Mandated climate risk and carbon disclosures are becoming increasingly more likely in the US and internationally. As of 2022, several financial regulators have already publicly affirmed that climate is a systemic risk. As more regulatory bodies begin proposing and enforcing disclosure requirements, public companies will soon have to answer and comply.
Proposals have been made by various institutions, many of which we summarize in our article here. The definition and implementation mechanisms for ESG and climate reporting vary across the globe. This article explores how lack of coordination across international reporting implementation mechanisms and requirements can pose economic challenges and delay climate change mitigation. Regulators and enforcers have been mobilizing in different countries with varying methodologies and enforcing mechanisms; however, climate change is a global problem and requires global coordination.
The number of sustainability reporting initiatives, regulations, frameworks, and standards continues to increase, making the world’s already-lacking ESG data even more fragmented, difficult to navigate and complex. Additionally, these institutions have no authority on enforcing sustainability disclosures internationally. Different countries have many different approaches to defining and enforcing climate disclosures and sustainability accounting standards:
The EU: The European Union’s approach is centrally managed by the European Climate Law. The Council of the EU and European Parliament recently reached a provisional agreement on improvements to the Corporate Sustainability Reporting Directive (CSRD). This proposal will require disclosures (down to the subsidiary level) from all large companies and all companies listed on regulated markets. Additionally, reported information must be certified by an accredited independent auditor or certifier.
The US: The United States’ approach to climate disclosures is voluntary and the choice to disclose climate information is primarily driven by stakeholder (shareholders, community, environmentalist) pressure and public image concerns. Companies who are voluntarily reporting are not required to have information verified by a third party. The pending SEC rule that will mandate climate disclosures only applies to public companies and the SEC cannot enforce standards and will need approval by political groups and businesses.
ESG reporting approaches are being developed without global coordination, resulting in opaque investment environments, more confusion, and unaligned reporting goals. This lack of coordination, combined with several implementation challenges can have severe implications on financial markets and climate mitigation achievement. At the enforcer level, it is impossible to say who should have the regulatory authority to apply rules, who should have the final say in defining rules, and how these rules should be rolled out. At the company level, limited full-time sustainability resources, compliance costs, and confusion from lack of standardization can make effective reporting almost impossible.
Public vs. Private Dilemma First, in the case of the SEC disclosure, the difficulty that these reporting challenges create puts significant pressure on public companies and not on companies operating in private markets. Companies in the US may decide to not go public in an attempt to avoid these hurdles, or go private (either privatizing a portion or in whole) to reduce climate compliance burden. In the EU, mandated disclosures include select private companies so opting to remain private is not a guarantee that they will not be required to report. If companies avoid going public to avoid climate disclosure requirements, businesses will continue to understate their impacts on the environment and contribute to climate change. A very large private company can do significant damage to the environment, but they would not be incentivized to clean their business practices.
Hidden Assets, Dirty Secrets Another mechanism for avoiding climate disclosures would be for public companies to divest their “dirty” businesses. Public companies can choose to sell heavy emitting business segments into private markets. These “dirty” assets will continue polluting completely under the radar. M&A diligence requirements do not currently include the transfer of climate impacts, reduction plans or requirements. Companies will claim that their footprint is smaller, meanwhile they are still contributing to and accelerating climate change. Again, this creates an imbalance between the US and EU, as well as European companies that are not currently mandated by the existing disclosures. By selling off heavy-emitting business units into private markets, dirty assets will be hidden and continue to negatively impact climate change.
Scope 3 Reporting to Signal the Market, for Better or for Worse Scope 3 emissions reporting is the most contested topic among disclosure topics. Scope 3 reporting requirements have not yet been determined or finalized by any of the proposed rules. The difficulty in gathering data, along with the difficulty in assessing and reporting that data, poses the question if scope 3 reporting will even be meaningful at this stage of climate disclosures. If companies are forced to comply, they will accumulate tremendous compliance costs for potentially meaningless data. Scope 3 emissions are difficult to allocate to the responsible emitter. Double counting of scope 3 emissions can signal incorrect high performance or hide under performance for companies that operate along a reporting company’s value chain. Investment decisions will be influenced by the scope 3 reporting requirements a company is referencing, and thus, the decisions will be made without a reliable baseline or fair comparison for those reporting off of varying requirements.
Endorsing a Global Baseline Effort At COP26, the International Sustainability Standards Board was formed to create a global standard for sustainability reporting that simply supports the pending work of the SEC, CSRD, and other pending sustainability disclosure rules. Though the ISSB will not have enforcing capability, it is an attempt to align existing standards across the world, a truly valid attempt at coordination. The main challenge will be acceptance and government support in different territories. For example, it is unlikely that the ISSB will be accepted in the US immediately, especially considering that political figures and select businesses are preparing to take legal action against the SEC pending disclosures. Despite political pressure delaying the process, more investors are acknowledging the importance of disclosures and will pressure companies to participate. The real question will be how aligned global reporting will be and if informed decisions can really be made from the disclosed information across reporting frameworks.
Emerging Markets Playing Catch Up The greatest increases in consumption, emissions, and social impacts in the coming decades will occur in emerging markets with entirely different frameworks and incentive mechanisms. In April, China announced it will increase coal output by 300 million tons this year. India also announced a 400 million tons increase of domestic coal production by the end of next year to reduce the likelihood of power outages from exacerbated heatwaves. Manufacturers in China, India, and Africa are relying on their own domestic markets for growth. Though the relationship between energy and economic growth deserves an article of its own, if there’s any chance of sustaining essential global resources, companies in emerging markets will need to improve in terms of resource management, emissions measurement and responsible governance.