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The ESG Interview: Making Climate Data Comparable

IOSCO Chair Ashley Alder believes we’re in sight of “a real step change” in sustainability reporting.

The IFRS Foundation’s climate-first approach to globally standardised sustainability reporting offers the most efficient path to decision-useful, corporate-level ESG information for institutional investors, according to Ashley Alder, Chair of IOSCO and CEO of Hong Kong’s Securities and Futures Commission (SFC).

And with a favourable following wind, the first fruits of the Foundation’s planned Sustainability Standards Board (SSB) – a mandatory global reporting standard for climate exposures – could be adopted and on the road to enforcement by securities regulators by this time next year.

“Without good corporate-level information, investors and asset management firms are operating with one hand tied behind their back in attempting to allocate capital across industries taking sustainability issues into account when the information is so disparate,” notes Alder.

Toward global convergence

Last month, the IFRS Foundation’s trustees confirmed the formation of a working group to undertake “technical preparation” for the creation of the proposed SSB, under the governance of the Foundation, meaning it would sit alongside the existing International Accounting Standards Board (IASB).

IOSCO, which formulates policy and sets standards for securities market regulation in 130 jurisdictions, was invited to join the working group as an advisor.

A key part of this preparation work is refining and approving the prototype climate-related disclosure standard published last December by the ‘group of five’, which builds on the recommendations of the Task Force for Climate-related Financial Disclosures (TCFD). This collaborative effort by the existing sustainability standards-setting bodies was specifically designed to give the SSB a flying start.

“It is a very big change from the previous position, whereby there were lots of very good efforts across different standard setters,” says Alder. “This is a real step change. The degree of support is very strong. You can see it as the first very significant global convergence and issuance of standards under a well-understood and strict governance process.”

IFRS’s pre-SSB working group has a lot on its plate over the next few months, in terms setting up its structure, membership and governance, as well as developing, consulting on and finalising the prototype. But Alder says the fact the SSB is not establishing a new standard entirely from scratch raises the prospect of it coming into use during the first half of 2022.

“If the IFRS Foundation can set up the SSB before COP26 in November, I would expect IOSCO to be able to signal this year that we think the prototype is the right basis for an endorsed standard. Once the standard is actually produced by the SSB, we should be in a position to endorse it fairly quickly. I’d expect this to happen as soon as possible next year, but can’t say whether that would be first or second quarter because of the number of pieces of the jigsaw that need to come together,” he explains.

As Alder points out, there are “no guarantees” when there are so many moving parts to the process. Consultation on an exposure draft, most likely for three months, must be conducted early next year, and some industry experts have suggested 2023 as the first year firms will need to ensure their reporting is in line with SSB rules.

Governance and oversight

Alder’s belief in the necessity of the mandatory sustainability reporting standards policed by securities regulators stems from the mixed levels of disclosure resulting from voluntary initiatives.

The TCFD recommendations, for example, have been widely endorsed by asset owners and implemented by global corporates, and are being written into the rulebooks in a number of jurisdictions.

But actual reporting has been highly variable. In his latest update to G20 members, Financial Stability Board Chair Randal Quarles noted the lack of comparability, saying the board would report on “ways to promote consistent, high-quality climate disclosures”.

“The quality of the reporting is still patchy, particularly at the harder end, i.e. the data around metrics and strategy,” says Alder.

In addition to the head start provided by sustainability standard-setters, Alder’s belief that IFRS and IOSCO can quickly deliver more decision-useful and comparable climate-risk information to investors rests also on their use of existing governance and oversight structures.

IOSCO has a degree of oversight over the governance of the IFRS Foundation, largely through its role as chair of the organisation’s Monitoring Board, and as such will monitor governance implications from the IFRS Trustees’ proposals on sustainability.

Consistent, comparable, and reliable

Further, IOSCO will use tried-and-tested mechanisms for the ‘propagation’ of the new SSB standards. It is currently setting up a Technical Expert Group (TEG) under its Sustainable Finance Task Force (SFT), which will review its technical recommendations and assess the SSB’s refinements to the prototype (and its successors), including industry-specific metrics.

In short, the TEG’s role is to validate that the prototype can be developed as an international reporting standard under the SSB and thus endorsed for implementation by IOSCO’s member securities commissions in their local jurisdictions. This is a similar process to how IOSCO has implemented IFRS reporting standards.

To be approved for adoption by IOSCO members, a standard must be able to “serve as a baseline for consistent and comparable approaches to mandatory sustainability-related disclosures across jurisdictions”, be compatible with existing accounting reporting standards, promote good governance of sustainability disclosures among issuers, and form the basis for developing an audit and assurance framework.

“Accounting standards are adopted in different ways by different jurisdictions as they have different legal or regulatory systems, but in most cases assurance is provided by the audit process,” says Alder. “Given the integral role of audit to how financial reporting is carried out under existing accounting standards, it’s reasonable to expect the audit industry will develop and provide a similar level of assurance in relation to sustainability reporting.”

In parallel, the TEG is effectively assessing and confirming the SSB’s fitness to serve as a global supplier of sustainability-related corporate reporting standards to its members, pursuant to their adoption in local markets in order to achieve consistent, comparable, and reliable cross-border sustainability-related reporting requirements.

Delivering the building blocks

The IFRS Foundation’s approach is focused on an enterprise-value approach to sustainability reporting, meaning it prioritises using standards to highlight the impact of ESG-related risks on enterprises, rather than the other way round. This has been contrasted to the approach outlined by the European Financial Reporting Advisory Group, an advisory body the European Commission, which more closely embraces double materiality.

IOSCO is broadly supportive of the climate-first, enterprise value-led approach of the IFRS. But it has also recommended the Foundation set up a “a multi-stakeholder expert consultative committee” to promote coordination between the SSB’s standards and complementary sustainability standards preferred by certain stakeholders or jurisdictions, thus supporting global consistency and comparability.

IOSCO has stated that this approach could support “the practical delivery of the ‘building blocks’ of a global comprehensive corporate reporting system”, thus allowing jurisdictions to go further and faster if they wish, while retaining cross-border comparability.

Beyond necessary new high-level coordination structures, Alder believes securities regulators may be able to monitor compliance with sustainability reporting standards on a day-to-day basis in a similar way to their existing oversight of issuers’ financial statements.

“As securities regulators, we don’t need to reinvent the wheel too much because, by and large, we tend to have jurisdiction over serious omissions – as well as statements which are materially inaccurate – which ultimately mislead the market. That [function] can operate in the same way in relation to sustainability issues, albeit based on an assessment of materiality,” he observes.

But there is a recognition of the fact that investors’ information needs on ESG risks go beyond those historically required from investee companies. When many issuers are expected to undertake a complex and urgent transition to net-zero business models, investors need them to provide a degree of certainty on where they are going as well as where they have been.

“A company disclosing its carbon footprint is similar to a traditional financial statement in that it is historic to a certain degree, whereas the scenario analysis at the heart of TCFD comes with a different set of considerations because they are ‘what-if’ projections. There are important aspects of sustainability financial disclosures which are, because they are forward looking, quite different to traditional financial statements,” says Alder.

Regulators’ expectations of asset managers

As a global standards-setter in its own right, IOSCO is focused on improving sustainability-related information flows to asset owners from asset managers, as well as from underlying investee corporates.

Following on from an IOSCO report published Q2 2020, the organisation established its SFT, with a remit to improve sustainability-related disclosures, definitions and investor protections. So far, the SFT’s work has focused on asset manager and issuer disclosures, ESG ratings and greenwashing.

“To help them assess and compare fund options, I think asset owners’ would like to see far greater clarity on regulators’ expectations of asset managers, including transparency of how they take account of sustainability issues in their investment processes, risk management and governance,” says Alder. “When it comes to the carbon profile or emission footprint of different investments, blind reliance on aggregate ratings won’t be enough because it has to be a substantive job.”

IOSCO’s SFT will release a consultation report on regulators’ requirements of asset managers by the summer. The report will aim to cover the integration of climate risk into managers’ investment processes and overall risk assessments, including governance frameworks and disclosure requirements. On disclosure, it will look both at firm- and product-level disclosures and will cover issues related to greenwashing.

Global and local challenges

Like all members of the IOSCO board, Alder views sustainability reporting issues from the global and the local level. As CEO of the SFC, Hong Kong’s financial markets regulator, he has overseen a consultation exercise focused on assessing the appropriate regulatory requirements of asset managers.

The document proposes baseline requirements for all asset managers registered in the jurisdiction, with enhanced expectations for larger firms, based on size and complexity of the manager’s business and funds.

Published in October 2020, the SFC’s ‘Consultation Paper on the Management and Disclosure of Climate-related Risks by Fund Managers’ is part of the regulator’s wider strategy, outlined in 2018, to support the development of the green finance sector in Hong Kong.

An SFC survey in December 2019 found asset managers were neither disclosing ESG risks nor integrating climate risks into investment decisions consistently, with the regulator concluding that practices “may not meet the expectations of asset owners”.

The SFC proposes amending its Fund Manager Code of Conduct to require climate-related risks to be taken into consideration in investment and risk processes, and for disclosures to be made to meet investor demand and avoid greenwashing, partially leveraging TCFD.

The consultation closed in January and conclusions are pending. The SFC’s activities form part of a market-wide regulatory effort to ensure Hong Kong is well-positioned as a hub for sustainable finance in the longer term. Alder is Co-Chair of the Green and Sustainable Finance Cross-Agency Steering Group.

Primus inter pares

For Alder, initiatives by regulators to improve the sustainability-related information flows to investors from issuers and asset managers are effectively two sides of the same coin.

“The most pressing issue is corporate or real-economy level disclosure. If you don’t have sufficiently consistent and reliable disclosure by businesses, asset managers can describe risk and governance around sustainability, but they still won’t get very far because they won’t have the underlying information to make a proper assessment. The two issues are very highly interlinked and you cannot have one without the other,” he says.

And while he believes climate-related data has to be the biggest priority for regulators and standards-setters, work on standardisation in this area is only the first step toward greater consistency, comparability, and reliability across all areas of sustainability disclosure, taking in environmental, social and governance factors.

“I’m absolutely convinced that focusing on climate upfront, or a ‘climate-first’ approach that IOSCO supports, is the right way to do this. First, it’s important and urgent. Second, it’s a highly developed area with objective data and metrics,” says Alder. “Climate reporting will be an evolving set of expectations, not least because it doesn’t sit in isolation from other environmental risks, such as biodiversity.”

 

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