In March of this year I wrote about how to establish a global set of standards for companies to report on their environmental, social, and governance (ESG) performance—or so-called “nonfinancial information.”
I’m pleased to report that significant progress has been made in the past five months.
Key to this achievement is the foundational work of five NGOs (The Five) whose missions are aligned with this goal: CDP, the Climate Disclosure Standards Board (CDSB), the Global Reporting Initiative (GRI), and the Sustainability Accounting Standards Board (SASB), guide the overwhelming majority of ESG disclosure and the International integrated Reporting Council (IIRC) provides the framework for how to connect ESG disclosure to reporting on financial and other capitals.
Their work is particularly critical now, as governments and major accounting bodies are acting on standards. The IFRS and IFAC have recognized the need for mandated standards for nonfinancial information. The EU, in reviewing its Non-financial Reporting Directive (NFRD), has instructed EFRAG to establish a European Lab Project Task Force to make recommendations on standards for nonfinancial information, as a prelude to their stated intention to regulate. And a variety of business groups, including the IBC/WEF and the Big Four have voiced the need for global ESG reporting standards for companies and markets.
All of these groups should build on the work of “The Five.”
Not only are they field leaders, they also recognize that they are stronger as a group than individually. And while each of “The Five” has its own particular approach to ESG standards and reporting, much of their technical content is complementary rather than overlapping. This is clear in their recent “Statement of Intent to Work Together Towards Comprehensive Corporate Reporting (The Statement)” authored by The Five and facilitated by the Impact Management Project, the World Economic Forum, and Deloitte. I think this is the most significant step in setting global ESG reporting standards taken to date.
In order to better understand the motivation behind this report and what these organizations hope will come out of it, I spoke with Janine Guillot (CEO of SASB), Eric Hespenheide (Chairman of GRI), Mardi McBrien (Managing Director of CDSB), Paul Simpson (CEO of CDP), and Charles Tilley (CEO of the IIRC).
All five cited a shared sense of urgency as a motivating factor. “The time has come,” McBrien said, for “getting decision-ready ESG information to the capital markets.” Companies and investors have been clamoring for this, expressing confusion about the number of different frameworks and standards. Pressure has grown dramatically as sustainability has become mainstream. As Tilley put it, “This is a fantastic time to be able to take all of these initiatives together and to drive change.” McBrien and Simpson noted that the organizations had worked together bilaterally in various ways in the past, but Simpson acknowledged that “We’ve all felt the pressure for greater coherence and to show how we are complementary.”
In “The Statement” they were able to do so. Guillot observed, “I’m particularly proud that we were able to lay out a common language for the field and articulate how the actors fit together within that.” Hespenheide pointed out a deeper benefit to their work by noting that “This is an opportunity to define, as a group but [also] individually, what is meant by the terms ‘collaboration, rationalization, and harmonization.’”
Getting five people from different organizations to agree on the content of a report can be challenging. McBrien noted that the group “drew on what was already in the market and filled in the gaps behind that,” observing that, “This is the first time that five of us have sat around a table and have had a good conversation about how to work through the trickier parts.”
One of the trickiest parts is the definition of materiality. Guillot framed it this way: “Can you delineate views on materiality, or are they really one?”
The simplest framing of this question is whether what defines a material issue from a reporting point of view is something that matters to investors or something that matters to society. The former is about long-term enterprise value creation. The latter is about the positive and negative externalities in the world being created by a company’s operations, products, and services. Simpson noted that “how to delineate what is material for enterprise value creation, and for wider impact on people and planet was the biggest dialogue and debate that we had. What is material to some and not to others, and over what time frame. The EU’s notion of “double materiality” recognizes the importance of both perspectives.”
The Five took a big step forward in the practical resolution of this question by explaining materiality as a nested concept. As shown below, Figure 2 from “The Statement” depicts materiality as emanating outward from a core of information reflected in the financial accounts, which is handled by FASB and the IASB; then to a complement of ESG information that is material for enterprise value creation, which is the focus of SASB (relevant industry-specific information) and CDSB (a complementary slice of industry-agnostic disclosure on climate and other environmental matters). This information, in turn, is a subset of the full range of relevant ESG information that GRI addresses for reporting to a broad range of users, of which CDP’s market-led disclosure platform covers climate, water, and forestry in greater depth. The IIRC’s “International <IR> Framework,” which is focused on value creation over the long-term, connects reporting of ESG information to reporting on financial and other capitals.
All agree that Figure 2 is both a useful framing and an over-simplification of the reality of standard setting today. Hespenheide observed, “While there is a desire by some to have a bright line or a clear difference between which group is focused on the company and which is focused on society, it’s not as clear cut as that.”
In addition, the boundary lines between materiality “zones” are dotted in the diagram to emphasize the complex reality that they are neither bright nor fixed. Here the notion of “dynamic materiality,” (which I’ve written about before) is essential. Figure 1 from the report, shown below, illustrates that issues that are material from a societal perspective (such as climate change) can become material from an enterprise perspective, either slowly or rapidly. Tilley called this “a very exciting chart” in that it could facilitate a transition to a definition of materiality appropriate to current conditions.
Guillot raised a second tricky issue: “… whether it is possible to get a single set of standards that encompasses what is material for different audiences.” There is no simple answer to this. At the very least there should be “interoperability,” which means there should be structural connectivity between standards that companies use to report to different audiences; and, where information about a topic is relevant for different audiences (such work-related injuries), the related metrics are ideally the same. Towards that end, The Five are preparing a tangible example of how their combined content can be applied to climate to meet the needs of the capital markets, and have either integrated or are integrating their content with the elements set out by the Task Force on Climate-related Financial Disclosures (TCFD). This exercise will also demonstrate an architecture that can be applied across other sustainability topics. A further step, which GRI and SASB are exploring, is to link standard-setting processes to avoid costly reconciliation of metrics. Hespenheide emphasized that “It’s going to be important for us to follow through quickly on what we say we’re going to do.”
Getting to global standards for ESG reporting obviously involves others beyond these five organizations. Guillot rightly described their effort as “the building blocks for a global solution.”
The IFRS Foundation, which oversees the IASB, recently released a consultation paper on its role in sustainability reporting. Guillot emphasized that the “IFRS is the fastest path to global legitimacy for a solution.” Supporting this view, IFAC has called for a Sustainability Standards Board, alongside IASB, in an expanded IFRS remit. Reflecting on the EU’s notion of double materiality, Simpson hoped “The IFRS is going to be about enterprise value creation and the impact on the environment and society.” IOSCO also has a critical role to play by indicating that global standards for ESG reporting must be a priority and has received an open letter from “The Five.” Last week, Erik Thedéen, Chair of IOSCO’s Sustainable Finance Taskforce, explained that IOSCO is in a unique position to facilitate progress on sustainability standards for the capital markets, noting the opportunity to bring together the governance, global legitimacy, and standard-setting experience of the IFRS Foundation with the domain expertise of The Five. Figure 6 (below) from The Statement depicts how the standards for financial information and nonfinancial information are related to each other.
Here is my opinion on the fastest route to global standards.
The EU leads as the “standards and reporting requirer” but not the “standards maker.” As noted by Hespenheide, “The best way to drive change is to mandate reporting.” In doing so, the EU pushes for an acceleration of global standard-setting based on the combined work of The Five, an expanded role for the IFRS Foundation, and coordination between IOSCO (as securities regulators) and the additional public interest bodies needed for appropriate governance of the “double materiality” requirement. EFRAG’s Task Force includes recommendations about how The Five’s content might be improved to meet regulatory needs. While the EU can only set reporting requirements for companies in the EU, it emphasizes its recommendation of globally applicable standards. As a result, other jurisdictions follow the EU’s leadership, including the U.S., building on the current support of major U.S. corporations and asset managers (although that will require that these companies lead a change in the political environment).
The WEF-IBC/Big Four are instrumental by making it clear that, in their own work, that they want to collaborate with others to catalyze a global solution. The WEF-IBC/Big Four lack standing to set standards (companies and accounting firms cannot set their own standards, and they lack the requisite standard-setting governance). They risk confusing the issue by publicly implying otherwise.
McBrien nicely summarized the current reporting state of affairs. “This feels like a moment of global systemic change. It’s now or never. It’s going to take a global collective effort from all of ourselves as well as our stakeholders.”
The window of opportunity is a short one, a year at most. I am not naïve about the many political undercurrents that exist. Standard setting is a process fraught with peril and depends upon the good will of everyone who has a voice in it. I’m hopeful that all involved will continue to rise rapidly to the occasion. It’s crunch time.