Why ESG reporting requires scientific verification

A credible set of sustainability reporting standards need to be science-based, incorporate double materiality, and go beyond simply climate-related financial risks to broader sustainability issues.

Summary


In March 2021, we published "Making sense of a chaotic ESG reporting landscape", providing an overview of the major reporting initiatives, key milestones and the countries moving towards mandatory climate-related reporting. This report provides our perspective on how reporting frameworks need to evolve particularly in an environment where financial regulators around the world are increasingly focusing on the need for sustainability reporting.

Notably, the European Commission (EC) has taken a leading role in relation to sustainable development and sustainable finance policies[1]. International fora such as the G-20, the Financial Stability Board and the International Platform on Sustainable Finance as well as important jurisdictions such as the United States, are also adopting a proactive approach in this policy area.

For example, in March 2021, the Securities and Exchange Commission (SEC) in the United States initiated a public consultation[2] towards facilitating the disclosure of consistent, comparable, and reliable information on sustainability reporting and specifically as it relates to climate change. In addition, the International Financial Reporting Standards Foundation (IFRS), the non-profit accounting standards board, recently provided an update on its public consultation[3] towards the development and maintenance of a global set of comparable and consistent sustainability reporting standards.

The more active role of governments and standard setters reflects the need to:

  • reduce the costs associated with sustainability reporting
  • meet the growing demand for sustainability information particularly from investors
  • provide greater clarity and certainty as to what sustainability information to report
  • promote a global standard

Within this context of growing interest in sustainability reporting, the following aspects require greater scrutiny, especially from the standpoint of impact investing and double materiality, which refers to not just how the world affects a company, but also how the operations of a company affect the world:

  1. While there is no dearth of existing frameworks for sustainability reporting, accountants and standard setters typically lack the science background to full assess ESG risks. This is also true of financial analysts as well. Hence, to build a credible and robust set of sustainability reporting standards will require a deeper involvement of the scientific community

  2. When it comes to sustainability reporting focused on climate change, this will require scientific ratification, because the translation of climate risk into financial risk is far from optimal. There is also a significant time scale mismatch between single materiality and double materiality, which makes any sustainability reporting framework without double materiality half-baked

This paper delves into these issues. Our main conclusion is that the concept of accounting frameworks for sustainability reporting need to be science-based. Without incorporating science into measurement, asset managers and asset owners will continue to lack the technical expertise to assess either climate risks and opportunities or the impact their investments have on society.

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1. European Financial Reporting Advisory Group (February 2021). Final Report on Proposals for a relevant and dynamic EU sustainability reporting standard-setting

2. U.S. Securities and Exchange Commission (March 15, 2021). Public Input Welcomed on Climate Change Disclosures

3. IFRS (March 08, 2021). IFRS Foundation Trustees announce strategic direction and further steps based on feedback to sustainability reporting consultation

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