The International Sustainability Standards Board (ISSB) was established in 2021 to create the first mandatory, global ESG reporting standards. For those who are not yet convinced of the need for sustainability reporting, we borrow the following from the Task Force on Climate-Related Financial Disclosures (TCFD) which states, “One of the essential functions of financial markets is to price risk to support informed, efficient capital-allocation decisions. To carry out this function, financial markets need accurate and timely disclosure from companies. Without the right information, investors and others may incorrectly price or value assets, leading to a misallocation of capital.”
The ISSB published its first two drafts of proposed reporting standards in March of this year, one on climate and the other dealing with general sustainability disclosures. Interested parties were invited to comment, and they did. This article in Bloomberg Tax states that over 1,330 letters were received from companies, investors, regulators, and researchers, addressing one or both topics.
We wish we could say that all of those letters were written to congratulate the ISSB on a job well done. Not surprisingly, that is not the case. According to the Bloomberg article the stakeholder letters described the ISSB’s proposed reporting standards as both too vague and too narrow, and argued that firms would have too much leeway in reporting on sustainability.
This feedback raises many important issues. We start by acknowledging it would be extremely difficult (impossible) to come up with a set of standards that everyone enthusiastically embraced and endorsed on the first go. Kudos to the ISSB for taking a stab at it and offering up something for others to review, criticize, and make better. On a positive note, the Bloomberg article does say that many of the comment letters supported the ISSB’s decision to use existing rules, such as the TCFD, as the basis for the new proposed standards.
Clearly, standards are needed
It is safe to say that most people who have looked at sustainability reports would agree that standards are needed. Currently, companies either report ESG risks using inconsistent voluntary standards, or not at all. In many cases, a company simply discloses whatever it chooses to disclose—needless to say, there are few/no instances where a company voluntarily reports that its ESG practices are sloppy and inadequate.
Even when companies are required to issue a sustainability report, the reports are inconsistent. This is one of the (many) reasons it is so difficult to make comparisons across companies with respect to ESG practices. In its comment letter, the United Nations Department of Economic and Social Affairs argued that companies should report on a single, core set of issues rather than the industry-specific rules suggested by the ISSB to avoid “selective disclosures”. We see pros and cons on that one.
Double Materiality
There was some pushback on the ISSB’s decision to aim reporting at investors, rather than taking a broader approach, which the European Union would prefer. This gets at the issue of “double materiality”, which was raised in a number of comments. The ISSB decided to base its reporting standards on rules that were created by the Sustainability Accounting Standards Board, a voluntary standard-setter that was recently absorbed by the ISSB. Those rules consider the impact of sustainability issues on investors—in other words, how ESG risks affect companies, and therefore their shareholders and lenders.
Critics say that international standards should take the “double materiality” perspective used by the EU. This would not only consider the potential harm to investors as a result of climate change and other sustainability issues (an obvious example: the impact of flooding and fires on the insurance industry). Double materiality would also require companies to disclose the damage they cause as a result of their ESG practices (or lack thereof). For example, as currently written the ISSB’s standards would not require the fossil fuel industry or coal-burning power plants to discuss the impact of their activities on the environment.
The Bloomberg Tax article cites the comment letter from the European Central Bank, which said “any international standard should require companies to disclose not only issues that influence enterprise value, but also information on the company’s broader environmental and social impact (‘double materiality’)”. Many of the investors who are likely to be the primary users of the information provided under the reporting standards, agree with the ECB, and submitted comment letters in favor of the EU’s double materiality approach. We see pros and cons, but more pros. We believe the topic deserves a longer discussion and will address it in a later piece.
Interestingly, a survey of large global companies recently released by the International Federation of Accountants reports that 72% of the survey respondents use the Global Reporting Initiative standards whose voluntary rules are the basis of the EU’s broader double materiality approach, compared to 38% that use the Sustainability Accounting Standards Board’s rules.
Definitions needed, and compatibility urged
There were also frequent calls for better definitions of key terms. Many criticized the ISSB for failing to define some of the basic terms used in the proposed standards. This is consistent with the UN’s comments noted above, that the proposal would give companies too much leeway over what to report. Accounting firm EY pointed out that terms such as ‘significant’, ‘material’, ‘relevant’, and ‘vulnerable’, are open to wide interpretation.”
Other comments urged the ISSB to work with the International Accounting Standards Board, to make financial and ESG reporting rules compatible. Accounting professor Richard Murphy went so far as to say that instead of separate ESG reporting rules, we need “a single new accounting standard that places sustainability on the balance sheet as a cost to be recognized.”
OWL ESG is at the forefront of supplying stakeholders with well-rounded, in-depth data about companies’ sustainability activities, from all angles. Please contact us for more information.
