A climate change demonstration at 2021’s COP26 summit, where the formation of the ISSB was announced (Getty)
On Nov 3, 2021, dozens of people were gathered in a cavernous conference hall in the heart of Glasgow, Scotland. It was the fourth day of the United Nations Climate Change Conference, better known as COP26, an event that had featured a pantheon of world leaders and business titans.
But, the people in the conference hall that day weren’t there to hear from a president or CEO.
They had gathered for an announcement by a technocrat named Erkki Liikanen. A former Finnish finance minister, Liikanen is the chair of the IFRS Foundation, which sets accounting rules used by 140 jurisdictions.
With relatively little fanfare, Liikanen stepped up to the podium and said that his foundation was forming an international body to develop rules to standardize the way companies disclose the expected impacts on their financials of future climate-related disasters such as droughts, rising sea levels and more intense storms that are expected to accompany climate change.
“Capital markets have an essential role to play in reaching net zero,” said Liikanen, referring to the goal of negating the greenhouse gas emissions that are driving climate change. “That can only happen when sustainability information is produced with the same rigour, assurance of quality and global comparability as financial information.”
The new body, called the International Sustainability Standards Board or ISSB, would bring an end to what some have called the “Wild West” of sustainability reporting. But its unveiling raised questions. How rigorous would the standards be? What exactly would they cover? And how would investors know if companies are living up to their commitments?
One year later, we’re starting to get answers to those questions—and experts say they have deep implications for both capital markets and the accounting profession.
“I would describe it as the fastest-evolving development that I’ve seen in the accounting sphere [in] 40 years,” Bob Bosshard, the chair of the Canadian Auditing and Assurance Standards Board, says of the spread of sustainability standards. “It has taken off with great rapidity and urgency.”
Sustainability reporting has its origins in the environmental movement of the 1960s. That’s when books like Rachel Carson’s Silent Spring, a shocking exposé on chemical pesticides, began to cast a spotlight on the environmental misdeeds of major corporations. After a series of environmental disasters over the next 15 years—including a fire on Cleveland’s Cuyahoga River and the discovery of toxic waste under a Niagara Falls, USA subdivision—leaders began to realize that the planet had a breaking point.
But the risks facing investors wouldn’t come into sharp focus until 1989, when the oil tanker Exxon Valdez ran aground off the coast of Alaska, spilling 11 million litres of oil. As images of crude oil-covered seabirds flooded airwaves and Exxon faced billions of dollars in penalties, the public began to demand more information about the environmental records of companies.
The Valdez disaster led to the founding of the Global Reporting Initiative, which would unveil the world’s first framework for sustainability reporting in 2000. Its standards would eventually branch out from environmental concerns and into social and governance issues.
In the following years, as concerns over climate change spread, so did sustainability standards. Today, there are more than 600 such guidelines, according to software maker Brightest, which helps firms track their environmental, social and governance (ESG) performance.
Experts say that’s too much of a good thing. What many derisively call the “alphabet soup” of sustainability standards has sown confusion among investors and allowed companies to cherry pick what data they disclose.
“I would describe the current state of climate reporting as: Choose your own adventure and grade your own paper,” stated Tegan Keele, leader of KPMG’s Climate Data and Technology Practice, in a KPMG report earlier this year. “You can hand-pick whatever makes you look good and ignore the rest.”
The ISSB, which this summer launched operations of a centre in Montreal, joining other international offices as well as the board’s home in Frankfurt, is aiming to change that. Its goal is to create a global baseline for sustainability disclosures by early 2023. Backers say that will have three big benefits: it would give investors the information they need to make informed decisions; it would allow analysts to compare the sustainability of companies from around the world; and it would push organizations to do better.
“Environmental, social and governance information has always been out there in the market in some form or another, but there’s [a growing] recognition that these issues are not distinct from financial performance,” says Rosemary McGuire, vice-president of research, guidance and support at CPA Canada. “They’re not just nice to have. They’re actually critical to assessing the future prospects of an organization.”
The new sustainability board has two major players in the standard-setting space: the Sustainability Accounting Standards Board and Task Force on Climate-Related Financial Disclosures. Earlier this year, the ISSB released draft standards based on work from both organizations. The proposed standards address general requirements for sustainability reporting as well as climate-related disclosures and would require organizations to disclose information in four main areas:
- their governance processes for managing sustainability risks;
- their short-, medium- and long-term strategies for addressing sustainability;
- their risk management protocols; and
- their sustainability metrics and targets.
Firms would need to describe precisely how climate-change-related risks could “reasonably be expected” to affect their business model, cash flow and cost of borrowing. The perils companies would need to address include so-called “acute risks,” like floods and cyclones, and “chronic risks,” like hotter temperatures and rising sea levels.
Those dangers are significant. A recent report from Deloitte found that, left unchecked, climate change could cost the global economy US$178 trillion by 2070.
The ISSB says its standards will help investors navigate what could be rocky times ahead.
“Our mission … is to answer the needs of investors,” board chairman Emmanuel Faber said during an interview last summer with CPA Canada chair Richard Olfert. “Everything that we do, the quality and ambition of the standards that we set, are here to ensure that we fully meet those needs.”
In June, the formation of the Canadian Sustainability and Standards Board (CSSB) was announced to give the country a voice in the creation of new standards. The body will also work in “lockstep” with the ISSB to support the adoption of the new sustainability rules in Canada, said Omolola Fashesin, a sustainability standards expert at Financial Reporting and Assurance Standards Canada.
Ultimately, it will be up to regulators to decide on which sustainability standards to apply. Regulators in Canada and the United States have released draft rules for sustainability/climate reporting. While there are some differences, McGuire expects those rules to eventually coalesce around the standards proposed by the international board.
In some quarters, especially the American political right-wing, the proposals have generated a fierce backlash. In an editorial in the Wall Street Journal, former U.S. Vice-President Mike Pence called ESG a “pernicious strategy” of the “woke left.” In August, Florida governor Ron DeSantis, a potential presidential candidate, banned his state’s pension fund from considering ESG when making investments, decrying what he called the political “perversion” of capital markets.
Those in the industry, though, say clear, evidence-based sustainability rules would go a long way toward depoliticizing investment decisions.
“At the end of the day, there’s a critical mass of people that want this information,” says McGuire. “Creating standards will minimize the view that this is a political exercise or that there’s a hidden agenda behind disclosing that information.”
In Canada, 94 per cent of the largest public companies already report on their ESG performance, according to the International Federation of Accountants. But there have long been questions about what companies are disclosing and how they are verifying their claims. For example, just over half of Canadian companies that disclosed sustainability data in 2020 obtained assurance. In France, that number was more than 95 per cent. As well, on average, Canadian firms released their audited sustainability reports almost 100 days after their financial audit; the average in Europe was nine days.
As reporting standards become codified, experts expect the slow walking of sustainability reports here to come to an end.
“Reporting by public entities will be more integrated,” says Bosshard. “So, the annual report not only will address financial information as it does historically, but it will also have robust disclosures around sustainability because the two are so entwined around business risk and achievement.”
Canada’s standard for verifying attestation engagements other than audits or reviews of historical financial information, known as the Canadian Standard on Assurance Engagements 3000, can be used with any set of sustainability standards. “The assurance standard is already here, we’re ready to rock and roll, we’re just waiting for the regulators to mandate guidelines and say what comes next,” Bosshard said. (The International Auditing and Assurance Standards Board is developing updated assurance standards, which Bosshard says will contain “bespoke” solutions for sustainability criteria.)
Most companies now receive what is known as limited assurance on their sustainability disclosures. As the market matures, Bosshard thinks the more rigorous standard of reasonable assurance could be applied.
“All journeys begin with a first step. This is very much a first step,” he says.
The standard-setting push has been complicated by fault lines in the movement. The draft standards from the ISSB require companies to disclose sustainability information that affects their value. But some experts say disclosures should go well beyond that and chart a company’s impact on the planet, whether or not that’s financially material. This concept, known as double materiality, is at the core of reporting rules proposed by European regulators.
With the planet labouring under the weight of climate change and pollution, that approach is vital, said Charles Cho, a professor of sustainability accounting at York University’s Schulich School of Business.
“Looking at sustainability only through the narrow lens of the investor is to me quite dangerous for the planet.”
Cho believes disclosure standards should require firms to report “hardcore” data on things like greenhouse gas emissions and pollution. Those rules, he said, are crucial to preventing greenwashing and fundamentally changing the corporate world’s relationship with the planet.
Annual report “pictures of children and blue skies—that to me is communications and is completely useless,” he said. “We want hard, science-based data.”
Many in the industry, like McGuire, say it’s important to understand a company’s overall impact on the environment. But taking a narrower focus will allow the ISSB to issue its rules quickly and establish itself as a leader in a fast-evolving space.
“I would also argue that the needs of investors and other stakeholders are not always mutually exclusive,” McGuire says. “It's not an us versus them conversation.”
Whatever standards regulators eventually settle on, industry players say their implementation will be complex.
“To meet the informational needs of investors on non-financial reporting—that’s a pretty darn big goal,” said Marc Seigel, a sustainability expert with EY, at a conference earlier this year.
“The financial markets and the financial accounting standards board and the [U.S. Securities and Exchange Commission] have had 90 years of maturation to meet that goal. And now we’re trying to squash and compress that into 90 months and in some cases 90 days. This is going to be a bumpy ride.”
MORE ON CPAs AND SUSTAINABILITY
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