A Starter’s Guide to the Future of ESG Reporting
Now that environmental, social and governance (ESG) reporting is an EU regulatory provision, it has become clear that executive management teams and their board of directors want assurance that the reported ESG data meets regulatory requirements.
Although ESG is described as non-financial by the Non-Financial Directive 2014/95/EU, the companies covered within the scope of the directive must disclose information on policies, risks and outcomes in regard to environmental matters, social and employee-related aspects, respect for human rights, anti-corruption and bribery issues.
No small task, as many companies are still living in an ESG data reporting ecosystem that is manual, time-consuming, error-prone and complex. As a result, companies face two key challenges to the digital transformation for good data governance around ESG data:
1. ESG is confusing!
The first challenge of ESG reporting is navigating the plethora of ESG measurement methods, frameworks, guidance, protocols, rankings, indices and standards that are disconnected from the reporting process.
Regulatory authoritative reporting frameworks are there to help companies implement what to report and the controls to improve accuracy, completeness and reliability of ESG information, including guidance on supporting evidence.
According to the Reporting Exchange, there are over 2,000 ESG reporting provisions by regulators, over 1,400 key ESG indicators and over 1,000 organisations involved in the development of ESG frameworks and initiatives. One company alone will use multiple frameworks and standards and assemble multiple reports.
Although well-intentioned individually as standards and frameworks, when taken as a whole, this global, disjointed patchwork has grown so large that it now works counterproductive to the original intent.
It breeds confusion and inconsistency rather than bringing structure, standardisation and comparability. Plus, it drains staff resources and may lead to high costs that are disproportionate to the value added.
As regulators and companies become more knowledgeable about the myriad of ESG disclosure practices and datasets that are used to assess an organisation's overall sustainability, the linking of vocabularies governing those practices and datasets becomes more critical.
To add to the complexity, companies’ business environments and reporting standards and frameworks are constantly changing. As such, one or more of its internal controls and materiality matrices may not operate as effectively as in the past and must be constantly reviewed to stay fit for purpose.
Alignment and standardisation
Harvard recently introduced an ESG reporting framework called the Impact Weighted Accounts Initiative. It sets out to develop accounting measurements and reporting standards to translate all ESG categories into measurable currency that can consistently measure the ESG accounting impact on a company’s financial statements.
The approach is to standardise an accounting process that adds an impact measure of risk to each company’s accounting system to produce a second set of books that reflects the monetised impact of ESG efforts, rather than an ESG scoring method. This initiative is supported by the Impact Management Project (IMP).
Some work has been done to address the alphabet soup, including the efforts by the Corporate Reporting Dialogue’s Better Alignment Project, which has made significant progress in defining alignment. However, even then we are still living in an analogue world with ESG data locked up in digital documents—making it difficult to compare companies on an apples-to-apples basis.
Another important milestone is that the IFRS Trustees noted that several influential stakeholders have expressed a view that the IFRS Foundation could, or should, play a role in harmonising or aligning standards for ESG issues.
With so much fragmentation, we need alignment of ESG disclosures, including a digital transformation, and the IFRS Foundation could play an instrumental role.
2. The fragmented ESG reporting data ecosystem
The second challenge is trying to generate a single source of truth which can be linked to multiple disclosures and views in the ESG data ecosystem. In simple terms, we look at the second ESG challenge from a data life cycle with three phases:
The Fragmented ESG Reporting Data Ecosystem Graph:
Step 1: Input
The first step of the process is ensuring data accessibility and data availability.
One of the biggest challenges is the manner of the flows and interfaces between input, throughput and output across various systems. Plus, sometimes the data is not captured at all in any system.
These systems are not always aligned, and often require manual intervention to ensure that the output of one system is reprocessed in the necessary format to be validated for submission to multiple disclosure destinations. A well-defined purpose for collecting the data becomes essential.
Data accessibility plagues most ESG compliance teams. For them, the most valuable resource in transparency and disclosure is costly or just impossible to access. Given the ESG data input challenge, which is likely to persist for a while, the current timeline for the application of the EU Non-Financial Directive can pose a serious data quality challenge to many companies.
Step 2: Throughput
Once the compliance team has ensured that the data required is accessible and available, they must ensure they meet the reporting requirements of each regulatory or voluntary ESG disclosure provision. Any ESG compliance team looking to gather and report information in the throughput phase about its ESG practices, and weave that data into multiple disclosure documents, which include financial disclosures, can experience a somewhat daunting task.
In this phase, the fragmentation of data types and data definitions become key challenges. Sometimes, different regulators require the same information in their specific formats or data types. Surprisingly, some individual regulators also call for the same information in different forms and in different data formats.
Data definition fragmentation can also become a real challenge when reporting the same information to multiple regulators. It is not even uncommon to find differences in interpretation of the definition of various data elements among regulators. This assembling, dismantling and repackaging of data in the required format can cause compliance risks.
We all know that the critical decisions are only as good as the data they are based on and forward-thinking compliance teams must embrace good data governance around ESG data in the same manner they implemented controls around their financial reporting processes.
Step 3: Output
After the first two phases, ESG data is further connected to multiple output reports, where the need to ensure a single source of truth linked to multiple views becomes essential. This is necessary to ensure that everyone on the compliance team bases statutory reporting decisions on the same data.
In summary, the data from a regulated entity’s enterprise resource planning (ERP) software needs to be compiled and repackaged in the throughput phase in order to meet a regulator’s form and data format requirements for filing submissions to more than 19 electronic regulatory or voluntary submission platforms in one jurisdiction alone.
Given the pressures of managing a multitude of ESG frameworks and regulations coupled with the risk of the potential of material fines and the growing cost of managing all the data, the costs and risks of compliance and reporting are real.
Time to embrace digital transformation
More than ever, the ability to manage torrents of ESG reporting data is critical to a company’s success, and to meet their EU statutory reporting requirements. Increasingly disconnected and fragmented regulatory environments make compliance overly burdensome for many companies while also inhibiting investors and other stakeholders from obtaining useful information.
In the midst of a global pandemic, where access to quality data from remote locations is paramount to meet ESG statutory reporting requirements, the need for a solution is even more critical for financial, non-financial and the emerging forms of ESG data to embrace a digital transformation.
This amounts to a perfect storm for compliance teams to embrace the digital transformation of ESG.