Environment, social and governance (ESG) matters have received a lot of press recently. In 2023, two new global sustainability standards were published, and California passed two controversial new laws that will require the largest entities doing business in the state to report climate-related disclosures beginning in 2026. Even if the existing guidance doesn’t apply to your business, here’s why you should consider voluntarily reporting and obtaining assurance of ESG data.
Breaking it down
Today, businesses are facing increasing pressure to adopt sound ESG practices and provide transparent disclosures in their financial statements on these matters. Perhaps the biggest challenge in understanding ESG is identifying and addressing all the different concepts and actions that fall under its umbrella. Here’s a rundown of some examples:
Environmental practices. These include consumption of energy and other resources, efforts to lessen carbon emissions, recycling, and sourcing and usage of materials.
Social practices. These include an unbiased hiring process; fair labor policies; diversity, equity and inclusion measures; and workplace safety procedures.
Governance practices. This subcategory includes ethics, integrity in how business is done, anti-fraud measures, pay equity, legal compliance, cybersecurity and other privacy measures.
Complying with developing guidance
The pressure to report on ESG matters isn’t just coming from the general public. It’s coming from various rule-making entities. For example, in June 2023, the International Sustainability Standards Board (ISSB) issued the following two standards:
- International Financial Reporting Standard (IFRS) S1, General Requirements for Disclosure of Sustainability-Related Financial Information, which provides a global baseline for disclosing sustainability-related risks and opportunities, and
- IFRS S2, Climate-Related Disclosures, which provides reporting requirements specific to climate-related disclosures.
Portions of the international standards go into effect on January 1, 2024. The guidance is pending approval by more than 140 jurisdictions worldwide. The United States isn’t among the countries that have adopted IFRS, however.
In October 2023, California passed two controversial new laws that will affect large entities doing business in that state, starting in 2026. First, the Climate Corporate Data Accountability Act will require business entities with more than $1 billion in total annual revenue 1) to report annually their Scope 1, 2 and 3 greenhouse gas emissions and 2) to obtain assurance for their reported emissions. The second law, Greenhouse Gases: Climate-Related Financial Risk, will require business entities with more than $500 million in annual revenue to disclose their climate-related financial risk based on recommendations of the state’s task force on climate-related financial disclosures. Both laws are expected to face legal challenges.
Important: California’s climate disclosure requirements go beyond the mandatory climate disclosures proposed by the U.S. Securities and Exchange Commission. (See “Current and Proposed SEC requirements,” below.)
Conversely, governors in some other states are pushing back on ESG matters. Earlier this year, Florida Governor Ron DeSantis announced plans to introduce legislation that would affect Floridians by prohibiting:
- Financial institutions from discriminating against customers based on their religious, political, or social beliefs — including their support for increasing our energy independence,
- The financial sector from considering social credit scores in banking and lending practices,
- The use of ESG in investment decisions at the state and local level,
- All state and local entities, including direct support organizations, from considering, giving preference to, or requesting information about ESG as part of the procurement and contracting process, and
- The use of ESG factors by state and local governments when issuing bonds, including a contract prohibition on rating agencies whose ESG ratings negatively impact the issuer’s bond ratings.
DeSantis is currently leading an alliance of governors from 18 states to “push back against” President Biden’s ESG agenda, according to a news release.
Recognizing the benefits
For now, ESG reporting is largely voluntary for smaller private businesses. However, many choose to implement sustainable practices — and share their progress with customers, employees and others — for various business reasons.
In certain industries, ESG reporting may help attract new business opportunities. For instance, large companies and governmental bodies that build new facilities may consider ESG practices in determining which general contractors to solicit or accept bids from. And some even look into subcontractors and suppliers as well.
Likewise, sustainable business practices may expand your business’s access to capital. For example, Wells Fargo committed to $500 billion in sustainability financing between 2021 and 2030. Banks that engage in sustainability financing programs may provide economic incentives to borrowers that meet agreed-upon annual targets for reducing greenhouse gas emissions. Conversely, they may impose economic penalties for failure to achieve emissions targets.
In addition, job seekers and employees — especially younger ones — may consider employers’ ESG practices in deciding where to work. Companies that tout solid ESG practices may have a leg up on other employers when it comes to attracting and retaining skilled workers in today’s tight labor market.
Responsible ESG practices can also help mitigate risks and control costs. For instance, by going green, your business may be able to reduce fuel and energy consumption, streamline its supply chain, and minimize waste. Addressing social practices can help prevent employment litigation and curtail workers’ compensation costs. And tightening up governance can prevent costly fraud and data breaches.
What’s right for your organization?
Before deciding to launch a major ESG initiative, it’s important to evaluate the expected costs and benefits to make sure it’s a wise financial decision that will add long-term value. If you’re interested in improving your company’s ESG practices, talk with your CPA about evaluating your initiative’s financial feasibility, as well as ways to incorporate ESG information into your financial reports, internal communications and marketing materials.
Sidebar: Current and Proposed SEC requirements
The Securities and Exchange Commission (SEC) doesn’t specifically require companies to provide investors with information about environmental, social and governance (ESG) matters. But some information related to these risks must be disclosed under U.S. Generally Accepted Accounting Principles (GAAP) in the following sections of a company’s financial statements:
Description of business. This disclosure describes the business and that of its subsidiaries, including information about its form of organization, principal products and services, major customers, competitive conditions, and costs of complying with environmental laws.
Legal proceedings. This disclosure briefly explains any material pending legal proceedings in which the company, any of its subsidiaries and any of its property are involved. It includes disclosure of environmental litigation arising under any federal, state or local regulations regarding the discharge of materials into the environment or protection of the environment.
Risk factors. These disclosures highlight the most significant factors that make an investment in the company speculative or risky.
Management’s discussion and analysis. These disclosures enable investors to see the company’s liquidity, capital resources and financial results through the eyes of management. Here, companies must identify known trends, events, demands, commitments and uncertainties that are reasonably likely to have a material effect on financial condition or operating performance.
In addition to these disclosures, some companies may issue separate sustainability reports that cover a broad range of nonfinancial issues. Unfortunately, without uniform sustainability reporting standards, these reports can be inconsistent. Some investor groups believe that ESG disclosures aren’t being sufficiently used in the United States. They believe that the FASB could be missing an opportunity to put more emphasis on climate reporting and other sustainability matters in GAAP financial statements.
In March 2022, the Securities and Exchange Commission (SEC) issued a controversial proposal that would require public companies to report on their Scope 1 and 2 greenhouse gas emissions, as well as Scope 3 emissions of their suppliers and value chains. However, the proposal has stalled, and it’s currently unclear when — or if — the SEC will issue a final climate disclosure rule. The proposal received more than 16,000 public comments, including many from industry groups criticizing the rule for being excessively burdensome and costly for companies.
One potential obstacle to a final SEC rule on climate disclosures is a recent U.S. Supreme Court decision — West Virginia v. Environmental Protection Agency — which limited the U.S. Environmental Protection Agency’s regulation of greenhouse gas emissions. The “major questions doctrine” was used in this high-profile case. Under this doctrine, Congress must explicitly authorize an agency to undertake actions of “great political and economic significance.”
Some speculate the SEC also might be holding back for political reasons. ESG regulations are a hotly debated topic, pitting investors and special interest groups who may want more information about ESG matters against businesses that may be resistant to resource-intensive mandatory disclosures. We’ll keep you updated on any significant developments.
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