In recent years, ESG (Environmental, Social, and Governance) reporting has become increasingly important to investors around the world. As more companies recognise the importance of responsible and sustainable practices, the need for transparent reporting on ESG factors has become mandatory in many jurisdictions. In this article, we will explore what ESG reporting is, why it is important, and the mandatory requirements across the world.
ESG reporting refers to the process of disclosing information about a company's performance in relation to environmental, social, and governance factors. ESG reporting involves a company collecting data on these factors, analyzing its performance, and then disclosing this information to investors and other stakeholders. ESG reports can take many forms, ranging from standalone reports to integrated annual reports that combine financial and non-financial information. The purpose of ESG reporting is to provide investors with a comprehensive view of a company's operations, including its impact on the environment and society, and how it is managed.
There are several reasons why ESG reporting has become increasingly important to investors around the world. Firstly, investors are recognising that companies that prioritise ESG factors are more likely to be sustainable in the long term. Companies that manage environmental and social risks and opportunities effectively are more likely to avoid negative impacts and capitalise on opportunities. This can result in better financial performance, which is important for investors seeking to achieve long-term returns.
Secondly, ESG reporting provides investors with valuable information about a company's risks and opportunities. By analysing ESG factors, investors can gain insights into a company's operations, its impact on the environment and society, and how it is managed. This information can help investors make more informed decisions about where to allocate their capital.
The EU has introduced several regulations aimed at promoting sustainable finance and ESG disclosure. These include Corporate Sustainability Reporting Directive (CSRD) , will require large companies operating in the EU to disclose more detailed information about their sustainability performance and impacts. The EU has also introduced a Taxonomy Regulation, which establishes a classification system for sustainable activities, and the Sustainable Finance Disclosure Regulation (SFDR), which requires financial market participants to disclose how they integrate ESG factors into their investment decisions.
1. The Non-Financial Reporting Directive (NFRD)- is an EU regulation that requires certain large companies to disclose non-financial information, such as environmental and social impacts, in their annual reports. The NFRD applies to public-interest entities with more than 500 employees and aims to increase transparency and comparability of non-financial information across companies and sectors. It is being replaced by CSRD.
2. Corporate Sustainability Reporting Directive (CSRD) - This is a proposed regulation from the European Commission that aims to revise and expand the existing Non-Financial Reporting Directive (NFRD) to make it more comprehensive, enforceable, and consistent with international reporting standards. The CSRD is expected to be implemented by 2024, and will require large companies operating in the EU to disclose more detailed information about their sustainability performance and impacts.
3. Sustainable Finance Disclosure Regulation (SFDR) - This is a regulation that came into effect in March 2021 for financial market participants and financial advisers operating in the EU. It aims to promote transparency and consistency in ESG-related disclosures, by requiring financial firms to disclose how they integrate sustainability risks and factors into their investment decision-making, and how they manage those risks.
4. EU Taxonomy - This is a classification system that sets out criteria for determining whether economic activities can be considered environmentally sustainable, in line with the EU's environmental objectives. It aims to help investors and companies identify sustainable investments and align their activities with the EU's climate goals. The taxonomy is being implemented in stages, with the first phase covering climate change mitigation and adaptation, and the second phase covering other environmental objectives such as circular economy and pollution control.
In addition to the Non-Financial Reporting Directive (NFRD), the UK has introduced the Streamlined Energy and Carbon Reporting (SECR) regulation, which requires large companies to report their energy consumption and greenhouse gas emissions. The UK has also established the Task Force on Climate-related Financial Disclosures (TCFD), which provides recommendations for companies on how to disclose climate-related financial risks and opportunities.
1. UK Task Force on Climate-related Financial Disclosures (TCFD) - This is a voluntary framework developed by the Financial Stability Board, aimed at helping companies disclose climate-related risks and opportunities in their financial reporting. The UK government has announced plans to make TCFD-aligned disclosures mandatory across the economy by 2025.
2. Streamlined Energy and Carbon Reporting (SECR)- is a UK regulation that requires large companies to report their annual energy consumption and greenhouse gas emissions in their annual reports. The SECR applies to all quoted companies and large unquoted companies with at least 250 employees or an annual turnover of at least £36 million and an annual balance sheet total of at least £18 million. The aim of the SECR is to increase transparency around energy use and carbon emissions among large companies and encourage them to take action to reduce their carbon footprint.
While the US does not have national ESG regulations, some states have introduced their own regulations. For example, California requires public pension funds to consider ESG factors in their investment decisions. The Securities and Exchange Commission (SEC) has also issued guidance on ESG disclosure, which requires companies to disclose material ESG information in their public filings. In addition, President Biden has made ESG and climate change a priority, and his administration is expected to introduce new ESG regulations in the future.
SEC upcoming rules - The US Securities and Exchange Commission (SEC) is currently working on several rule-making initiatives related to ESG reporting, including proposals on climate change disclosures, human capital management, and board diversity.
ESG reporting plays a critical role in providing investors with valuable information about a company's ESG performance, risks, and opportunities. As mandatory requirements for ESG reporting continue to expand across the world, it is clear that companies must prioritize ESG factors if they hope to remain competitive in the long term. By investing in ESG funds and supporting companies that prioritize ESG factors, investors can help drive positive change and promote sustainable practices.
Learn more on how Wequity supports investors with reporting on ESG via this link.