At-A-Glance

Non-Financial Reporting Takes Center Stage

Environmental, Social and Governmental (ESG) issues gain prominence

Up until recently, reporting on so called “non-financial” ESG issues was seen widely as beyond the purview of accountants. Accurate and consistent reporting in this arena has been an elusive target, consequently relegating the topic to the fringes. Difficulties in identifying and quantifying relevant factors has only led to confusion and delay. Meanwhile, the challenges experienced just in trying to develop standardized financial accounting measures have dominated the focus of accounting boards. Though fairly well resolved at this point for major topics, financial reporting standards have taken decades to work out.

But with the multi-faceted complexities of functioning in today’s world, investors, regulators, and other stakeholders are demanding greater attention to non-financial factors that can seriously impact an organization’s operations and even existence in the near and long term future.

Without a central focus on ESG, various groups have separately devised a diversity of frameworks and guidelines, exacerbating the confusion. Finally, in November, the IASB announced the formation of the International Sustainability Standards Board (ISSB) with the intention to “to deliver a comprehensive global baseline of sustainability-related disclosure standards that provide investors and other capital market participants with information about companies’ sustainability-related risks and opportunities to help them make informed decisions.” The announcement was the culmination of comprehensive efforts to bring together the diverse groups into a joint effort. Also released at this time were prototypes for general sustainability disclosures and climate-related disclosures that were an outgrowth of an earlier prototype released in December 2020. 

The announcement could not have been more timely, as government agencies are now issuing new regulations. As of this month, April 2022, the United Kingdom requires large companies to include disclosures in financial reports that address climate-related risks and opportunities, following recommendations published in 2017 by the Taskforce on Climate-related Financial Disclosures (TCFD). Also, the US Securities and Exchange Commission (SEC) on March 21, 2022, proposed a rule that would require filers to include a note in audited financial statements about climate-related risks that could materially impact financial condition and profitability, as well as specific information on greenhouse gas emissions and other climate-related financial metrics. The proposal will have a two-month comment period.

If the SEC rule becomes effective in December 2022, disclosure compliance for larger filers would generally occur in the 2023 fiscal year and in fiscal 2025 for smaller filers. Greenhouse gas (GHG) emissions have been divided into three categories. Scope 1 includes direct GHG emissions from an entity’s operations. Scope 2 includes indirect GHG emissions generated by an entity’s consumption of purchased energy. Scope 3 includes all other indirect GHG emissions. Smaller filers would be exempt from Scope 3 disclosures. The audit requirement applies to Scopes 1 & 2 and occurs a couple years after initial disclosure compliance.

The ISSB did not take long to offers its first two proposals for standards. On March 31, 2022, exposure drafts were issued covering general sustainability-related disclosure requirements and climate-related disclosures. The proposals follow the lead of the TCFD guidelines and the November 2021 prototypes. The general standard is a catchall set of requirements for disclosing material sustainability-related risks and opportunities that have not been covered by a specific ISSB standard. The second standard proposal is the first to address a specific issue, namely climate change. As stated in this proposal:

“The Exposure Draft was developed in response to calls from users of general purpose financial reporting for more consistent, complete, comparable and verifiable information, including consistent metrics and standardised qualitative disclosures, to help them assess how climate-related matters and the associated risks and opportunities affect:

• an entity’s financial position and financial performance;
•  an amount, timing and certainty of the entity’s future cash flows over the short, medium and long term and, therefore, the assessment of enterprise value by users of general purpose financial reporting; and
• an entity’s strategy and business model.” 

The climate standard proposal provides details organized by governance, strategy, risk management, and metrics and targets. For example, in the area of metrics and targets, how an entity measures, monitors, and manages its risks are to be disclosed by cross-industry categories (such as greenhouse gas emissions), industry specific categories, metrics used to measure progress toward mitigation, and targets for mitigation.

Major industries are working to stay ahead of the new reporting requirements. Companies, such as Salesforce, Microsoft, Amazon, and Google, have released or are developing platforms and products to help customers facilitate the process and quantification necessary for disclosing sustainability. In April, 2022, Microsoft rolled out the first application of its Microsoft Cloud for Sustainability, an extensible software-as-a-service solution designed to record, report, and reduce organizational environmental impact through automated data connections and actionable insights. Microsoft is partnering with consulting firm, Accenture, and others, to apply these tools. 

With the backing of the IASB, the new sustainability standards provide a strong case for focusing ESG efforts in a unified direction going forward. Nevertheless, there is still a long way to go. There will be spirited discussion surrounding the new proposals over the coming months. The SEC climate change proposal alone is over 500 pages, making it one of the largest events toward corporate regulation ever. Criticism of the SEC’s proposal has already arisen from both sides of the aisle in the US Senate. Before either the accounting standards or the governmental regulations are approved, significant revisions will likely be incorporated that enhance the initial offerings. That is to be expected. Then further standards and rules on specific ESG categories and ongoing improvements will guide developments as superior technologies and methodologies emerge in coming years.  

Further details can be found at  ISSB publishes draft proposals for global sustainability disclosures and SEC Statement on the Enhancement and Standardization of Climate-Related Disclosures for Investors.

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