A deep dive into the rise of non-financial reporting and what it means for business
Dr. Jane Thostrup Jagd, Director Net Zero Finance
Non-financial reporting standards are being adopted globally, from Australia to Malaysia and Costa Rica to South Korea. As part of our deep dive into the diversity of these standards and their utility, we’ve distilled what you need to know, from the interesting differences between the standards to what they mean for scope 3 reporting.
At the end of May 2024, over half of the global economy by GDP was using or taking steps to introduce the International Sustainability Standards Board’s (ISSB) Standards in their legal or regulatory frameworks.
More than 20 jurisdictions worldwide are now using or plan to adopt the ISSB standards including Australia, Bolivia, Brazil, Canada, China, Costa Rica, Hong Kong, Japan, Kenya, Malaysia, the Philippines, Malaysia, New Zealand, Nigeria, Singapore, South Korea, Switzerland, Turkey and the UK.
All regulations, whether based on the ISSB standards or the EU or China’s own standards, have the Taskforce of Climate-Related Financial Disclosure (TCFD) principles inbuilt. This means companies MUST consider the financial risks of climate change on the company’s financial situation – short, medium and long term. From its launch in 2017 until winding up in 2023 (having fulfilled its remit), nearly 5,000 organizations supported the TCFD recommendations as a useful framework to increase transparency on climate-related risks and opportunities within financial markets.
The European Union’s Corporate Sustainability Reporting Directive (CSRD) and its European Sustainability Reporting Standards (ESRS) are being phased in from reporting years 2024-2028, depending on company size and listed status. Find out how early adopter companies are already reporting against the framework in our latest report.
Further afield, China’s Sustainability Disclosure Standards are based on the ISSB standards, but tailored to the Chinese market.
While the ISSB standards and California’s regulations are based on the principle of single materiality, i.e., how environmental risks and opportunities can impact an organization, both the EU standards and the Chinese standards are based on the principle of double materiality. Put simply, this means that companies must both report on risks from the company’s activities to society and the environment e.g. treatment of wastewater run-off and workforce impacts due to the transition to new technologies, but also how external risks impact the company e.g. flooding, drought and CO2 taxes.
Figure 1: S&P Global, ’Where does the world stand on ISSB adoption?’, Jennifer Laidlaw, accessed June 2024, <https://www.spglobal.com/esg/insights/june-2024-where-does-the-world-stand-on-issb-adoption>
What does non-financial reporting cover?
Non-financial reporting standards require companies to formally disclose data regularly covering ESG topics including climate including GHG emissions, energy and carbon credits but also other environmental themes like water or biodiversity. ESG topics also cover social topics like number of employees, gender pay gap, or governance topics like lobbying, fines, whistleblower solutions, etc.
Non-financial reporting may be voluntary using reporting frameworks such as CDP’s questionnaires or mandatory and can apply to a range of companies, regardless of size or listed status. Many countries globally have some degree of legislation on GHG emissions reporting. But on top of this have even more countries gone in the direction of establishing Taxonomies, which supports both identification of green companies, but even more importantly also can raise capital to green sub-projects within companies via green bonds.
From reporting year 2026, approximately 3,000 listed SMEs will also be mandated to report according to a special version of the CSRD called LSME. Non-listed SMEs can also voluntarily report using the CSRD’s upcoming VSME framework. More than 8,250 SMEs are already undertaking annual climate reporting using the SME Climate Hub’s Reporting Tool, preparing them for future reporting on a voluntary or mandatory basis. In April 2024, CDP rolled out a dedicated SME corporate questionnaire, which is a simplified version of their corporate questionnaire and allows SMEs to report voluntarily.
The business benefits of getting reporting right go beyond compliance. The company data produced by non-financial reporting helps investors to identify which companies are investing in the clean energy transition and can highlight gaps in action which may lead to stranded assets and hence costs. For example, if a delivery company has a large fleet of diesel vehicles and no plans for electrification and most of its customers live in high density urban areas subject to low emissions traffic zones, then this may indicate to investors that there is a high likelihood of asset stranding for this firm, ultimately impacting the company’s bottom line.
What about scope 3?
Things get more complicated when it comes to Scope 3 emissions, which can be difficult to calculate, especially when it comes to downstream emissions i.e., the emissions created by the customer’s use and disposal of the product and service, etc.
Upstream we see many online calculation solutions, which the companies can choose to use. Therefore, there is a greater likelihood the companies will be better at reporting on these emissions. But the companies should be aware of potential documentation requirements from their auditor/assurer, if their ESG reporting is assured.
Companies cannot have perfect oversight of all the scope 3 data. Much of this data is estimated – hopefully on solid and transparent assumptions, which are assured – but it is still estimated. When it comes to non-financial reporting, the estimated or imperfect quality of this data can impact comparability and therefore how useful this data is to investors. Therefore, the transparency of accounting principles is essential for further dialogue with the stakeholders, including investors.
Whether investors find Scope 3 comparable or not, the inclusion of Scope 3 reporting in most non-financial reporting standards is essential for decarbonization in line with a 1.5° C pathway as set out by the IPCC scientists. The reason is, that reporting on these upstream and downstream emissions allows companies to identify hot spots, showing them the most emitting parts of their value chains and it is therefore an efficient base for prompting efficient action.
Companies can address their scope 3 emissions in a manageable way through Tier 1 supplier engagement using the Supplier Cascade approach. For information about the Supplier Cascade and to sign up as an early adopter visit the webpage. Meanwhile the SME Climate Hub now has a growing suite of tools that larger companies can leverage to engage small businesses in their value chains. Learn more about these tools.
The countries leading the way on mandatory reporting
While certain regions are pulling ahead in terms of mandating non-financial reporting, this doesn’t mean that all European countries are applying these rules evenly. While companies across the Nordic countries are leading on early adoption, other EU member states including Austria, Belgium, Greece, Malta, Portugal and Iceland have not adopted the CSRD legislation, missing the July 2024 deadline to do so.
Elsewhere, Canada and Australia are also leading the way, with Australia passing its mandatory climate reporting bill for large and medium-sized companies through the senate in late August 2024.
Meanwhile in the U.S, the SEC ruling on climate-related risks is subject to a temporary stay pending a judicial review of the rules. Since the rules were proposed almost two and half years ago, and despite scope 3 being removed from the draft regulation, the potential rules represent a good start for the future of U.S. climate disclosure laws.
What does the future look like?
As more and more countries globally encourage and adopt non-financial reporting by companies of all sizes, data coverage will increase, and comparability will probably be improved – not the least due to more assurance of the data. This means it will be of greater use to investors in their decision-making and a more informed picture of which companies are really walking the walk on rapid decarbonization and a just transition, rather than merely talking the talk.
As with any new regulation, we are bound to see teething problems in the first year of disclosure, especially for unlisted companies and SMEs that have never done this type of reporting before. The demands are significant and challenging, especially for the EU-based companies, but non-financial reporting will get easier every year.