Is One Set of ESG Standards Coming Soon?

The announcement at this week’s World Economic Forum (WEF) that sixty-one global companies, which together generate revenue totaling $4.3 trillion and employ 7 million people, have agreed to implement WEF’s common environmental, social and governance (ESG) metrics for stakeholder capitalism is further proof that the aspiration for a single set of ESG standards for business reporting is moving fast. 

The confusion, lack of consistency and comparability in existing sustainability reporting has long been felt, with the oft-used phrase “alphabet soup” marking the debate amongst companies and investors alike.  

It is important not just to describe these developments, but to understand why the speed is accelerating and to harness this for what happens next.

Investor-led momentum

Since describing this as a "race to the top" here on TriplePundit five months ago, the WEF announcement has come hard on the heels of an interim report by the body working on European Union ESG standards, the production of a prototype climate-related disclosure standard by the “Big 5” voluntary sustainability framework and standard-setters, and consultation by the International Financial Reporting Standards (IFRS) Foundation on whether it should address sustainability reporting in its own standard-setting.

Probably the biggest push to this momentum arises from the rising voice of investors that ESG issues are increasingly relevant to them, but that they can barely use corporate sustainability reporting as it is undertaken today. 

When I was CEO at the International Integrated Reporting Council, we received an independent report from McKinsey, which showed 75 percent of institutional investors wanted a single sustainability standard, with 85 percent saying this is needed to be able to allocate capital more effectively. 

BlackRock Chair and CEO Larry Fink, whose annual letter to company CEOs has become the hallmark of this movement, says in his 2021 letter also published this week: “We strongly support moving to a single global standard, which will enable investors to make more informed decisions about how to achieve durable long-term returns.”

These developments have certainly influenced the IFRS Foundation to consider stepping in, although its paper is careful to reference different stakeholders and to justify its proposals on combating fragmentation, cost and complexity in existing sustainability reporting.  

The Foundation is currently analyzing more than 600 responses to its consultation, but it would be surprising if it does not proceed towards the formation of a new Sustainability Standards Board working alongside - and connected to - the International Accounting Standards Board for financial reporting.

The challenge may be in how long it takes to achieve this within its deeply entrenched governance processes.

Companies want to move faster

The second major factor lies in the frustration amongst companies themselves, suffering from reporting fatigue but also sharing the vision of many stakeholders that progress is too slow to enable societal and environmental challenges to be met in time.

The COVID-19 pandemic may have increased awareness of systemic risks and proven that ESG-ready companies have been more resilient at a time of crisis, but it has still seen a reversal in progress towards the Sustainable Development Goals (SDGs).

The sustainability context – the time and collective impact efforts that streamlined ESG standards will have in meeting Paris and SDG targets – remains all-too-often missing from the discussions.

Nevertheless, the WEF initiative encapsulates the push from companies to move faster, providing a core set of 21 core and 34 expanded ESG metrics, with speakers in the online Davos Agenda calling these “a standard” and predicting a further “huge increase” in take-up by the Forum’s next meeting in January 2022.

What has struck me from this week’s Davos debates and a new background paper published to coincide with the Davos Agenda announcement, “The Future of the Corporation,” is the strength of the ambition from business leaders to move beyond profit maximization to “stakeholder capitalism.” This also seems largely missing from the other actors in ESG standards and stands as a further challenge to them. 

At the very least, as long as companies including HSBC, Mahindra Group, Royal Dutch Shell, Sony and Unilever implement their pledge in the 2020 and 2021 reporting cycle, we will have an early opportunity to assess whether the new reports are perceived differently by investors and other stakeholders. 

European ESG standards – which definition of materiality?

The final report of the European Financial Reporting Advisory Group mandated to consider European ESG standards is due as soon as next month. It has already published proposed principles, operational guidelines and an architecture for new EU standards. 

At an outreach meeting with eleven European-wide business, investment and accountancy organizations held earlier this month, there was strong support for the bloc’s definition of “double materiality” - both financial and ESG relevance for the reporting - with a majority of respondents saying companies’ social and environmental impact is the most important component in designing the reporting standards.

This stands in stark contrast to the focus on how ESG factors have an impact on “enterprise value creation” as the ultimate objective, which is at the heart of all of the other initiatives. 

Many see this financial imperative as a driver rather than an inhibitor, but the exact definitions for materiality chosen by the European Union and by the IFRS Foundation will crucially determine the future path for ESG standards - and may well diverge. 

Existing ESG reporting as a building block

If this all seems as confusing as ever, it is heartening to see the “Big 5” recognize their metrics are building blocks and communicating a willingness to contribute to the establishment of a new set of ESG standards, rather than simply defend their own organizational space. 

“The EU as well as the IFRS are going through a process.  All of us are interested in helping them to meet their ambition of creating a new reporting regime,” GRI Chair Eric Hespinheide told an online event to launch the new prototype. “We may not be in the room but are in discussion, and can leverage the intellectual capital we’ve created over twenty years, to help them to move quickly.”

EFRAG Project Task Force Chair Patrick de Cambourg showed his readiness for Europe to build on existing metrics and to interact with the global players but said the EU must design its own standards first, “to make international cooperation a two-way process.”

WEF Chair Klaus Schwab said: “We are working together with standard-setting agencies and governments not to create a competition, but to create a generally accepted common framework of metrics. It needs a key number of companies to report, but to then to integrate this in standard-setting.” 

Watch these continuing fast-moving developments. But there really may be harmony in the harmonization. 

Image credit: Benjamin Child/Unsplash