The reporting challenges
There is another challenge that sits alongside all this, however, that simply can’t be ignored: ESG reporting. ‘Doing’ ESG may ultimately be the most important thing, but every business must also be able to report on it with accurate, robust, and transparent information. Investors and other stakeholders need and demand it. And regulators are acting at pace to mandate it too.
In fact, arguably there has never been as much activity, at such speed, around corporate reporting requirements as is happening right now in relation to ESG. There are three sets of ESG reporting standards being developed, and they are all moving fast. In the US, the SEC released proposals in March that are out for consultation until late May. Meanwhile, the newly-formed International Sustainability Standards Board (ISSB) – a sister organization to the International Accounting Standards Board (IASB) – has put forward proposals for consultation too. While the European Union has already published a Directive on EU Sustainability Standards that is due to go through political negotiations and voting later this year.
All three sets of standards should be finalized or near-finalized by the end of this year, with effective dates most likely falling in the 2023 – 2025 range. Given the significance and scope of what these standards will be requiring, this is change at lightning speed.
The challenge will be made harder again by the fact that, while the three sets of standards can be expected to have many commonalities, there will also inevitably be some differences. And many organizations will need to report under all three in one form or another if they have an international footprint. With many chemicals businesses being truly multi-national, the sector could really feel the effects of this.
Take for example a US-headquartered chemicals business with a subsidiary in Europe and another one in Australia. The business would need to report on a consolidated basis against the SEC rules, while reporting in line with EU requirements for its European subsidiary, and potentially in accordance with the ISSB standards for its Australian business. The latter would depend on how/whether Australia chose to adopt the ISSB standards, as will be the case in every jurisdiction – adding yet another layer of complexity.
You can quickly see how demanding and time-consuming the task could become. Add to this, that the subsidiary information filed is likely to receive far more attention than is traditionally the case for financial subsidiary filings. Financial filings are largely an administrative exercise for tax/legal purposes. No one pays significant attention to them – it’s the consolidated group accounts that most users pore over. But subsidiary ESG filings could be of huge interest to a wide range of stakeholders – from regulators and investors to activists, NGOs, community groups and the public at large.
A significant workload
While there are differences between the three sets of proposed standards, the guiding principles and end-goals are the same: ESG information and metrics should be gathered, calculated, assured and reported with the same rigor and level of technical detail as financial information is today. Proposed standards are also generally built from or inspired by the framework of the Taskforce on Climate-Related Financial Disclosures (TCFD), which some organizations have already begun to report some information in line with. The four pillars of the TCFD – Governance, Strategy, Risk Management, Metrics and Targets – are the same pillars underpinning the SEC’s proposals.
To meet the requirements, organizations will need to develop new processes, controls, and data streams – and ensure that they stand up to the scrutiny of an auditor’s lens in assuring them.
Make no mistake that significant work will be required. A lot of the information and controls that will be needed sit outside the traditional reporting and oversight process – it may not be captured by existing ERP systems for example. Many organizations, understandably enough, are currently relying on manual and/or unstructured sources such as spreadsheets and emails to gather ESG data. But where data is collated in this way, there is a high risk of both error and incompleteness. Better systems and processes will be required. There will also need to be close collaboration between sustainability teams and finance and controller teams to reconcile any tensions between the ambition for reporting and what can be reported on.
Resources could become a huge challenge, too. As ESG becomes a reporting matter, it is likely to become the responsibility of the finance and controllership functions, but they are already under significant pressure to manage the existing reporting workload – these new requirements will likely add considerably to the demands and may also require some specialized skillsets. Expect a war for talent as businesses look to recruit the talent needed. Arrangements with some third-party service providers around the provision or analysis of specific data sets and information may also be necessary.
Get started now – and don’t forget assurance
All these factors could lead to a perfect storm: enhanced and complex regulatory requirements, with pressure on resources, and limited time. This just underlines that it’s important to get started on the journey now – not in a year or two years’ time.
Businesses should start mapping out what systems, processes, policies and controls they will need to gather and aggregate the information required. Not forgetting that most of this information will need to be externally assured too. As the assurance requirements grow over time (moving from ‘limited assurance’ in the early stages to more detailed ‘reasonable assurance’), organizations will need to make sure they have sufficiently robust processes and controls to stand up to those independent certification standards.
And it’s not just a case of submitting your data for assurance when you reach the first reporting cycle – that’s too late, and too fraught with risk in the event that the assurer identifies gaps or deficiencies that there is no time to rectify. It will be necessary to make sure your data is ready to be assured first, by going through a precondition assurance exercise.
Under the microscope: SEC proposals
So what kind of information will chemical businesses and others need to report? Taking the SEC proposals as an example, they would require domestic or foreign registrants to include certain climate-related information in registration documentation and periodic reports, including:
- Climate-related risks and their actual or likely material impacts on the business, strategy, and outlook
- Governance and risk management processes related to these risks
- Greenhouse gas (GHG) emissions
- Certain climate-related financial statement metrics and related disclosures in a note to the audited financial statements
- Information about climate-related targets and goals
The proposals surprised some observers by the depth of some of their accounting requirements. For example, they would require that some ESG-related information be reported within the financial statements themselves. This contrasts with the ISSB’s proposed rules that would see ESG disclosures sitting outside the financial statements.
The proposed financial statement disclosures fall into three broad categories: financial impact metrics, expenditure metrics, and financial estimates and assumptions. The aim is to disclose the financial impact of climate-related conditions and events (e.g., severe weather) and transition activities on the consolidated financial statements.
A snapshot of the key requirement is as follows: