Non-Financial Reporting Harmonization Is Underway

Several initiatives are being developed with a view to harmonize reporting standards for corporate Environmental, Social and Governance (ESG) disclosures. The goal is to instill more consistency amid multiple preexisting reporting frameworks, in hope these streamlining initiatives do not come to contradict one another. Here are 3 essential principles for the development of such a standard.

1.     Non-Financial Reporting In 2020: A Case Of Multiplying Reporting Frameworks And Business Fatigue

Corporate non-financial reporting has considerably evolved in recent years. A number of voluntary reporting frameworks the likes of the GRI, SASB, CDP, TCFD, CDSB have helped companies to share more relevant and comprehensive ESG information.

However, each framework offers its own approach and focuses on a specific audience or issues and ultimately hinges on an independently devised choice of indicators. Such approaches are not easily combined when it comes to developing a non-financial performance statement.

ESG rating agencies – which are very influential in the market – have also developed private rating methodologies based on their own selection of indicators. This adds an extra layer of complexity to the matter. Due to these methodological differences, these agencies may assign radically different scores to a given company.

The multiplication of reporting frameworks led to a complete absence of data comparability. As companies disclose their non-financial information, they face contrasting voluntary frameworks, rating agency requirements and individual stakeholder expectations. As a result of being based on varying units or methodologies, published ESG performance indicators are seldom comparable from one company to another. For carbon accounting alone, European regulator ESMA observes “carbon emissions are published as total emissions, total emissions at constant production, emissions per ton of production, ton of emissions per hour of production and emissions intensity ratio“.

There has been a resounding call to put an end to the multiplication of reporting schemes. Investors demand more comparable non-financial data across companies. As for the teams in charge of corporate reporting, they have expressed weariness as to the avalanche of contradictory injunctions and requests. All aspire to a reasoned streamlining of non-financial reporting.

2.    The Harmonization Of Non-Financial Reporting Is Underway

At least 2 initiatives are being developed to streamline preexisting reporting frameworks.

A European Initiative

The European Commission is looking to amend the Directive on the Non-Financial Information of Companies (NFRD) to streamline more reliable and comparable information.

Its intention is to align reporting requirements with the recommendations of the Taskforce on Climate-related Financial Disclosure (TCFD). Based on an online public consultation published last Spring, the European Commission plans to go a step further, by developing its own reporting framework, based on preexisting voluntary approaches. This public consultation also shed light on the possibility of making the auditing of non-financial information mandatory.

A Global Initiative Led By Regulators

In 2019, 7 states – among which the European Union, Canada, India and China – launched the International Platform on Responsible Finance (IPSF). Its goal is to coordinate likeminded activities across participating financial markets, in order to produce non-financial information, ranging from taxonomies to labels and reporting frameworks. 

A Private International Initiative

The World Economic Forum – the international public-private cooperation organization that meets annually in Davos – developed a standard which selected 62 indicators from existing frameworks.

Intended as universal and industry-agnostic, the standard consists of 2 components:

• The first is a core set of 22 reporting
  lines commonly found in corporate disclosures. The requested information
  includes quantitative indicators and descriptive elements.

• The second covers 37 reporting lines. Its content is less ubiquitous in sustainable development reports.

The resulting 65 reporting lines are organized around 4 pillars of governance, people, planet and prosperity.

Other Harmonization Initiatives Not Aimed At Creating A Single Standard

Other initiatives have attempted to promote more consistency in applying readily-available reporting approaches, without offering suggestions as to how to effectively harmonize the overarching framework. Such is notably the case of the World Business Council on Sustainable Development’s Reporting Exchange initiative, which compiles, thematically organizes and streamlines the indicators of 70 voluntary and mandatory reporting frameworks. Another initiative, the Corporate Reporting Dialogue, suggested reference tables to navigate different reporting frameworks focused on climate change.

To avoid further confusion, it is crucial such initiatives act in concert. This coordination must take place between national and regional regulators and in conjunction with private initiatives, or run the risk of resulting in contrasting standards in Europe, the United States and the rest of the world.

3.    Three principles for a harmonized and relevant reporting framework

At Yale University, we discussed the necessary principles for a successfully harmonized reporting framework. In our view, such a standard should follow 3 key goals, namely to provide complete, comparable and reliable information.

Comprehensive Information

As tempting as it might be to develop a single ESG reporting standard applicable to all businesses, regardless of their activities and geographies… it simply would not work. All companies are different; each brings its own know-how, history, value chain and strategy. We would instead suggest ESG information be structured around 3 main components:

• Common information
  to all companies – which is precisely what the World Economic Forum is currently
  working on;

• Information
  specific to key sectoral issues – which could find inspiration in the work of
  the SASB and GRI;

• Company information,
  including methods, strategies and issues related to its specific corporate
  culture, economic context and the activity its different entities.

The underpinning intention is not to produce exhaustive ESG disclosures likely to drown stakeholders in a flood of information. On the contrary, it is a question of intelligently integrating materiality principles so that companies may communicate relevant information, whether or not this information is required by preexisting frameworks.

Comparable Information – Based On Public Methodologies

Whether universal or sectoral, each indicator included in the projected streamlined standard should also be subject to a public methodology the likes of the GHG Protocol. Such a methodology would formalize the exact unit of the indicator, the scope of the study (value chain, legal entities, franchises and M&A), underlying documents and data aggregation protocol. As this would be public and common to all companies, the result could be verified by auditors. To allow for a democratic consultation process, such methodologies would benefit from being developed by the ISO organization.

Credible Information – With Inbuilt Verification Processes

Producing reliable information is a major challenge, particularly for globalized companies operating in various countries. Europe is therefore preparing to make the auditing of non-financial information mandatory. It is however unlikely that other major financial centers operating at a more international level will follow in the coming years. Until then, we believe a harmonized ESG reporting standard should define data quality control principles across all businesses.

In view of the 3 above-mentioned principles, the efforts European Commission and World Economic Forum are certainly encouraging. One must hope such initiatives will also live up to market expectations.