Financial reporting has long been regulated to control the quality and transparency of data considered material to a company and to properly functioning markets. ESG, while going through a relatively fast and recent maturation, has most often been left to individual companies to decide both what metrics, and in what format to report. The disparity in rigor could be seen as a proxy for their perceived relative priority in the organisation, and in turn the amount of scrutiny applied by formal risk management and governance processes.
However, as ESG issues are increasingly recognised as relevant to both companies and investors, there is a growing expectation for ESG disclosures to be included in financial reporting, and in turn, to be subject to greater controls. One of the more prominent examples of the increased demand for rigor is the rules regarding climate change disclosures proposed by the SEC earlier this year. While uncertainty remains to date about when the SEC’s proposed rules will go into effect or what their final scope will include, the fact remains that the trend in ESG data generation, management, and disclosure is moving from voluntary to mandatory.
Pressure for quality ESG data is growing
Investor pressure demanding greater quality of ESG data cannot be overstated. The fragmented landscape of ESG reporting and latitude in ESG related disclosure has led to disparity in quality and consistency, making decision-useful data more difficult to procure. Recent progress towards regulating and standardising ESG related disclosures have stemmed from this type of feedback.
The EU and UK have typically led these efforts, whether through targeted regulation such as the Modern Slavery Act or more broad ordinances such as the Non-Financial Reporting Directive (NFRD). The United States is currently grappling with their own approach to ESG related requirements through the SEC proposal on climate related risk disclosures. The proposal alone is already driving transformations similar to what we saw with Sarbanes-Oxley, a US federal law that mandated rigorous practices in financial record keeping and reporting, in the early 2000s.
Companies will need a process to produce high quality, defensible ESG data that are more aligned with financial reporting requirements.
The trend is clear: voluntary is moving to mandatory
Regardless of the specifics of any given initiative, there is a clear trend towards greater accountability for what is often deemed non-financial data. The recognition of ESG related data’s connection to financial materiality is changing the total mix of information available to investors and stakeholders. The expectation is clear that what is currently seen as voluntary is quickly moving into the realm of mandatory disclosures. In turn, companies will need a process to produce high quality, defensible ESG data that are more aligned with financial reporting requirements.
This will mean preparing datasets, processes, and controls to undergo some degree of 3rd party assurance. Companies that recognise and begin planning for these evolving expectations early on will be best positioned to manage investor questions, reduce regulatory risk, and potential costs of non-compliance. Seasoned disclosures will already know that rigorous and replicable data generation is an iterative process that improves with experience. Waiting for circumstance to dictate process will lead to weak disclosure, missed deadlines, and budget overruns.
How to prepare for the SEC climate disclosure rule and changing disclosure landscape
To best prepare, companies need to be addressing the challenge as one of disclosure controls and procedures (DCP) rather than purely sustainability related. The subject matter is secondary to the procedures behind data methodology, collection, quality assurance, and auditability.
Often this process starts with simple questions such as:
- Where does my ESG data come from internally?
- Who owns it?
- Is the chain of custody documented?
- What quality assurance (QA) is there on ESG data prior to publication?
The answer to those foundational questions will help determine at what stage in ESG reporting and disclosure-process maturity your company is at. In the shorter term, as requirements are still taking shape, companies will see increased internal reviews and approval for ESG related disclosure through corporate finance, legal, and executive teams who are looking to understand and vet what was previously considered immaterial, voluntary disclosure, relegated to Corporate Social Responsibility teams.
To streamline the ever-growing annual disclosure calendar, companies need to establish a detailed system of record for ESG-type data. This necessitates the development of improved documentation, process, and procedures so data can be confidently collected, QA’d, traced, and ultimately assured externally. Building out this method of substantiation for ESG reporting allows company stakeholders to access and audit data integrity much more confidently.
Developing that system of record is a deceptively challenging task. It often involves coordinating dozens of subject matter experts, which may be from internal departments or affiliated external organisations. Companies will need to set clear expectations and define documentation procedures. Only once the data owners and business processes have been exhaustively mapped, can companies begin to look at refining for efficiency, or automating collection and reporting.
Most companies do not have well defined processes, controls, and systems of record for ESG information and disclosure. Getting this organised should be priority number one. Once established, auditability and compliance with regulated disclosure requirements will not feel so overwhelming. With well-defined business requirements instituted, moving to the next stage of building process efficiency improvements and automation is much simpler. However, while on this journey and similarly to prior Sarbanes-Oxley transformations, companies are often finding that certain parts of their current processes need immediate upgrades to satisfy the forthcoming control regimes and subsequent audit process.
Anthesis can help
Every reporting season, the team at Anthesis supports clients’ progress through their unique ESG data management environment. Should you wish to learn more, please reach out to the contacts below to discuss how Anthesis can support your ESG data procedures and disclosure governance.