As the World Economic Forum publishes its annual risk report, business risks in the short term continue to be dominated by matters such as geopolitics, social cohesion and inflation, while the largest longer-term risks remain extreme weather, loss of biodiversity and the potential collapse of natural ecosystems.
It is therefore not surprising that there is much focus on how companies are addressing these matters. Mandatory sustainability reporting is often seen as a way of improving transparency and accountability to provide decision-useful information investors can use to help drive capital towards sustainable and resilient business.
The formation of the International Sustainability Standards Board (ISSB) and use of these standards to help build a global baseline of consistent and comparable sustainability information have been widely supported by investors, business leaders, policymakers and regulators.
There has been an encouraging early response in recent months, including support during COP28, for adoption of these standards by a number of jurisdictions.
Adoption in full, to which jurisdictions may add requirements as needed to reflect local priorities, is the preferred way to build a global baseline.
Fragmented regulatory reporting requirements, on the other hand, can detract from a global baseline and from decision-useful information, by switching the focus to compliance, away from material sustainability information that is overseen by the board.
Complying with even one set of sustainability reporting requirements is not a small challenge. Companies will have lots to do to achieve a robust approach necessary for high-quality reporting.
For example, in order to comply with the requirements of the EU Corporate Sustainability Reporting Directive (CSRD), even companies that have long histories of reporting on a wide range of sustainability matters will have to extend their governance and internal controls to cover a much broader data set and get ready to have that information assured.
This task becomes much harder, complex and costly if multiple jurisdictional frameworks have to be complied with.
Much time and effort could be invested by standard-setters, regulators and legislators into exercises that aim to demonstrate alignment – or “interoperability” – between various standards and frameworks, but such exercises result in reconciliation tools, leaving multinational companies having to report in accordance with many sets of jurisdictional requirements.
To avoid fragmented regulatory requirements and to support harmonised disclosures that are comparable, decision-useful and cost effective, there is a need to find ways to enable companies to identify material sustainability information that supports board decisions and to communicate it consistently to build the trust of investors.
One way this can be achieved, and fragmentation can be reduced, is if regulators permit companies outside their own jurisdictions to use globally recognised standards to meet corresponding jurisdictional requirements.
This approach would build on the principle of “equivalence”, which historically has been applied for financial reporting.
For example, in the US, foreign filers were permitted to apply IFRS Accounting Standards rather than US generally accepted accounting principles (GAAP). In the EU, where companies must report using “IFRS as endorsed in the EU”, US GAAP, among others, had been determined to be equivalent for foreign filers.
The principle of “equivalence” could therefore provide a valuable systemic tool to reduce the cost and complexity of sustainability reporting for companies while advancing the objective of achieving consistent and comparable disclosures that are relevant to investors.
“A focus on high-quality, transparent, consistent, comparable and decision-useful information supports credible stewardship”
Such an approach would allow companies to use the ISSB standards to satisfy various jurisdictional reporting obligations around the world.
The US Securities and Exchange Commission (SEC) requested feedback on a potential alternative reporting provision, specifically referencing the ISSB standards as one option in its consultation on the Proposed Rule on the Enhancement and Standardization of Climate-related Financial Disclosures for Investors (see question 189 in proposed rule).
If the proposed rule is finalised and alternative reporting under the ISSB standards is made available not only to foreign filers but to all US registrants, this would provide an impetus for US companies operating globally to adopt ISSB standards in order to satisfy both their domestic reporting obligations and those in other jurisdictions that have either adopted or also allow the use of the ISSB standards as an alternative reporting provision.
The California State Senate Bill on climate-related financial risk disclosure sets a useful precedent by recognising ISSB standards as an acceptable framework for reporting under the bill, which is particularly relevant because the Task Force on Climate-related Financial Disclosures (TCFD) has now sunset with the Financial Stability Board publicly stating that IFRS S2 can serve as a global framework for climate-related disclosures.
The EU CSRD adopted a double materiality lens, requiring companies to report not only on risks and opportunities, but also on impacts. The ISSB standards do not require reporting on impacts that are not determined to be financially material.
Therefore, it would seem inappropriate to argue “equivalence” between the two. But the Global Reporting Initiative (GRI) standards, which use an impact materiality lens, are helpful here.
Many companies already voluntarily report using GRI standards and are now looking to adopt ISSB standards either voluntarily in response to investor demand for this information or because of the various jurisdictional requirements to do so.
The CSRD expressly leaves open the possibility of recognising an equivalent standard. Perhaps the European Commission could accept compliance with both ISSB and GRI standards – in other words, reporting that delivers both financial and impact materiality perspectives – as equivalent to reporting in line with the requirements of the CSRD for many foreign companies and groups that are affected by its extraterritorial reach.
Such an approach could be considered both when the domestic jurisdiction of the parent of a multinational group requires one or both of these sets as part of its mandatory disclosure obligations or the company or group chooses to report voluntarily using both ISSB and GRI standards.
If the concept of equivalence were to be introduced in this way, not only could it help achieve greater global comparability, but it may help limit the amount of time and resources that companies invest in compliance activities to meet multiple requirements, disclosure reconciliations and attempts to identify material information amidst the multiple portrayals of the same information resulting from multiple jurisdictional sustainability disclosure regimes.
A focus on high-quality, transparent, consistent, comparable and decision-useful information supports credible stewardship, evidencing that a company is holding itself to account in setting out and meeting corporate commitments.
This involves board oversight, which promotes rigorous internal governance, controls, processes and monitoring and enhances the reliability of sustainability information.
It puts emphasis on the role of the CFO, which is key for a holistic portrayal of business dynamics and performance and achieving the same level of rigour for sustainability information that is applied to financial information.
Such governance and discipline over the reporting process is necessary for investors to have more confidence that material sustainability information is not misstated, helping them to mitigate risks in their analysis and investment decisions.
This, in turn, can help not only improve the effectiveness and resilience of capital markets but also help integrate material sustainability-related risks and opportunities into the heart of business.
Veronica Poole is Deloitte’s Global IFRS and Corporate Reporting Leader
