At first, ESG disclosure was optional, but soon ESG reporting will be mandatory due to government regulations for many companies in the U.S. and the European Union. Understanding the emerging regulations and ESG reporting frameworks is important for both achieving compliance and delivering the right information to stakeholders.

Environmental, social, and governance (ESG) remains an emerging set of principles, which is why there is continued growth in the number of rating agencies, reporting mechanisms, and government regulations. The ESG program is widely viewed now as a risk minimization opportunity, but the industry is becoming a confusing array of data collection and disclosure options. As the U.S. and the European Union governments move to develop and implement ESG disclosure regulations, coupled with increasing stakeholder demands for disclosure, organizations must delve into the muddy landscape of regulations, rating agencies and their frameworks, standards, and reporting. The regulatory requirements are moving ESG reporting from a voluntary effort to a compliance one that must be integrated into ESG disclosures designed to meet stakeholder needs. It is no longer an either-or situation, as ESG becomes a critical business strategy for long-term competitive success.

Regulatory Compliance Changes ESG Disclosure

ESG is not a new principle, but significant disclosure has been mostly voluntary up to this point. Whenever business reporting is voluntary, the end result is a variety of companies offering different data collection and reporting platforms, and ESG is no exception. ESG disclosure refers to public reporting of performance for various environmental, social, and governance issues for purposes of transparency and accountability. There is now a long list of companies and other organizations offering ESG platforms for ease of disclosure. Some top voluntary ESG frameworks include the Global Reporting Initiative (GRI), the Sustainability Accounting Standards Board (SASB), and the UN Sustainable Development Goals. There are other more-focused frameworks also, such as the Carbon Disclosure Project (CDP). To add further complexity, ESG frameworks are emerging that blend multiple frameworks into one. The large number of reporting frameworks means there is currently no consistency in disclosure reporting, typical of an emerging industry.

Until government regulatory agencies got involved in ESG disclosure practices, ESG was primarily driven by market demands for transparency. Now there are existing (or soon-to-come) ESG disclosure regulations requiring compliance with mandated disclosure rules in the U.S., European Union (EU) and Canada. Canada is expected to start requiring specific ESG reporting and climate disclosures in 2024 from certain organizations, including banks, insurance companies, and financial institutions.

The European Union is the most advanced in ESG regulations. It will soon finalize the Corporate Sustainability Reporting Directive (CSRD), which will lead to more than 50,000 companies being required to report ESG indications that are independently verified. Reporting and enforcement will begin in FY 2024, but the EU Taxonomy is already effective for companies regulated under the Non-Financial Reporting Directive (NFRD) and will be effective for financial organizations in 2023. The CSRD requires more firms to report and expand reporting requirements compared to the EU Taxonomy, and it will be effective from 2024-2025. Reporting for certain non-EU companies begins in 2028.

The U.S. is lagging behind the EU, but is soon catching up to some degree. The U.S. Securities and Exchange Commission (SEC) has published a proposed ESG rule titled The Enhancement and Standardization of Climate-Related Disclosures for Investors, which is expected to be finalized in April 2023. Companies registering with the SEC will be required to “provide certain climate-related risks” and supply “information about a registrant’s climate-related risks that are reasonably likely to have a material impact on its business, results of operations, or financial condition.” There are federal agencies and states proposing rules for major federal contractors also. The U.S. Department of Defense, U.S. General Services Administration, and National Aeronautics and Space Administration developed the Federal Supplier Climate Risks and Resilience Rule. California and New York state representatives have introduced bills requiring companies to report greenhouse gas emissions in an understandable format. The New York bill requires alignment with disclosure standards, like the SEC rule, when it is finalized.

Layered Transitioning to Sustainability Reporting

In summary, the current and next five years will witness major ESG disclosure requirements becoming mandatory. Making sense of ESG disclosure requirements can begin with companies preparing now for the disclosure regulations. Aideen ODochartaigh outlined five steps for transitioning to ESG disclosure in Berkeley-Hass’s California Management Review. The first step is to dedicate the financial and human resources needed for accurate ESG measurement and reporting. Step 2 is to connect top-down vision with bottom-up data collection. Step 3 is to measure all relevant ESG topics to prepare for any possible future regulation. The fourth step is to prioritize performance by utilizing environmental management accounting tools. The fifth step is to engage within and across industries to address challenges and support innovation.

Deloitte explored how to start with ESG reporting. The recommendation is to begin by thinking in terms of sustainability layers. The overarching goals are the UN Sustainable Development Goals (SDGs) and the Paris Climate Agreement. These inform government regulations for minimal reporting requirements. The next layer beneath regulatory requirements is stakeholder expectations. The bottom layer is the reporting framework that shows the organization’s alignment with stakeholder interests and concerns. Says Deloitte: “The breadth and depth of ESG issues are significant. Narrowing down this breadth and depth to a manageable level is the purpose of selecting a framework and then conducting a materiality assessment in accordance with that framework.” The recommendations include checking on the frameworks that industry peers and leaders are using, defining the specific target audience of the report, and beginning with the GRI framework because it can be built out over time. It is compatible with many other standards, including the SDGs and SASB industry standards and is expected to be compatible with the CSRD.

Disclosing ESG for Success

ESG disclosures are becoming important sources of data in the pursuit of sustainability. Though there are many options, some more complex than others, the best approach is to transition toward full disclosure by taking steps. One thing is for sure: ESG disclosure reporting is moving towards becoming both government mandated and necessary to attract and retain customers and investors. Businesses transitioning now will be more prepared to adapt to stakeholder demands and comply with regulatory requirements. The added benefit is that disclosure reporting signals leaders as to where improvements can be made in areas such as energy and water efficiency and human rights, and will help leadership identify and minimize risks.