From Voluntary to Mandatory: ESG Disclosure
Written by Sophie Logan
Global emissions are exactly that, global. No individual country or company can independently reduce emissions on a scale large enough to mitigate climate change. The Intergovernmental Panel on Climate Change (IPCC) has identified 1.5℃ as the peak temperature change to avoid many catastrophic effects of climate change. The world is currently on track for 3℃ by 2100. A collective action problem, climate change requires actors to work in parallel to account for and reduce emissions.
Individual transparency is the first step toward collective action. In March, the US Securities and Exchange Commission (SEC) released its climate disclosure proposal requiring public companies to measure and report their carbon footprint. With greater transparency, decarbonization efforts can focus on the sectors most responsible for and exposed to climate change.
Carbon is one of many ways that companies affect our environment and society. Beyond the regulatory reporting baseline, companies can select one of many frameworks to share their broader environmental, social, and governance (ESG) performance. Prominent examples include UN Sustainable Development Goals (SDGs), Science Based Targets Initiative (SBTi), and the Task Force for Climate Related Disclosure (TCFD).
While financial reporting is highly standardized both in format and accounting principles, there is no GAAP or IFRS equivalent for ESG. Many of the current frameworks are effective, but their differing methodologies prevent the creation of a comparable dataset. As regulator for US financial markets, the SEC is best positioned to enforce reporting standardization. In explaining the climate disclosure proposal, SEC Chair Gary Gensler said, “[The new regulation] would provide investors with consistent, comparable, and decision-useful information for making their investment decisions.”
Without broader regulation and standardization for ESG reporting, companies are free to choose the reporting frameworks and KPIs that best market their environmental and social impact. Investors and consumers are left to scour corporate sustainability reports for ESG data. Companies are incentivized to highlight corporate strengths and good deeds while downplaying or omitting negative impacts.
Indeed, stakeholders like customers and investors are rewarding companies for outperformance on ESG indicators and demanding transparency. According to NYU Stern research, sustainability-marketed products were 16.1% of consumer goods but delivered 54.7% of market growth. BlackRock expects ESG investments to reach $1 trillion by 2030, requiring greater transparency on the ESG performance of funds and their underlying holdings. Private companies are incentivized to track ESG performance ahead of mandated reporting, using the dataset to mitigate business risk and open new market opportunities.
https://www.ipcc.ch/report/ar6/wg1/downloads/report/IPCC_AR6_WGI_SPM.pdf
https://www.sec.gov/news/press-release/2022-46
https://www.stern.nyu.edu/sites/default/files/assets/documents/Q1%20-%20SMSI%202021.pdf