportunities.
By laying the groundwork, companies can use various assessment tools to further understand their ESG business values and what is most material to stakeholders regarding ESG risk and opportunities.
Preparing for the revolution
Many investors expect that 2023 will see the proposed SEC rulings finalised and an implementation timeline defined. There are several steps that companies should take right now to be prepared, including reevaluating current data, disclosures, and processes, as well as finding new strategies that will help support this transition.
Although regulation is crucial, focusing only on external, shorter-term motivators and detractors fails to dive deeper into the true purpose and complexity of ESG, thereby limiting the potential for growth and value creation. Regardless of these impending regulations, such as the SEC rulings or CRSD, implementing successful ESG strategies can help increase business value in several key areas, including top-line growth, lower costs, alignment with governmental initiatives, talent retention, return on company investments, and stronger risk management practices, among others.