In recent years, developed economies around the world have embarked on a collective journey to make the planet more liveable and sustainable. They have tightened regulations related to environmental protection and biodiversity, all in pursuit of their commitments to the United Nations Sustainable Development Goals (UN SDGs). As a result, businesses, large and small, are increasingly recognizing the significance of Environmental, Social, and Governance (ESG) metrics and sustainability disclosures.
In this evolving landscape, knowledge institutions and consulting companies have played a crucial role in designing reporting parameters, assessment frameworks, and disclosure requirements to help companies align with global sustainability reporting standards. ESG-related Key Performance Indicators (KPIs) are now integral for tracking progress and identifying areas of improvement. Notably, several organizations have taken the lead in developing and promoting ESG standards and KPIs, including the Sustainability Accounting Standards Board (SASB), Global Reporting Initiative (GRI), Task Force on Climate-related Financial Disclosures (TCFD), Climate Disclosure Standards Board (CDSB), and International Integrated Reporting Council (IIRC).
One of the driving forces behind this global interest in environmental ratings and disclosures is the demand for green energy and the funds required to transition from high-emission to low-emission and eventually achieve net-zero emissions. Governments worldwide have recognized the importance of attracting private sector investments in renewable energy projects to achieve their climate objectives. For instance, in the United States, the Inflation Reduction Act has allocated a substantial $369 billion for clean energy and climate-related initiatives, leading to a surge in green energy investments. Similarly, Europe and the UK have swiftly implemented incentives to attract and retain renewable energy businesses.
The European Union, for instance, has proposed measures such as relaxing state aid rules and introducing the Green Deal Industrial Plan to compete with the US initiative. This plan aims to bolster manufacturing capacity for net-zero technologies, promote clean energy scaling, and enhance energy resilience. Within this proposal lies the Net-Zero Industry Act, designed to strengthen renewables manufacturing and energy resilience within the EU. These financial incentives are pivotal in advancing renewable energy projects and aligning with climate goals.
Amid this growing focus on ESG, market participants have recognized the need for clear reporting standards. The International Financial Reporting Standards (IFRS) has introduced IFRS S1 and IFRS S2, unifying disclosures on environmental factors such as waste and emissions, effectively integrating sustainability with financial information. These standards aim to simplify the complex system of ESG metrics and disclosures, providing a comprehensive, consistent, and verifiable framework useful for market participants. Both IFRS S1 and S2 are set to take effect from January 2024, further emphasizing the importance of standardized ESG reporting.
However, while ESG reporting gains momentum, regulators worldwide are closely monitoring the approaches, objectives, methodologies, and indicators used by various companies. Many of these methodologies remain opaque and undisclosed. Companies employ diverse methodologies, using a wide range of indicators and data points, varying from 180 to over 1000, to create their unique rating scales. This divergence can be observed in instances like MSCI, which focuses on rating funds, while Dow Jones ESG ratings consider indices.
In Europe, ESG data quality concerns have prompted action. The UK’s Financial Conduct Authority (FCA) issued a voluntary Code of Conduct for ESG rating providers to ensure consistency and accuracy, aiding investor decisions.
The European Commission (EC) proposed stricter measures, requiring ESG rating providers to clarify their methodologies and obtain regulatory approval, bolstering trust among investors and regulators.
In the UK, the Financial Reporting Council (FRC) advocates changes linking executive pay to ESG performance. Studies show European and UK companies considering ESG metrics in executive compensation to prevent greenwashing.
ESG-related litigation is rising, shifting from company disputes to regulatory challenges in the EU and UK, including cases on climate risks and sustainability classifications.
In the US, companies face shareholder and regulatory pressure to enhance ESG transparency. Shareholders allege unmet environmental and diversity commitments, while the SEC proposes comprehensive ESG disclosure regulations. Global stakeholders closely watch these developments.
Relevant authorities in the EU, UK, and US have adopted varying approaches to regulating collaborative sustainability initiatives. The EU and UK generally support such initiatives, with the EU providing clear guidelines, and the UK adopting a slightly broader interpretation. In contrast, the US has expressed competition concerns regarding climate-focused collaborations. This divergence in regulatory approaches is likely to make companies cautious about participating in sustainability projects, especially those with cross-border implications. The ongoing debate over the role of relevant authorities in addressing climate change adds complexity to the regulatory landscape, leaving businesses to navigate varying perspectives on the legality of ESG initiatives.
As the landscape of ESG regulations and reporting continues to evolve, companies in 2024 face both challenges and opportunities. The diversity in regulatory approaches across regions emphasizes the need for a strategic and adaptable approach to ESG reporting and disclosure. Here are key considerations for companies planning their ESG reporting in 2024:
- Regional Variations
- Holistic Approach
- Collaboration
- Data Quality
- Scenario Planning
- Transparency
- Materiality Assessment
- Continuous Improvement
Companies that proactively adapt to regional nuances, adopt a holistic approach, and prioritize transparency will be well-positioned to navigate this dynamic environment successfully. By aligning ESG efforts with their core purpose and engaging with stakeholders, organizations can not only meet regulatory requirements but also drive positive societal impact and create long-term value.
Article Credits: The Times of India