The call highlights the challenges in developing alignment between global ESG reporting standards.

By Paul A. Davies, Sarah Fortt, Betty M. HuberMichael D. Green, and James Bee

The European Central Bank (ECB) and the International Monetary Fund (IMF), two of the world’s leading public financial institutions have stressed the importance of consistency in global ESG-disclosure standards in a public message to one of the pre-eminent global standards setters. The call reflects a key challenge inherent in developing a set of ESG-disclosure standards that satisfy all stakeholders, while regulatory developments in this area continue to evolve rapidly worldwide.

The ISSB Standards

The International Sustainability Standards Board (ISSB), established at COP26 in Glasgow by the International Financial Reporting Standards (IFRS) Trustees, has proposed the creation of a set of “global baseline” ESG reporting standards that companies worldwide can report to. The ISSB has become somewhat of a focal point in the global ESG reporting standards discussions, both due to its unique approach and international reception. A clear example of this is that the ISSB has attracted a considerable amount of traction from institutions including the UK government and G7 finance ministers since its inception, in recognition of the fact that corporate ESG reporting has to date relied on a wide range of voluntary standards that some believe has led to disparate and incomparable reporting by different companies.

To seek to rectify this “alphabet soup” of standards (so called due to the number of acronyms used to refer to the existing range of standards), the ISSB has sought to consolidate a number of ESG standard setting organisations into its framework, including the Value Reporting Foundation (the issuer of the SASB[1] Standards that were among the more popular existing reporting standards and which entity has now merged with and into the IFRS). The ISSB’s intention is that, by consolidating such entities, the standards that the ISSB released would be the go-to standard for ESG corporate reporting worldwide, giving users of general purpose financial reporting easy-to-use, comparable disclosures from a wide range of companies.

Further to this objective, the ISSB consulted on its first two proposed standards, the General Disclosure Standard and the Climate Standard, between March and July 2022, and has indicated that it will consult on further standards over the coming months.

Challenges With Mandatory Standards

However, the ISSB is not the only organisation that has tapped into investors’ appetite for comparable and consistent ESG disclosures from companies. Governments and regulators around the world have also recognised the challenges with the existing disparate frameworks and, as a result, have started the process of developing mandatory ESG disclosure standards for companies in their jurisdictions.

The mandatory nature of regulatory requirements will mean that, to the extent the ISSB standards are not aligned with, or complementary to, the various jurisdictional standards, organizations that wish to report against the ISSB standards may be required to undertake a potentially costly and time-consuming double reporting process if they wish to align with the standards required under local law (which may include mandatory requirements of multiple jurisdictions in the case of certain multinational companies) and those of the ISSB. Alongside the costs of double reporting, companies also face challenges in ensuring that they address gaps in their reporting processes, and are not inconsistent in the ESG information that they report pursuant to different frameworks.  For precisely these reasons, the IMF noted that “interoperability between the forthcoming ISSB standards and jurisdictional requirements… is important to avoid further fragmentation”, and that without such interoperability, it will be challenging for ISSB-aligned disclosures to develop traction with reporting companies in key jurisdictions with mandatory disclosure requirements.

These jurisdictions include the US, where the Securities and Exchange Commission has proposed climate-related (with other rules related to broader ESG issues expected in the future) disclosure rules that would  be applicable to  U.S. and foreign registrants as well as an ESG disclosure proposal that would be applicable to registered investment funds and advisers (the SEC Proposals); the European Union, where a considerable number of companies will be required to report in line with the requirements of the forthcoming Corporate Sustainability Reporting Directive (CSRD); and the UK, where certain companies are already required to report to the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), and the government is in the process of developing overarching Sustainability Disclosure Requirements (SDR).

While it may be straightforward for the IMF to identify the importance of interoperability, achieving this in practice may be challenging, in large part due to the inherent differences of many of the proposed standards across jurisdictions, in addition to a number of fundamental differences in the approach to regulation by regulators in different jurisdictions (e.g. in approach to fiduciary duties and corporate responsibility). Some of the key conceptual differences are a primary focus on disclosure of information that meets a threshold of “financial materiality” (which is what the ISSB states that proposed ISSB standards will be aimed at) versus “double materiality”, and whether standards should focus on climate-related factors only or a wider range of ESG issues.

The challenges in satisfying all stakeholders were further demonstrated by the European Central Bank’s (ECB) comment that, in order to meet stakeholder expectations, any international standard should focus on double materiality, and that the ISSB should look to “iron out” differences between it and other standard setting institutions. As noted above, the current ISSB draft standards reportedly do not have a core focus on double materiality.  This is also largely true of existing standards in the UK (the TCFD recommendations) and the SEC Proposals. Therefore, any change to double materiality, or definitive approach to materiality at all, by the ISSB may in fact lose alignment in certain jurisdictions while gaining it in others.

The argument also pushes both ways – on 9 August, the Net-Zero Asset Owner Alliance (NZAOA) and European Securities and Markets Authority (ESMA) issued a public call to the group developing the disclosure requirements that will support the CSRD, urging them to align the disclosure drafts with the ISSB. Therefore, while it is clear that stakeholders globally are in favour of alignment between ESG disclosure standards, there does not appear to be consensus over which standards setting institutions should adapt to ensure consistency with others.

The final form ISSB standards are still to be announced (expected by year-end), and it will be interesting to monitor how the ISSB seeks to take on board the words of the IMF and ECB, as well as the comments received during the public consultation process, when it issues its revised drafts of the General Disclosure Standard and the Climate Standard. One thing that is clear, however, is that developing alignment between ESG disclosures globally is proving to be a challenge that is easier to identify than to resolve, and companies should continue to be alive to the increasingly regular developments in this area to ensure they are in a position to collect and report information in the most effective manner.

Latham & Watkins will continue to monitor developments in this area.

[1] Sustainability Accounting Standards Board.