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The ESG Interview: And Then There Were Four

Katie Schmitz Eulitt, SASB’s Director of Investor Outreach, looks forward to another year of progress in sustainability disclosure.

“2020 was a terrible year in almost every other respect, but it was a better year for ESG disclosure. It started off like any other year and then started to drift quite dramatically.”

Katie Schmitz Eulitt, Director of Investor Outreach at the Sustainability Accounting Standards Board (SASB), anticipates over the next 12 months a further acceleration of the momentum already gathering behind consolidation and harmonisation of sustainability reporting frameworks.

There are many reasons for her optimism that investors will soon enjoy greater transparency and comparability when assessing the efforts of investee companies to monitor and manage material ESG risks.

First, her organisation – which she joined when it was “little more than a power point” – is in the throes of a merger, which will strain the alphabet soup of standards bodies currently striving to help ESG-focused investors to conduct their due diligence.

Second, her country – following the recent inauguration of Joe Biden as the 46th President of the United States – is renewing its participation in international efforts to combat climate change, thus potentially unleashing a wave of regulatory and policy activity, including work aimed at standardising corporate sustainability disclosures.

Third, her peers – the five bodies swimming in that alphabet soup – recently capped a year of ever-closer collaboration with the release of a prototype global standard focused on climate-related disclosure. This early fruit of their collective labours not only combines existing frameworks, thus edging nearer to a universal sustainability reporting system, it also aligns with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).

All of these contribute to Schmitz Eulitt’s sense of expectation. As much as anything, however, it is driven by the hope that a longer established standards reporting body, the International Financial Reporting Standards (IFRS) Foundation, will lend its weight and reach to the task of global sustainability reporting consolidation.

In September 2020, the IFRS Foundation launched a consultation paper on sustainability reporting, partly to gauge support for the creation of a Sustainability Standards Board which would “develop and maintain a global set of sustainability-reporting standards initially focused on climate-related risks”, within its existing institutional and governance structure.

The consultation ended in December and the IFRS Foundation is expected to provide an update on its intentions shortly.

“We’re eagerly anticipating the outcome of that consultation and stand ready to continue to collaborate and work towards a further evolution of this space,” says Schmitz Eulitt. “We think the IFRS Foundation is uniquely positioned to significantly establish a globally accepted sustainability standard for the capital markets.”

Subject to confirmation, the ‘group of five’ – SASB, International Integrated Reporting Council (IIRC), Global Reporting Initiative (GRI), Climate Disclosure Standards Board (CDSB), and CDP – has already given the IFRS Foundation a helping hand. The prototype climate-reporting standard was designed with likely future developments in mind. As such, the IFRS Foundation should be able to lift it “off the shelf”, according to Schmitz Eulitt.

Geo-political realities

This process of standards harmonisation and consolidation can only go so far, however. One of the realities that provides challenges to investors, corporates and standards bodies alike is the differences in legal and regulatory frameworks across jurisdictions.

With the limits of globalisation – and the alignment of rules in different markets – having been reached, at least for now, any multilateral initiatives must accommodate these realities in order to be universally applicable. “Some jurisdictions are moving much more aggressively and quickly, with higher aspirations than others,” says Schmitz Eulitt.

If, as she says, the existing sustainability reporting bodies started out as “different tools for different purposes”, then SASB is very much a product of its American context, with its focus on wide collaboration with stakeholders and ongoing market feedback in order to identify the ESG factors that are financially material within a particular sector or industry.

But that does not stop the San Francisco-based organisation acknowledging the upsides and the potential global reach of the concept of dual materiality, included in the current revisions to Europe’s Non-Financial Disclosure Regulation (NFRD). The guidelines to the NFRD recognise that materiality is an evolving continuum, meaning that environmental or social issues can develop financial consequences over time. Further, dual materiality accepts the need for a commercial entity to consider and report on its impact on economic and social issues as well as the issues that impact it.

In parallel with last year’s consultation process on proposed revisions to the NFRD, SASB CEO Janine Guillot published a blog post saying the directive could prove “a giant leap forward”, paving the way for a globally accepted system for non-financial disclosure.

But flexibility remains critical, notes Schmitz Eulitt, pointing out that double materiality would be difficult to introduce into US securities regulation, for example.

“We need a system that is flexible enough and has fundamental building blocks that can and do align with US securities laws, but can be baked into the fundamental building blocks of these other systems,” she says.

Growing acceptance

For all sustainability reporting bodies, the challenge is to serve as the building blocks in an uncertain geopolitical environment whilst responding to the needs of stakeholders. While SASB believes its framework is flexible enough to support the NFRD, its utilisation in the UK and US, where political developments are driving change in the ESG investing and disclosure space, also looks positive.

It does no harm that BlackRock CEO Larry Fink recently reiterated his support for SASB-aligned reporting in his annual letter to CEOs.

The UK’s Financial Reporting Council has urged companies to disclose climate information in line with TCFD recommendations and ESG information more broadly aligned with SASB standards. In Washington, once the US re-enters the Paris Agreement, Schmitz Eulitt hopes the Biden administration will use existing regulatory powers to strengthen corporate disclosure of climate, and other ESG, risks.

“We’re hoping the Securities and Exchange Commission (SEC) will follow the lead of the FRC. The SEC stance remains to be seen, but there have been a number of recommendations made to them by investors. We also hope the administration will get more involved in multinational efforts to establish global standards, having been sidelined for a while,” she says.

The current acting chair of the SEC, Commissioner Allison Herren Lee, is a longstanding proponent of regulatory reform to improve the quality, consistency and comparability of the non-financial disclosures of US companies, recently observing: “I am not fully convinced we can achieve a standardised regime without regulatory involvement – so I think there is a place for the SEC to get involved to ascertain standardised disclosures are both consistent and reliable.”

Focus on value

As regulatory developments play out, SASB will keep a watching brief while getting on with the logistical and organisational challenges of completing its merger with the London-headquartered IIRC, and the continuing work of developing and refining standards in league with stakeholders.

The decision to merge to create the Value Reporting Foundation (VRF), which will be led by SASB CEO Janine Guillot, was announced in November, with a mandate to provide investors with a “comprehensive corporate reporting framework across the full range of enterprise value drivers and standards to drive global sustainability performance”.

Schmitz Eulitt characterises the merger as inevitable and logical, given the urgent need for simplicity in sustainability reporting and the differing skill sets of the two organisations. The work of building on shared concepts continues apace, with expectations of merger completion by the middle of this year.

“They just fit together like hand in glove,” she says. “The IIRC is a framework in search of standards and SASB is a set of standards that doesn’t have a framework, beyond our own conceptual framework. We also have a shared focus on investor needs and enterprise value creation.”

The plan is for the VRF to facilitate the combined use of the International <IR> Framework and SASB Standards. “Integrated reporting describes all relevant value creation topics and the approach to integrating them in corporate thought and reporting. SASB provides the precise definitions of the data that should be reported for these topics in each industry,” said Barry Melancon, Chair of the IIRC Board, at the time of the merger announcement.

Adding to the narrative

Schmitz Eulitt sees the merger as an important step toward facilitating fully integrated reporting by companies and thus more decision-useful inputs for institutional investors.

As companies become more integrated in their approach to generating value from different forms of capital, investors will need new and better ways to compare their performance, she suggests. Historically, ‘non-financial’ sustainability-related information has been published largely in a narrative form, making it hard for investors to compare companies in a similar fashion to traditional financial metrics.

Sustainability reporting standards have addressed some of these challenges, but they need to evolve to maintain relevance and utility. “Investors are trying to get a better picture of how companies’ sustainability activities align with their strategy more broadly and how they contribute to either enterprise value creation or the avoidance of destruction,” says Schmitz Eulitt.

“To support integrated reporting, we will provide the standards by which firms can express the performance of their sustainability strategy over time. We’re adding a quantitative means of comparing performance over time to the narrative,” she notes.

This does not, however, lead to investors relying on the same core set of metrics to assess sustainability performance across all investee companies, in the way that many currently use per earnings ratios. Simplification is welcome, to facilitate comparability, but over-simplification can obscure rather than provide clarity.

Human capital management is an area in which different metrics are expected by investors across industries, Schmitz Eulitt notes. Employee health and safety metrics will be different for a services company versus a firm in oil and gas exploration, for example. “As an investor, I would want to have different information at the metric level for companies in different industries, for it to be meaningful.”

Investors on board

Human capital is one of several current research projects at SASB, in response to feedback from stakeholders. While SASB typically develops standards based on the materiality of issues to a specific industry, this area requires a different approach, combining industry specific-evidence on the importance of human capital management to company performance with broader perspectives and inputs.

“Human capital and the issues related to it can mean very different things to different people, so we needed first to establish a framework to get everyone on the same page, and then we’ll go about setting more standards,” Schmitz Eulitt explains.

As with all of SASB’s standards development work, investors will play a critical role. Although SASB’s research projects are open to public consultation and listed on the organisation’s website, investor input is a more structured process.

Almost 200 institutional investors licence SASB’s standards framework and / or are members of the SASB Alliance, which provides education and other resources. These asset managers and asset owners include some of the largest sovereign wealth funds in the world, collectively representing just under US$60 trillion AUM.

The most active of these investor members are invited to join the Investor Advisory Group, which currently has 55 members. This can lead to work on specific standards, via the separate Standards Advisory Group, but it also involves engagement with corporates to explain investor information needs on sustainability disclosures.

“There can be a bit of a mystery. Corporates often want to know: what are investors actually doing with this information? Are they really incorporating it into their investment decisions and if so how, and why?”

On the micro- and the macro-level, the next 12 months in sustainability disclosure could be as much of a roller-coaster as the last, suggests Schmitz Eulitt.

“We’re hoping that 2021 continues on the path we started on in 2020 with such significant progress to further consolidation in the field and the establishment of an internationally recognised standard for sustainability reporting,” she says.

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