TaxLegi 27.10.2022

It is inevitable that financial reporting will evolve to corporate reporting that includes, among other things, sustainability information. As the new requirements on sustainability reporting are being drafted, refined, and tested, it is obvious that stakeholders will be facing several challenges. Navigating the patchwork of requirements, the lack of widely accepted definitions and the evolving landscape, just to name a few. But the biggest of all is the availability and reliability of data that is needed to address the (potential) overlapping requirements, set by a different regulators and standards setters across the globe.

Our profession will also be impacted, especially, as we have been asked to provide assurance on the corporate sustainability reports once the new rules kick in. Professional accountants should be informed of the new rules and the emerging trends, invest in their knowledge around sustainability, and influence the debate around these current issues. My advice: make sure that you catch the train.

Introduction

The modus operandi of the capital markets was initially developed and subsequently evolved primarily, some may argue exclusively, around the needs of investors and shareholders. To this end, financial reporting, as a means for providing reliable and relevant signals to the market, in an effort to decrease the information asymmetry between management and investors, focused on the financials: assets, liabilities, profits, earnings per share, cash flows, dividends …

As the societies progressed, things have now changed. With a more inclusive capital markets model, access to information, awareness, general curiosity, as well as the focus to corporate responsibility shifted the attention to more than merely a corporate’s fiduciary duties. As a matter of fact, the scrutiny of sustainability matters has become even more important.

This doesn’t mean that financial reporting is becoming irrelevant. On the contrary, financial information is the centrepiece of corporate reporting, around which sustainability information helps in bringing the full corporate story to capital markets.

Moving to more inclusive capital markets model

A more inclusive model means that the needs of a wider stakeholder group shall be addressed via corporate reporting. To achieve this, reporting should incorporate sustainability information, sometimes called ESG: Environmental (e.g., information on the impact of the entity on climate change and the impact of climate change on the entity, details on Green House Gas emissions), Social (e.g., diversity and inclusion), and Governance (e.g., internal controls, addressing fraud). The big leap on this debate is the fact that the stakeholders were heard by policy makers, resulting to new initiatives in developing reporting requirements.

In fact, we see several new legislations and standards across the globe. At the international arena, the newly formed International Sustainability Standards Board (ISSB), under the umbrella of the International Financial Reporting Standards (IFRS) Foundation, issued its first two draft standards, addressing the investors’ needs for sustainability reporting. In Europe, the European Commission finalised its long-awaited Corporate Sustainability Reporting Directive (CSRD), under which the European Financial Reporting Advisory Group (EFRAG) has been asked to develop the European Sustainability Reporting Standards (ESRSs). In the US the Securities and Exchange Commission (SEC) published its requirements focusing on climate change. An observer can only be thrilled by the swift responses from standard setters, but equally petrified by the risk of having a patchwork of different, overlapping and maybe contradictory requirements across the world. This gives rise to several challenges for all involved in this process.

The Challenges

Not only preparers of Corporate Reporting, who will be the first to face the challenges ahead, but investors, other interested parties (e.g., employees, NGOs, the society at large) and of course our profession will be heavily impacted. The avalanche of the new requirements will be at our doorsteps very soon.

The number and nature of challenges differ from entity to entity, from stakeholder to stakeholder, but some of them are common. Allow me to introduce three: i) understand the relevant requirements, ii) data, iii) comparability and interpretation.

The first is to grasp the relevant requirements that apply to a particular reporting entity. As discussed earlier, different regulators and standard setters have taken initiatives to develop reporting requirements. These are not always (at least not fully) aligned. For example, the draft standards of the ISSB focus on the needs of investors, while the draft ESRSs include the concept of double materiality (the impact of climate change on the entity – aligned with the ISSB, but also the impact of the entity on the environment). Getting a good understanding on which framework applies to the reporting entity is also a challenge, as the European rules have extraterritorial applications.

Taking all into account, defining the scope and the application of the requirements will be a huge task, which needs to be addressed even before starting the design of the new corporate/sustainability report. Next to preparers (who are directly impacted) other stakeholders need to go through similar process, so that they comprehend what has been reported and how it compares to other entities/industries.

Once the scope is set, the second challenge comes to light: DATA. Data other than financial, is not always readily available, and even if is it, it is not subject to the same rigorous internal scrutiny and controls.

In addition, entities are required to base their reports on external information, as the current proposals extend beyond the boundaries of the traditional reporting entity. Examples include the scope 2 and scope 3 Green House Gas emissions, covering the direct and indirect emissions of the entities’ supply chain all the way to its final consumers. This means that, to achieve completeness, an entity needs to rely on information that is provided by its suppliers and produce estimates for its customers, which puts additional pressure on the availability and reliability of data.

As soon as the first two challenges are addressed, management and other stakeholders will be tasked with understanding the reported information, comparing them across entities (or even within the same entity, e.g., within departments) and making the relevant decisions, e.g., invest, set Key Performance Indicators (KPIs), assess management’s performance against the goals.

To be able to overcome all these, one should be able to appreciate data points that are neither well defined, nor easily comparable. Furthermore, some frameworks allow for entity specific information (see for examples ESRS), which will require additional communication to and education of the different stakeholders.

In instances like this, where uncertainty exists and the market participants are not well placed to develop a market practice, regulators step in to close the gap by introducing a number of rules (see the EU Taxonomy on green investments). This is much welcomed in this interim period, however policymakers need to be able to allow flexibility and to ensure that the rules change as needed, e.g., as the stakeholders gain experience, experimentation will allow room for further innovations in corporate reporting to address the emerging information needs.

The Accountancy Profession

Our profession is heavily affected. Not only we are facing the same challenges as other stakeholders, but we will also be asked to provide assurance on sustainability information. As we already know from our experience, this requires additional efforts compared to other stakeholders to overcome the same challenges, especially in gaining an understanding around the processes for identifying, extracting, and reporting information, so that we can opine on the final report.

The only way to make sure that our profession remains relevant in this context, and that it is well equipped to face the uncertainties, is to ensure that we all are keeping up with the developments and to the extent possible influence the debate (e.g., by providing input via comment letters, participate to fruitful discussions).

Be aware though that the train has already left the station. I hope that I see you all on board.

We are at the dawn of a new era with regards to Corporate Reporting, and all need to be well suited and supported in this journey. At EY, we are committed to maintaining a leading-edge understanding of the changes that may affect the business environment. Our tool, EY Atlas Client Edition¹ (here) is available for free to everyone and offers access to EY interpretations and thought leadership content.

Connect with the author via LI: www.linkedin.com/in/ppantelis

Contact:

• Pantelis Pavlou

End Notes:

¹ The views expressed in this article represent the personal opinions of the author and not necessarily the official position of EY