Over the past few years, the regulatory environment for ESG has shifted dramatically. Led by widespread progress in Europe, the United States has methodically laid the groundwork for implementing regulatory requirements on various ESG disclosures. With climate disclosures as the most pressing, the SEC has now published its plan for requiring corporations with registered securities to disclose a variety of climate data.
This marks a turning point in the ESG disclosure community. Just three years ago, it was considered unlikely that regulations would be passed in the US and most stakeholders weren’t optimistic; however, the power of free markets has made it clear that ESG is a top priority. As investor pressure for transparency around ESG has increased, the weight on companies to disclose a litany of ESG data has driven the number of ESG disclosures up at a rapid pace. In many ways, this forces the hand of the SEC and other regulatory bodies. Companies are disclosing more and more ESG data in absence of regulation, and investors are beginning to rely on this information in their investment decisions.
It is the SEC’s mandate to oversee this, and so the rationale for introducing regulation has become a stronger proposition as a result of the increased dependency on this data by investors.
March 2022 saw continued momentum in both the EU and US regulatory landscape, more stringent rules and regulations are being put in place across the globe. The EU continues to make progress to increase the quality of sustainability data that is disclosed today, building on existing requirements on ESG disclosure. The SEC released its anticipated first draft of proposed mandatory climate-related disclosures. With a sixty-day comment window open now, the SEC is expected to finalize the rules before the end of 2022.
The absence of ESG regulation, combined with the exponential increase in demand for ESG data by investors, has driven a proliferation of primarily uncoordinated efforts in this space. While the need for better ESG data has persisted for years, the current societal context paired with a critical mass of institutional investors has tipped the scale. ESG reporting has become table stakes for nearly every public company and many private companies as well. ESG is a key focus of board rooms, the c-suite, and the day-to-day of companies. However, in an environment without regulation for several years, the internal ecosystem for ESG management and disclosure has become more of a check the box exercise rather than something that is woven into corporate DNA.
The current ESG disclosure landscape is unstructured.
Regulation brings structure, organization, and alignment. With better alignment comes better usability of information for company management and more informed investors and shareholders. The goal of corporate sustainability and incorporating ESG factors into strategic decisions is to enable investors and companies to allocate resources more efficiently to operations that provide long-term sustained economic and social benefits. To do this, we need regulation to help align efforts and standardize the way we communicate about ESG.
So far, we’ve had a number of standards pop into existence, merge, and merge again. We’ve seen SASB, GRI, TCFD, and CDP emerge as the leading standards and frameworks employed by companies to disclose their sustainability performance. SASB has grown in popularity rapidly. Due to their sector-specific materiality, SASB has become foundational for further alignment of standards. These standards and frameworks continue to be the medium in which ESG is communicated from companies to investors.
The most important work being done in alignment is the effort within the ISSB. The ISSB was established to develop a comprehensive global baseline of sustainability disclosures. March continued to be a truly remarkable month for ESG disclosures as the ISSB released the first drafts of comprehensive global sustainability disclosures. When complete, the ISSB will reduce the noise in this ecosystem dramatically. A part of IFRS, the international financial reporting standards foundation, the ISSB brings the backing and support to the standardization of sustainability disclosures that have been dramatically lacking.
Paired with an increasingly prominent regulatory environment, comprehensive disclosure standards are necessary to bridge the gap between the unorganized ESG world we live in today to a unified reporting ecosystem that enables the efficient flow of relevant information.
The increasing focus on ESG is impossible to ignore. Companies are grappling with this transition period in a variety of ways. Most importantly, with regulation comes a need for more robust and financial-grade governance and reporting capabilities. Unfortunately, companies are still underprepared to meet this challenge. Historically, ESG and sustainability reporting has been an afterthought without much internal support. According to a recent BCG / INSEAD study, nearly half of corporate board members surveyed cited a lack of knowledge, data, or capabilities as the largest roadblock to effective ESG oversight.
Today, as the SEC and other regulatory bodies are beginning to build their internal capabilities for detecting fraud, companies are going to have to move towards internal systems that enable rapid and dependable data collection that can be easily audited. While the exact end result of regulation is uncertain, the momentum around ESG reporting indicates that it is here to stay and companies will need to improve internal ESG management and reporting capabilities to be prepared for this new era of business.
