What Are ESG Reporting Standards in 2022? Exploring What’s Expected This Year and Beyond
What are ESG Reporting Standards in 2022?
ESG (environmental, social, and governance) reporting standards have changed in the last year alone, with even more changes on the horizon for 2022 and beyond.
Historically, companies complied with ESG reporting voluntarily, but there have never been any legal or regulatory requirements in place.
For example, according to a study completed by the Governance & Accountability Institute in 2020, 92% of S&P 500 companies published a sustainability report in 2020.
And disclosing corporate sustainability is a global progression. According to a KPMG study, 80% of companies worldwide report sustainability performance.
Before we get into the trends of 2022 and what it means for the companies affected, let’s start with the basics of ESG information.
What is ESG Reporting?
As controllers and accountants, you’re likely familiar with ESG disclosures, at least in a broad sense.
However, since many of the changes coming this year, and likely into 2023, will make ESG reporting mandatory, it’s a good idea to brush up on the basics.
As a side note, small to medium enterprises (SMEs) likely won’t be required to report by any regulatory agency. But as a supplier to larger companies, you may find this type of non-financial reporting becomes part of your routine.
Let’s take a look at what ESG reporting covers.
ESG disclosure requirements broadly cover three topics: environment, social and corporate governance.
Environment reporting covers the following:
- climate change
- carbon emissions
- pollution and waste
- energy efficiency
- electronic waste
- environmental impact
- customer satisfaction
- human rights
- health and safety
- data protection and privacy
- gender and diversity
- community relations
- sustainability reporting
Governance metrics include:
- board diversity
- business ethics
- audit committee structure
- tax transparency
- corruption and instability
- whistleblower programs
These reports give detailed data through integrated reporting that’s often paired with an overall performance analysis that provides stakeholders and investors insight into the business’s goals and impact.
It goes beyond financial reporting, though that is often included as well. Think of it as a very specific prospectus.
As mentioned, these sustainability disclosures have typically been voluntary acts.
A small number of companies were required to disclose in the past. But there are 30 regulatory bodies (think of central banks, governments, financial regulators, etc.) across 11 jurisdictions, including the U.S., U.K., EU, Canada, and Japan, looking to tighten ESG reporting standards.
The writing is on the wall for sustainability reporting to become a requirement.
Thanks to new initiatives in the U.K. and across Europe, all private U.K. companies, limited liability partnerships with over 500 employees and income greater than £500M, and all publicly quoted U.K. companies will likely be required to complete ESG reporting as a part of their annual report.
This is in line with the Task Force on Climate-related Financial Disclosure (TCFD) and a directive issued by the European Commission, containing specific European sustainability reporting standards.
In the United States, the Securities and Exchange Commission (SEC) proposed making ESG performance reporting mandatory. There has been much debate around the proposal as many opponents question the SEC’s jurisdiction in such matters.
Still, the SEC expects to issue ESG standard disclosure rules that will go into effect in 2023. If that happens, affected organizations will need to spend 2022 setting up processes and systems to collect accurate data.
How many ESG reporting frameworks are there?
Since ESG reporting was only loosely regulated until recently, a company can use many different methodologies and reporting processes. And choosing the best option depends on the company’s goals.
That said, there are several common frameworks most companies use, and they’re broken up into three groups:
- Voluntary disclosure frameworks
- Guidance frameworks
- Third-party aggregators
Voluntary disclosure frameworks
Companies can choose between CDP, Global Real Estate Sustainability Benchmark (GRESB), and Dow Jones Sustainability Indices (DJSI) for voluntary disclosure frameworks.
Under this framework, a company generally discloses its sustainability-related policies, practices, and performance data. These agencies often use questionnaires for evaluation and ranking.
Under guidance frameworks, companies can choose between Sustainability Accounting Standards Board (SASB), Global Reporting Initiative (GRI), CDSB, and Task Force on Climate-related Financial Disclosures (TCFD).
Guidance frameworks help companies decide what to include in their reports. It covers providing the correct context, reaching the right audience, and ensuring the information consists of the most material topics for stakeholders.
Third-party aggregators include options such as Bloomberg Terminal ESG Analysis, Institutional Shareholder Services (ISS), MSCI, and Sustainalytics.
These third-party aggregators collect data on companies through mainstream regulatory filings, sustainability and CSR (corporate social responsibility) reports, and publicly available policies and information.
Why are ESG Reporting Standards Important?
There are three main reasons ESG reporting standards are essential: transparency, accountability, and confidence.
At the beginning of this article, we mentioned that ESG reporting is a very specific prospectus. Here’s why.
Whenever you invest in a mutual fund or stock, you want all the information about the key performance indicators so you can make an informed decision about whether you’d like to invest or not.
The same holds true with ESG reporting. It allows investors and stakeholders to see its goals and how current and potential ESG factors are handled. It enables them to make informed investment decisions.
And as younger investors enter the market, they are looking to make responsible investments. According to a PWC study, two-thirds of millennials consider a company’s environmental and social responsibility before purchasing.
This means sustainable development and financial performance will become closely intertwined.
Another reason ESG reporting is essential is that it holds stakeholders and board members accountable for their actions.
Businesses like to claim they care about ESG issues, but their ESG reporting lets the company’s behaviors and practices speak for themselves.
For example, if a company claims there are no gender-based pay inequalities, but its ESG data shows a wage gap of 3% between men and women, then the company has some work to do, and investors can see that.
Investors are far more likely to put money in a business they trust.
The quickest way to do that is to show investors the company stands by its word. If a company boasts several green initiatives, a verified ESG report showing those initiatives in place and successful can go a long way in building trust.
How is ESG Measured?
An ESG score measures how a company performs its environmental, social, and governance responsibilities. The trouble is, there isn’t a global standard scoring system. Several agencies provide scoring based on their own processes making comparability difficult.
It’s important to note that all the agencies offering an ESG score are third-party aggregates that rely on public information.
That means they calculate an ESG score based on how a company’s performance is perceived. If a company puts positive practices that counteract certain risks, but none of it is public information, it won’t help its ESG score.
The most common of these agencies is MSCI. They calculate ESG scores by scoring on different vital issues specific to the industry. MSCI uses a scale of AAA to CCC, and the agency considers each factor of the company’s exposure to ESG risks and how well the company compares to its competitors.
Sustainalytics is another agency that measures ESG. They focus on industry-specific ESG risks, and like MSCI, they combine risk management and exposure to calculate a company’s score.
Although there are different methods to calculate the ESG score, each agency focuses on critical issues to determine risk and how a company manages it. Matters under the environment and social areas are generally industry-specific, while the key issues for governance tend to be the same across the board.
Trends in ESG Reporting for 2022
For 2022, the top trend is climate.
Regarding ESG reporting, frameworks will focus heavily on climate issues and how companies plan to manage exposure to risk in that department.
The next trend to keep an eye on is changing market dynamics. As reporting becomes more mandated, more companies will begin reporting.
We’ll see the most significant push in reporting from SMEs. Although they may not be required to report, they’re often suppliers to large companies, which means the pressure will be on SMEs, so large companies maintain their ratings.
For example, net-zero emissions are a big focus in 2022. As companies transition to a net-zero economy, they’ll have to push for net-zero supply chains. That means suppliers will need to evaluate and report their greenhouse gas emissions and transition to larger companies or risk losing business.
A final trend that could emerge as environmental factors continue to be the focus in 2022 is a common ESG language.
The more companies report on these issues, the harder it will be for other companies to sweep misconduct under the rug. It will be much harder for companies to claim green initiatives and then use fancy language to hide they haven’t done what they promised.
Although the reporting regulations haven’t gone into effect just yet, many companies are putting processes in place now in anticipation of the requirements. Final conversations are expected to be finished by the Fall of 2022, regulations will go into effect in 2023. In the meantime, regulatory agencies are pushing an environmental agenda as the focus, eclipsing social and governance issues.
Sustainability issues should be integrated into business strategies to mitigate financial risks. With more and more investors looking to make sustainable investments, get acquainted with the disclosure requirements this year to get a head start.