Get Ready for More Transparent Sustainability Reporting

Rigorous sustainability-related financial disclosure is coming. The era of inconsistent, voluntary disclosure is giving way to mandatory reporting — but don’t treat this regulatory revolution as simply an exercise in compliance. It is instead essential work to gain greater visibility into your business’s exposure to risk and long-term prospects for success — for the benefit of both investors and management.

Action has been brisk this year on the regulatory front. The U.S. Securities and Exchange Commission (SEC) plans to issue its climate disclosure rules by the end of 2023. In June, the International Sustainability Standards Board (ISSB) issued its first global standards; the European Union issued its European Sustainability Reporting Standards (ESRS) in August. The ESRS reporting requirements will be mandatory for large European companies starting in 2024 and in due course for international companies with European operations. Corporate reporting hasn’t changed this much since the SEC was created in the wake of the 1929 stock market crash.

How should senior executives and boards respond to, and take advantage of, these changes? In this article, I will explain why focusing on what investors want from sustainability reporting is a critical lens for understanding how to act. Through that lens, I examine how best to navigate the evolving landscape of mandatory reporting.

What Investors Need to Know

Investors seeking gains via either growth or lasting value know that the energy sources that built the global economy are not those that will sustain it. Economic value will therefore be created by serving new and existing markets in different ways. Investors are looking to these different market conditions that lie ahead, where sustainability builds resilience and increases the capacity for growth.

Smart investors also know that if global warming is not slowed, and if natural resources continue to be depleted at the current rate, economic activity will suffer. Insurers are experts in anticipating and managing risk, and they are ahead of the game, rethinking where and how they do business. A consequence is that the costs of catastrophes related to climate change will increasingly be borne more directly by businesses and private citizens. The summer of 2023 saw New Yorkers sheltering inside from the smoke of Canadian forest fires; increasing damage from hurricanes in Florida; record high temperatures across the southern U.S.; and dangerous, damaging flooding from summer rains in the Northeast. These are the scouting parties for the effects of climate change; the main forces will be along later.

In the broader global context, investors want to know how you see the future, how you are planning to meet it, and what value you expect to be able to create. Current financial reporting alone cannot offer this; in a disruptive world, investors cannot evaluate your prospects based on past performance. Investing is making choices. Sustainability informs returns.

This is not just compliance, any more than accurately tracking revenue and expenses is done purely for the benefit of regulators. Nor is it a PR exercise afforded by selective voluntary disclosures. It is instead the recognition that in a world roiled by wicked, systemic problems, what is material to sound investment decisions is changing; corporate reporting must change as well.

How Mandatory Reporting Is Taking Shape

For public companies in the U.S., the primary consideration has to be the SEC’s forthcoming rules, which will address investors’ demands for climate-related disclosures. At a minimum, the rules will likely require reporting on greenhouse gas (GHG) emissions generated from a company’s directly controlled operations (Scope 1) and from its purchased electricity (Scope 2). More contentious is Scope 3 emissions, which occur as part of the value chain process by which the company makes its money, be that upstream in the production of inputs to the company’s operations or downstream in the use of the company’s products. The significance of these emissions varies enormously by industry. In some cases, where direct operations involve high emissions, Scope 3 might be relatively low. In other cases, Scope 3 might account for more than 90% of a company’s carbon footprint.

From an investor’s perspective, Scope 3 emissions are a risk factor because a business with a high carbon footprint is relatively vulnerable to transition-related risks. Such potential risks include regulations that restrict sales of carbon-intensive products (or make them more expensive), the loss of business or employees to competitors with stronger sustainability credentials, and the reduced availability of finance or the increased cost of capital. At the same time, a high carbon footprint can be seen as an opportunity for transition that reduces these risks and thus could increase the valuation of a company in relation to its peers. It is hard to make the case that information about significant Scope 3 emissions is not material to investors. It follows that — whether or not the SEC decides to mandate Scope 3 — companies that have Scope 3 in hand are better placed to be resilient than those that do not. It is inevitable that investors will seek this disclosure and that companies will increasingly provide it.

However, preparation for mandatory disclosure goes beyond keeping track of SEC requirements. This is because other regulators have extraterritorial reach and because sustainability reporting is inherently global, given international supply chains: Data is collected from your suppliers, who will in turn collect it from their suppliers, and so on up the supply chain. For a large corporation, this can easily amount to data from thousands of entities in many different countries. Good luck aggregating this data if it is not all measured in the same way. Meanwhile, your customers will be requiring sustainability data from you (and you from them, in order to understand downstream emissions). These customers will also be spread across different geographies. They might include unlisted and public-sector enterprises, because all are part of the value chain of listed companies. You don’t want each of them to be asking you to measure different things, using different units of measurement.

It therefore makes sense to align with the global standards of the ISSB, which have been endorsed by the International Organization of Securities Commissions. Fortunately, the SEC climate proposal closely aligns with the ISSB’s, and the agency “recognized the importance of global alignment and of drawing on existing frameworks that have enjoyed significant voluntary market uptake,” according to Allison Herren Lee, former SEC acting chair and commissioner. The widely used standards of the Sustainability Accounting Standards Board (SASB) have been subsumed within the ISSB’s, and both the Task Force on Climate-Related Financial Disclosures (TCFD) and the World Economic Forum have formally announced that they will sunset their guidance on climate disclosure and sustainability metrics, respectively, in favor of the ongoing work of the ISSB. Meanwhile, CDP — the global reporting platform for more than 50% of global market capitalization, formerly known as the Carbon Disclosure Project — will base its future data-capture work on ISSB standards. Overall, there is a clear direction of travel toward having the ISSB set the global baseline of investor-oriented sustainability disclosure standards that can be used across markets.

In addition — though not immediately obvious — voluntary alignment with global sustainability reporting practice will itself influence the rule-making of the SEC. The role of the SEC is to help ensure that markets are supplied with the material information that investors need and to do so in a way that passes a cost-benefit test. Where consensus has already formed around measurement and reporting, costs of reporting are lower, benefits to investors are greater, and material information is more readily available.

As noted above, business leaders must also be alert to the extraterritorial reach of some regulations. In early September, California passed legislation to mandate climate-related disclosures by any outside company doing business in the state and generating more than $1 billion in annual revenue. Meanwhile, international attention is currently focused on the EU’s ESRS requirements, which are far deeper and broader than the SEC’s are expected to be. There are 12 standards, covering a range of environmental, social, and governance disclosures in detail. And the scope of ESRS extends to “double materiality,” which means reporting not just to investors but also to all other stakeholders on issues material to them.

Step Up to Meet Demands for Rigorous Sustainability Reporting

As mandated corporate reporting expands to include sustainability issues, the following guidance can help you develop a plan to build the necessary capabilities.

Don’t stop what you’re already doing. You might be doing sustainability reporting in some form already, applying SASB, TCFD, or the Global Reporting Initiative (GRI) and/or reporting to CDP. You will need to build on these practices, but you are on the right road already.

Don’t let perfect be the enemy of good. In the realm of voluntary disclosures, what investors want is whatever you can reasonably provide. Keep in mind that sustainability data is only indirectly relevant. Investors don’t want to know your GHG emissions so much as they want to know how their presence affects your financials. For that purpose, reasonable estimation of emissions is typically good enough and, by such means as using industry averages, it is generally not hard to achieve. You should be careful to communicate the basis of your estimation, and you should not overstate the confidence you have in your measurements. Take advantage of safe harbor provisions, as appropriate. What your investors don’t want is nothing, which would convey that you aren’t being transparent, that you don’t have material information about your business, or both. Either would be a good reason for investors not to invest.

Align with financial reporting. If your sustainability report is separate from your financial reports and investor presentations, then you’re missing a trick. Investors want to understand how your sustainability-related position and performance affect your financial prospects. The more you can express your sustainability-related metrics and targets in the language of finance, the better. For example, it is one thing to have a target for net-zero GHG emissions; it’s another to set out a transition plan that quantifies the capital expenditure that will be required and that guides investors in understanding current and prospective income statement effects.

Focus on climate, and be ready for the SEC requirements. Because climate is the dominant sustainability issue, emissions are appropriately the focus of the SEC’s regulation. If you are not on top of climate-related reporting already, at some point you will need to be, including being prepared to have your data audited externally. Moreover, climate is most likely your best starting point in sustainability reporting. It affects all companies, measurement practices are relatively established, and market understanding is relatively high. And if you can do climate reporting well, you will have built the capabilities needed for most other aspects of sustainability reporting, such as relationships and data systems throughout your value chain, and the art of translating sustainability data into financial implications for evaluation by your investors. To have this foundation, you will need to extend your data and control systems beyond your directly controlled operations, because your sustainability performance can be understood only in a value chain context. You should therefore develop your (material) Scope 3 GHG emissions reporting regardless of whether it is mandated by the SEC. This will become easier to do once Scope 1 and 2 disclosure is widespread.

Tighten systems and controls throughout your value chain. You should expect greater influence and control from your finance and legal functions as sustainability reporting evolves from being voluntary to being mandatory, and ownership of sustainability reporting migrates away from existing homes, such as communications, external relations, and dedicated sustainability teams. This migration will come with a higher hurdle for systems and data quality, and so it will almost certainly mean additional costs. But, as ever, focus on the business case, which means thinking about benefits as well as costs.

A comparison with financial accounting is again helpful. Your finance function is expensive — maybe too expensive. And maybe it could be more efficient. But is anyone suggesting that your company would be better off without it? No doubt there was pushback on cost when the SEC first introduced disclosure requirements. But then the world moved on, and the net benefit from reporting has become well understood. The same is true for sustainability reporting. If you build an authentic sustainability story, the benefits will exceed the costs. In addition, and relatedly, you should stay ahead of the curve. In a world of satellite data and artificial intelligence, your sustainability performance will increasingly be reported to you rather than by you — a scenario in which the best legal and reputational protection is to be in control and transparent. Don’t allow your sustainability story to be an apologetic response to having breached the conditions of your social license to operate.

Align with the ISSB global baseline (and require your supply chain to do likewise). Your regulatory obligation is determined by the SEC. There is little reason to expect the SEC’s investor-oriented focus to diverge from that of the ISSB. Yet there is good reason to expect regulation to become tighter and faster in major jurisdictions elsewhere in the world. You operate in a global economy, where the benefits of investment decisions are greater and the costs of gathering reliable data are lower if everyone shares the same measurement and disclosure standards. Aligning with the ISSB is the most effective way to align with the SEC while also reducing costs and improving data quality.

Use ISSB standards as a baseline for ESRS. The fundamental difference between ISSB and ESRS is that the former requires reporting to investors (consistent with the SEC) while the latter also requires reporting on issues that are material to all other stakeholders. If your operations draw you into the extraterritorial reach of ESRS, your optimal response is simple: Do what you would do anyway to report in the U.S. and globally to your investors, and then separately include the additional disclosures required for ESRS compliance.

Contribute to the development of industry norms. Sustainability issues vary by industry. Companies are categorized by industry in the capital markets, to better enable like-for-like comparisons and to analyze shared exposures to industry-specific risks and opportunities. This is why the SASB standards are industry-based and why the ISSB has likewise committed to this standard-setting approach. Given that industry expertise sits within the industry and sustainability reporting remains a young practice, companies should participate proactively in discussions on best-practice reporting in their sectors, directly and indirectly helping to shape future standards.

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Above all, ensure that your sustainability reporting has an authentic connection with value creation. If it feels like an exercise in compliance, then your company is missing opportunities. There should be alignment between information that is valued by your investors and that which is valuable to you in leading the business. Investors might see the company as being at greater risk of being left behind in a rapidly changing and increasingly perilous world, and your reputation in the marketplace could suffer. Consider instead how a willing embrace of tracking and disclosing sustainability performance can not only win support from the market but also, via focus and accountability, help you manage your company through the profound transitions that the planet and society demand of us all.