Climate Action

Are we closing in on a common language on sustainable investing?

Financial markets rely on a common language. Before investors can take a view on a company’s prospects, they need to understand its assets and liabilities, its cashflows and earnings.

  • 01 February 2021
  • David Harris, Head of Sustainable Business and Arne Staal, Global Head of Product Management and Research, LSEG

Financial markets rely on a common language. Before investors can take a view on a company’s prospects, they need to understand its assets and liabilities, its cashflows and earnings. The current consensus on financial accounting standards took hundreds of years to evolve; a common language for sustainability metrics that companies can use to report their performance is still evolving. But due to the billions of dollars flowing into sustainable investment strategies the pressure is building for standardisation.

It is important to recognise the solid progress on sustainability standards and reporting that has been made over the last 20 years. Sustainability data was a scarce and novel commodity when we launched the FTSE4Good Index Series in 2001. However, there is still some way to go, and gaps in environmental, social and governance (ESG) metrics continue to make it difficult for investors to compare the sustainability performance of different companies.

But the picture on data is improving. ESG standard-setting bodies are coming together and aligning their demands. Of particular importance is that the International Organization of Securities Commissions (IOSCO) and International Financial Reporting Standards (IFRS) Foundation are aligned on the need to accelerate standardisation and reporting; something that sustainability advocates have been recommending for years.

As global sustainability standards align it will create consistent, comparable and transparent data. One of the most important recent developments is the focus of the IFRS Foundation on global sustainability reporting standards.

We support this initiative and believe its success will depend on all constituencies and key countries getting behind it. There is a risk that if IFRS is not able to bring together these different constituencies, further fragmentation in sustainability reporting standards will follow. 

The work of IFRS could build on a number of efforts currently underway to bring consistency to sustainability reporting. Last January, the World Economic Forum (WEF) began work with the Big Four accounting firms – Deloitte, EY, KPMG and PwC – to resolve what Deloitte CEO Punit Renjen described as “an alphabet soup of metrics”. In September it produced a report that sets out a four-pillar framework that draws heavily on the work of the various major voluntary sustainability reporting standard bodies.

WEF is also engaging with the leading data, analytics and index providers, including FTSE Russell to determine how the private sector can agree a set of common sustainability metrics.

In September, the five leading voluntary sustainability reporting standard-setters – CDP, the Climate Disclosure Standards Board (CDSB), the GRI, the International Integrated Reporting Council (IIRC) and the Sustainability Accounting Standards Board (SASB) – outlined their shared vision for a comprehensive corporate reporting system.

This system would, they explained, incorporate disclosures that “reflect an organisation’s significant impacts on the economy, environment and people and those that are material for enterprise value creation”. Progress has been made since with the announced merger of IIRC and SASB and indications of further plans for alignment. The five bodies subsequently produced a progress report with  a prototype disclosure standard for climate-related information. That prototype builds on the work of the Taskforce on Climate-related Financial Disclosures (TCFD), whose recommendations have done much to promote comparability in this area.

Regulatory bodies are clearly critical players here. IOSCO, which has a mandate to maintain efficient and transparent markets, has established a workstream to improve issuers’ sustainability-related disclosures, and work closely with the IFRS Foundation, chairing their Monitoring board.

IOSCO can harmonise global approaches but there is wide range of regional and national regulatory approaches at various stages of development and implementation, with the European Union continuing to take a strong and proactive role. The EU is revising the EU’s Non-Financial Reporting Directive and has also brought in sustainability disclosure requirements through benchmark regulations, SFDR (Sustainable Finance Disclosure Regulation) and the EU Sustainable Finance Taxonomy. The forthcoming advice of the European Financial Reporting Advisory Group (ERFAG) sustainability reporting taskforce on an EU sustainability reporting standard will be an important milestone.

In parallel, China, Japan, Canada, and the UK are also developing approaches to sustainability standards and reporting and it is likely that the US Securities and Exchange Commission will review this issue under the new Biden administration.

These various initiatives underscore both the relevance and importance of the IFRS work – and the challenges it faces.

We believe IFRS is in a strong position to develop globally consistent and comparable sustainability reporting standards, in close cooperation with IOSCO and with the engagement of key jurisdictions including EU, China and US.

But, if it is to succeed, it is vital that it brings together the various initiatives underway – particularly that of the voluntary reporting standard setters, as well as WEF’s work with the accountancy firms and with data and index providers.

It would be practical for IFRS to focus initially on climate disclosures, where there is already considerable consensus on metrics. Standards in emerging areas, such as biodiversity and natural capital, could follow as a market consensus is reached.

The development of taxonomies, such as those introduced by the EU, is a case in point. These could provide a vital framework for sustainability disclosures. They fit into the TCFD framework in providing a definition set for the TCFD metric for revenue from “low carbon products and services”. The taxonomies allow companies to identify the proportion of revenues they are generating from, and R&D investment they are putting into these products that provide solutions to the sustainability challenges the world faces.

In addition to the work by the EU, many other jurisdictions around the world are developing their own taxonomies, risking exactly the proliferation of approaches that impedes comparability by investors and consistency for corporates. The newly-formed International Platform on Sustainable Finance (IPSF) may provide a solution for international collaboration – depending on the success of a potential ‘common ground’ taxonomy.

Despite the challenges, responses to the IFRS consultation show that there is broad global support from the market for its ambition to agree a common language on sustainability performance. A consistent approach to sustainable investment, and ultimately a solution to climate, and other environmental challenges in the decades ahead depends on such common framework. The dictionary for this common sustainability language is now in target, if only we can all work together in bringing these different initiatives together. 

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