As climate-change related topics continue to grip headlines, the SEC is actively considering a proposal that would require public companies to include climate-related disclosures in periodic reports and registration statements. The proposed required disclosures are aimed at providing investors and other capital markets stakeholders with consistent, comparable, and reliable information to make investment decisions. The proposal would also require certain public companies to seek third-party assurance over Scope 1 and 2 Greenhouse Gas emissions disclosures.
This proposal is one of a handful that the SEC is weighing on environmental, social and governance (ESG) requirements, likely because investing based on ESG factors has become an increasingly popular strategy. According to Morningstar, in the first quarter of 2022, there was a sizable $343 billion invested in sustainable funds.
Historically, public companies voluntarily disclosed ESG information outside of documents that contain the audited financial statements, like the 10-K filed with the SEC. But with the SEC’s new proposal, this may soon change. Public company auditors, in their public interest role, are uniquely positioned to play an important role in ESG assurance.
“Like the audits of financial statements and internal control over financial reporting, auditors are experienced in providing assurance to enhance the reliability of company reported information. In some cases, they are already doing this for ESG-related data that companies provide.” says Desiré Carroll, CPA, Director at The Center for Audit Quality (CAQ).
The current landscape
What public companies disclose has long been driven – at least in part – by investors. In the case of ESG, it is no different. Carroll observed that separate letters from the CEOs of BlackRock and State Street Global Advisors (SSGA) announcing the importance of sustainability to their investment strategies highlighted investors’ growing interest in ESG matters and the need for companies to provide greater transparency into how they are managing ESG-related risks and opportunities.
“The COVID-19 pandemic also served as a catalyst for increased demand for ESG information,” said Carroll. “As employee health and safety were impacted and supply chains disrupted, the growing importance of managing ESG related risks and opportunities was further emphasized.” According to an analysis by the CAQ, 95% of S&P 500 companies already disclose ESG information, typically in a standalone report outside of an SEC submission. Of this, more than half had some form of assurance or verification over the ESG information.
What’s in store for ESG standards
While there is not yet a globally accepted ESG reporting system for public companies to use when disclosing this information, it is necessary for consistent, comparable ESG reporting. In its S&P 500 analysis, the CAQ found that there are currently many standards and frameworks that public companies use to report ESG metrics. Of the five commonly referenced standards and frameworks — Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB), The Task Force on Climate Change (TCFD), Integrated Reporting (IR) and CDP (formerly known as the Carbon Disclosure Project) — most public companies used at least one standard or framework, with many referencing multiple standards or frameworks.
With the formation of the International Sustainability Standards Board (ISSB), however, the hope is these frameworks and standards can evolve into one globally accepted system. The ISSB’s intention is to provide a comprehensive global baseline of ESG-related disclosure standards aimed at meeting investor’s information needs.
“We're seeing a consolidation and hopefully a move towards a global baseline of sustainability disclosure standards,” Carroll says. “Also, the support we’re seeing for the ISSB from groups like the G7 and investors representing over US$53 trillion in assets (from Asia, the European Union, North America and the UK) is encouraging.”
How auditors enhance the reliability of ESG reporting
Perhaps the most critical component of reliable and useful ESG information is the assurance that independent third-party auditors can provide. Auditors already play a crucial role in the flow of reliable information that investors use to make important decisions.
Assurance, when performed by a public company auditor, can enhance the information’s reliability because auditors are independent, maintain a system of quality control, and routinely incorporate specialists when needed. Further, they understand business processes, are experts at evaluating compliance with established standards and frameworks, and adhere to continuing professional education ethics and experience requirements.
“Similar to the way auditors make use of valuation or tax specialists in financial statement audits, they incorporate relevant ESG experts (like engineers or scientists) into ESG assurance engagements.”
Public company audit firms are taking steps to prepare for the SEC’s mandatory climate and other ESG requirements. Many firms are hiring new employees with expertise in ESG and upskilling current auditors with new tools and resources. In certain cases, audit firms are also already auditing climate information to the extent that it is material to and has been reported in the financial statements. For example, a material impairment in property, plant, and equipment resulting from a climate-related event (like a flood or wildfire) would be subject to the financial statement audit.
The demand for reliable ESG reporting is at an all-time high. As the SEC continues to weigh its climate change proposal, the CAQ and public company auditors continue to recognize the importance of ESG disclosure standards and rules, in combination with independent assurance, that brings more accountability, transparency and reliability. This combination of factors will enhance trust in public company reported ESG information.
