ESG reporting: What’s on the menu?
NFRD, TCFD, SFDR, SASB. A collection of acronyms likely to cause as much confusion for corporates as those used by texting millennials do for confounded parents. A lot is currently happening in the ESG reporting space, so we have set out those key developments to be aware of and what they mean.
Non-Financial Reporting Directive (NFRD)
The NFRD is nothing new for those corporates caught within scope. It requires large companies to disclose certain information on the way they operate and manage social and environmental challenges. As previously covered in our specific blog post on the NFRD, the regime is subject to change following a European Commission consultation that closed earlier in the Summer and the expectation of a draft Regulation in Q1 2021.
All large listed and financial companies in the EU that qualify as large public interest entities will need to keep an eye on these developments as the regime could shift from voluntary to mandatory and be extended to cover new areas of information such as climate change scenario analysis.
Taxonomy and Disclosures Regulation
The EU Sustainable Finance Package, the posterchild of the EU’s climate change agenda, is also having significant impacts on ESG reporting, both directly for financial institutions and indirectly for corporates.
The Sustainable Finance Disclosures Regulation (SFDR) will require (or encourage, depending on the size of the entity and type of product) disclosures to be made on websites, in periodic reporting and in pre-contractual documentation around how financial market participants incorporate sustainability into investment decision-making. This will require, on the part of corporates, the provision of granular detail on a wide range of “principal adverse impacts” on sustainability factors, a lot of which (for instance Scope 3 emissions) is not currently collated.
The related Sustainable Finance Taxonomy Regulation (SFTR) requires additional disclosures from the same financial market participants on how and to what extent certain investments support “environmentally sustainable” economic activities. The SFTR will also impact the NFRD, as entities caught within scope of the latter will be required by Article 8 of the former to disclose certain information including how and to what extent their activities are “associated with” (unhelpfully undefined) with “environmentally sustainable” economic activities and the proportion of turnover derived from products or services associated with such activities. A delegated act on the Article 8 requirement is due to be published by 1 June 2021, with the obligation applying to a limited extent from 1 January 2022. The standard required of environmental sustainability is significant and will represent a material hurdle for those aspiring to taxonomy compliant status.
Voluntary reporting frameworks
When it comes to voluntary reporting on ESG, there is no scarcity of available frameworks. Whether you choose to report under the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), or the standards set by the Global Reporting Initiative (GRI) or Sustainability Accounting Standards Board (SASB), there are plenty of options in the so-called alphabet soup. To be added to the mix over the next couple of years will be the Task Force on Nature-related Financial Disclosures (TNFD) aimed at “redirecting flows of finance at scale towards nature-positive activities to allow nature and people to flourish”.
The difficulty for many looking to report is which standard to choose given they all have their merits and overlapping elements but do not provide what many stakeholders and investors are looking for in terms of a universal standard to allow easy comparability between companies and their performance in this area.
So why not standardise sustainability reporting standards, you might ask. Well, there are overlapping developments on that front too.
First up, we have the European Financial Reporting Advisory Group (EFRAG) who has, at the direction of the European Commission, begun preparatory work on recommendations for a possible EU non-financial reporting standard. A progress report from EFRAG was due by 30 October, which we understand was discussed on 2 November and is expected to be published soon. A final report on EFRAG’s recommendations is expected by 31 January 2021. The aim is to pursue European standardisation, and from there international standardisation, of sustainability reporting. EFRAG’s work ties in with the review of the NFRD, which included a question for consultees on which of the existing global standards available should be incorporated into their (potential) new EU standard.
Turning to the TCFD and further to the significant groundswell around its adoption, in the UK the FCA consultation on whether to make reporting under the framework mandatory for premium listed companies has just closed. It is expected that the rule will apply to financial years beginning from 1 January 2021 and will see such entities required to report on a comply or explain basis.
Now moving out to a more global audience, the International Financial Reporting Standards Foundation (IFRS) has also recently published a consultation paper looking to assess the appetite for a global set of non-financial sustainability reporting standards. This runs until 31 December 2020, with more information available here.
The IFRS’ consultation might well have been received with more acclaim had it not followed hot on the heels of the announcement by the Big Four accounting firms of their own initiative to collaborate on a global reporting framework for environmental, social and governance standards. The framework, with 21 core and 34 extended metrics, covers issues from emissions to gender ratios and governance targets and is being encouraged by its proponents to be adopted by the members of the International Business Council for their 2021 accounts onwards.
What does it all mean?
Taking a step back, all of this means that some entities could face themselves reporting under the NFRD as guided by the European standard to be published by EFRAG, while also being:
- obligated to disclose in line with the TCFD (or explain why not and face the potential shareholder and stakeholder backlash that comes with it);
- pushed by financial institutions to provide granular information under the SFDR on one set of prescribed sustainability indicators (with the potential of additional unique indicators from each one); and
- assessed by their accountants against one of several sets of global non-financial reporting standards.
While the above will not apply to everyone (and for those it does apply to, it will simply not be practical), there are some clear takeaways. First, non-financial reporting will play a key role for companies going forwards. Second, companies are going to need to engage or face the potential consequences of failure to do so. And third, there is clear demand that the data published be comparable. The current situation may be a case of one too many chefs but, as in the social space with the UN Guiding Principles on Human Rights, one standard will (hopefully) eventually win out and when it does, companies need to make sure they can report to it.