The acronym ESG stands for Environmental, Social and Governance. Investors are progressively interested in these non-financial factors as part of their analysis of company and fund performance. ESG disclosures are increasingly standardized. Certain jurisdictions like the EU are moving to mandate sustainability reporting standards for all large companies.
What does ESG stand for?
The acronym ESG stands for environmental, social and governance factors. Investors are increasingly interested in these non-financial factors as part of their analysis of company and fund performance. Non-financial factors can influence stock performance, including material risks, reputation and growth opportunities. Governments, companies and investors are working together to define a common language and standardize the assessment of ESG performance to increase transparency.
A firm’s ESG score refers to its sustainability performance based on Environmental, Social and Governance criteria. ESG metrics vary from one industry to the other, but serve as a basis for new forms of responsible or sustainable investing:
- The environmental pillar accounts for, but is not limited to, a company’s impacts on the natural resources it uses, pollution, energy usage, waste and water treatment.
- The social criteria looks at a company’s respect for human rights within its entire stakeholder networks like its workforce, different levels of suppliers, consumers and communities impacted by operations.
- The governance criteria measures a company’s internal structure, decision-making processes, audit compliance and shareholder rights.
What is ESG disclosure?
ESG disclosures are ways for companies to communicate and report on their ESG performance to investors, shareholders or regulators. In all markets, companies face an increasing pressure to report on non-financial data related to their sustainability efforts, targets and performance. Companies disclose their ESG performance annually, often as stand-alone “sustainability reports”. These reports are the basis for institutional investors and impact investors to rank the sustainability efforts of the companies they wish to add to their portfolio. They paint a picture of the issues that are “material” to the company, meaning that have the potential to affect the firm’s business or issues that are consequences of business operations.
There is currently no mandatory reporting framework imposed for ESG disclosure. As a result, there is a high heterogeneity in terms of material issues covered, length, depth and scope of analysis. This makes it difficult to compare ESG performances within and across sectors.
Are ESG disclosures mandatory in 2022?
A few reporting frameworks like the Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB), and Taskforce on Climate-related Financial Disclosures (TCFD) signal that companies provide and report on robust data and have in place environmental management processes.
As of 2022, regulations are rapidly evolving and jurisdictions across the world are moving to mandate ESG, climate-related, or non-financial reporting at large. In fact, Deloitte predicts that “The ESG reporting landscape is now rapidly moving toward globally harmonized disclosure standards”. In the EU for example, the EU Corporate Sustainability Reporting Directive (CSRD) mandates public-interest entities (PIE) with more than 500 employees to publish an annual report on environmental matters, treatment of employees, anti-corruption and bribery, diversity, and respect for human rights. More specifically, they have to report the policies implemented, their outcomes, main risks of their business along with mitigation strategies and financial indicators.
The CSRD seeks to address the aforementioned shortcomings of diverse reporting frameworks that lead to incompatibility and inconsistent disclosures. The EU Commission has tasked the European Financial Reporting Advisory Group (EFRAG) to develop the mandatory EU sustainability-reporting standards. The current timeline is to have the first set of standards approved by the European Commission by October 2022 so that companies can use 2023 as a reference year for their first mandatory reports due in 2024.
Should ESG disclosures be audited?
While it is currently not mandatory to audit ESG disclosures in most markets, obtaining limited or reasonable assurance for entire reports or specific parts signals the accuracy and reliability of disclosed data.
The CSRD is pushing the boundaries of sustainability reporting by requiring the audit (assurance) of reported information. The scope of the statutory auditor’s engagement is now broadened to include:
- Compliance of the sustainability reporting standard
- Process and methodology adopted by the company to measure and report
- Mark up of sustainability reporting using XHTML format
EU Member states will have the authority to accredit any independent assurance service provider to provide limited assurance engagements. Statutory auditors and audit firms will be subject to requirements governing the provision of consistent assurance of non-financial disclosures.
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