Building block 7: Links to other standards and frameworks

SEC

IFRS S1 & S2 (by ISSB)

ESRS (by EFRAG) The proposal considers tagging the climate-related disclosures of registrants, including block text tagging and detail tagging of narrative and quantitative disclosures required by Subpart 1500 of Regulation S-K and Article 14 of Regulation S-X in Inline XBRL, as proposed. We welcome the proposal to require registrants to tag their climate-related disclosures, and the SEC should continue to integrate the climate-related data to the Electronic Data Gathering, Analysis, and Retrieval (EDGAR) database which contains registration statements, quarterly and annual reports and other forms which are mandatory submissions for listed companies.

The IFRS Foundation staff developed an XBRL representation of the (draft) IFRS Sustainability Disclosure Standards, considered as the IFRS sustainability disclosure taxonomy. We welcome that the IFRS Foundation is considering the tagging of disclosure prepared using the IFRS’ Sustainability Disclosure Standards. We suggest that the ISSB considers how specified disclosure channels could contribute to lower information costs. We believe that the EDGAR Database of the SEC provides a suitable starting point with an example of the set-up for financial disclosure.

ESRS E1 states that Sustainability information shall be presented (§106 b) under a structure that facilitates access to and understanding of the sustainability statements, both in human and machine-readable formats. We welcome the target for machine-readable sustainability information to enable the information to feed into the European Single Access Point (ESAP)30 as envisaged under the Capital Markets Union Action Plan31 .

Definition: Reporting standards and regulations can reference and refer to other existing standards and frameworks, especially to provide guidance and orientation to entities on how to disclose specific ESG information. There is a range of available (international) reporting standards specifying methodologies, metrics and KPIs for disclosure.

Overall recommendation: Reporting standards are particularly helpful if they enable the disclosure of specific and meaningful KPIs and metrics for certain sustainability topics. Reporting standards which offer detailed guidance could assist entities in reporting and increase comparability, particularly if specific KPIs and calculation methods are explicitly defined in the standards. However, different industries require specific industry guidance. Therefore, we highly recommend the SEC and the ISSB to develop industry-specific guidance and believe that the ESRS could provide a blueprint for such efforts.

30 EUTaxonomy, Corporate Sustainability Reporting, Sustainability Preferences and Fiduciary Duties: Directing finance towards the European Green Deal (2021) link 31 A Capital Markets Union for people and businesses-new action plan (2020) link

Design choice: New sustainability disclosure standards/regulations should build on and/or be linked to existing reporting standards

Standard Evaluation

SEC

IFRS S1 & S2 (by ISSB) The standard has been established based on reviews and input from the TCFD and GHG emission protocol, Global Reporting Initiative (GRI), CDP Climate Disclosure Standards Board (CDSB), the Value Reporting Foundation and the International Integrated Reporting Council (IIRC). We believe that for its current focus on climate reporting, the standard is sufficiently connected to other reporting standards and frameworks. If the disclosure content is expanded, as we recommend, further reporting standards (e.g. ESRS) and frameworks should accordingly be integrated as well (e.g. AFI).

The standards build on the TCFD, the SASB standards and industrybased standard-setting processes. We strongly suggest the ISSB further strengthen and make explicit the link to other sustainability reporting standards (e.g., GRI and ESRS), but also to consider more specialised, nature-related standards (e.g., CDP, AFI).

ESRS (by EFRAG) The standards include references to other existing standards and frameworks. We urge EFRAG to keep ambition levels high by building on and even going beyond existing standards. Furthermore, we recommend EFRAG to not only aim for consistency with other standards, but to even advocate for a rise of ambition levels in other reporting standards and frameworks.

Recommendation

THE CASE OF DEFORESTATION

To complement our overarching analysis with the illustration of a specific case, this section provides insights on how each building block relates to the topic of deforestation. We choose deforestation as the exemplificative case because it is closely linked to the two most important sustainability challenges we face today, namely climate change and biodiversity loss. As such, it is absolutely critical that sustainability disclosure standards sufficiently address the topic of deforestation and more broadly ecosystem conversion, as we highlight in the introduction of this brief. How each building block can support the reflection of deforestation in disclosure standards is illustrated in the following. Mandatory versus voluntary: The need for mandatory disclosure regulation also applies to the specific case of deforestation, as existing voluntary and market-based measures have failed to do so sufficiently. 32 Studies conducted as part of the elaboration of the EU regulation on deforestation-free products (to be adopted around the end of 2022)

have shown that mandatory measures are more effective than voluntary measures such as voluntary due diligence, labelling or private certification.33 As such, specific disclosure topics linked to deforestation should be mandated and specified precisely where possible. The lack of mandatory supply-chain-related disclosures has especially caused corporate actors to underinvest in improving traceability of their supply chains or to managing their deforestation impacts. Hence, the mandatory nature of deforestation-linked disclosure requirements must be applicable throughout firms’ supply chains. Disclosure content: Ecosystem conversion and specifically deforestation needs to be addressed via specific disclosure requirements and specific sets of disclosure standards if the sustainability disclosure standards aim to target climaterelated disclosures comprehensively. In comparison to the ESRS standards, emission-intensive land use changes are specifically underrepresented in the SEC and the ISSB proposals. Also, as recommended in the building block 2 above, we highly recommend addressing biodiversity and ecosystems in a specific set of disclosure standards of sustainability disclosure frameworks (e.g., as done in ESRS E4). This set of standards on biodiversity and ecosystems needs to especially address ecosystem conversion including deforestation through comprehensive, quantitative and comparable disclosure requirements. That includes the (1) size of areas converted, (2) type of ecosystem conversion, (3) location of production sites (georeferenced), and (4) cut-off date, or assessment period used to define ecosystem conversion linked to the undertaking or to its value chain by direct or indirect sourcing activities. 34 Furthermore, as deforestation is highly connected to social dynamics, close linkages need to be made to social standards, such as the ESRS S3 Affected Communities. While the overwhelming majority of tropical deforestation is linked to agriculture, it is a result of food (and to a smaller extent other) food commodity supply chains. As such, the issue of deforestation critically requires disclosures along firms’ supply chains, which should also be specifically highlighted in the respective standards. Furthermore, at least one third of recently deforested land does not even lead to active agricultural production but is a result of speculative clearing (and related social and economic dynamics). As such, it is essential to safeguard against a disregard of deforestation related impacts, which are not (yet) directly linked to certain products or services.35 Materiality: The double-materiality principle is a key prerequisite to address deforestation effectively. The principle of double materiality is embedded in the ESRS standards, whilethe SEC and ISSB proposals currently build on the narrow financial materiality approach. As such, the SEC and ISSB proposals do not address the critical deforestation impacts of firms. This is especially critical, as deforestation activities may not be identified as risks under the narrow financial materiality approach because deforestation is frequently not happening within direct operations of companies and may currently not be traceable to the firm level. The traceability problems thus allow deforestation impacts to remain externalities, which cause substantial welfare losses. As double materiality approaches can increase transparency about firms’ direct and indirect links to deforestation, they might enable the internalisation of deforestation-related externalities and thereby increase the financial materiality of these issues: Once information asymmetries are reduced and stakeholders informed about firms’ impacts on deforestation, firms might face financial consequences, for instance due to reputational loss. This interconnectedness of financial and impact materiality is captured by the concept of dynamic materiality, and highlights the importance to cover both the impact and the financial perspectives of materiality in disclosure regulations. Given the criticality of deforestation, we recommend specifying certain deforestation issues as per se material, meaning that they must always be reported on (by firms with certain characteristics, such as a certain size or sector

33 Proposal for a regulation of the European Parliament and of the Council on the making available on the Union market as well as export from the Union of certain commodities and products associated with deforestation and forest degradation and repealing Regulation (EU) No 995/2010 (2021) link. These findings were corroborated by the outcome of the Open Public Consultation, where the overwhelming majority of stakeholders —businessassociations and NGOs —supported a mandatory due diligence regime 34 A clear definition of cut-off dates or assessment periods is crucial in order to address the very destructive speculative practice of forest clearance followed by production several years later. Cut-off dates should be set in line with existing sector conventions (e.g., Amazon Soy Moratorium), legal requirements (e.g., Brazilian Forest Code) and certification schemes (e.g., Round Table on Sustainable Palm Oil, Forest Stewardship Council). For the Brazilian Soy Moratorium with cut-off dates 2006/8 see e.g.Heilmayret al.(2020)link;Forcertification schemes see e.g.,Roundtable on Sustainable Palm Oil (RSPO), 4 cut-off periods defined in: Annex 3 LUCA guidance document (2017)link;and Forest Stewardship Council (FSC)link 35 Pendrillet al. (2022) link

affiliation). Such per se material disclosure requirements should cover, (1) assessments and disclosures of firms’ direct impacts on land and natural ecosystems conversion, (2) assessments and disclosures of firms’ supply chain dependencies on key commodities linked to deforestation36 and (3) if such dependency exists, the reporting on the four disclosure requirements listed above in disclosure content. Scope: A more comprehensive scope of disclosure standards is more effective in tackling deforestation. Deforestation is linked to commodities that are imported by firms of different sizes, and to a great extent by SMEs. As such, SMEs are key for increasing sustainable livelihoods of forest-dependent people, for managing and protecting the natural resources and biodiversity of the forests and for combating climate change. 37 We recommend including SMEs in a larger scope but also recommend the current disclosure standard proposals consider and implement the proportionality principle. This means that firms of different sizes should be obliged to report on their activities with links to deforestation, but that especially smaller firms and those with smaller impacts on deforestation should be supported by either simplified disclosure standards or supportive reporting guidelines and tools. Including more companies in disclosure standards’ scope does not only improve decision making processes on the capital market, but also improves (unlisted) entities understanding and management of their deforestation impacts, which are likely to translate to financial risks in the future. Furthermore, it would prevent smaller firms from being excluded from certain markets when access depends on transparency provisions (as, for example, foreseen in the proposal for the EU regulation on deforestation-free products). Assurance: While it is currently challenging to assure firms’ (absence of) deforestation related impacts and/or risks, assurance is essential to increase the reliability and usability of deforestation related information. The mandatory implementation of assurance could also lead to the development of new solutions for better assessment of firms’ deforestation related impacts and risks. Such new assurance solutions could substantially contribute to the reliability and consequently usability of deforestation related information, which is currently oftentimes perceived as unreliable. The perceived unreliability of deforestation information is partly due to the difficulty of tracing deforestation to the product and firm level, which islinked to the fact that deforestation is often located in remote areas upstream national and international supply chains. Thanks to satellite-based data and traceability tools38 satellite imagery-derived landuse cover and change data as well as supply chain tracing data is increasingly available globally. Such information can however not always be attributed to specific producers, firms and consumers, which constitutes a substantial barrier to transparency on the firm level. In order to support auditors’ assessments of deforestation disclosures, we suggest to implement additional verification schemes, which may happen through cooperation with local actors, which are better equipped to verify firms’ information on deforestation.

39 Mandatory disclosure and verification of firm-level deforestation disclosures have the potential to constantly increase reliable data availability, and to thereby reduce the currently prevailing uncertainty and information asymmetries about firms’ deforestation impacts.40 Verified data to be disclosed should include (i) production sites’ geo-locations, (ii) scales to which products are traceable, and (iii) their land use change associated with sourcing regions. Verification can be provided e.g. by satellite-based tools in combination with local ground-truthing. We note that there is a high but not yet explored potential to involve local institutions41 with geographical proximity to upstream activities in such ground-truthing activities. Especially in remote areas and where land tenure schemes are still weak, their knowledge can make data more reliable and less prone to wrongful reporting. Such local “ground-truthing” of disclosed

36 such as the “covered products” of the proposal for EU regulation on deforestation-free products (2021) link 37 Supporting Small and Medium Enterprises (SMEs) in the Forest Sector: How can we do more? The rationale for a multi-sectoral approach (2017)link. 38 such as Trase, Global Forest Watch Pro, Mapbiomas 39 For example: if a company discloses that the soy sourced in their supply chain comes exclusively from specific production units in region x, that have not been deforested after 2008, then the local institution would have to confirm that this threshold was maintained for the reporting period and that the involved suppliers do not engage in deforestation as part of land speculation in other areas close-by. The disclosing company could provide information and proof of the local verification process as part of their report and/or such cooperation with local entities would become part of the auditors’ tasks 40 Fuhrmann et al. (2017) link 41 such as municipalities or representative organizations of communities and smallholders

information by corporates could – as a formalised process - also offer economic development options to local institutions and increase ownership for local sustainability transformation processes. Disclosure channel: Increasing the use of deforestation data can be enhanced through integrating deforestationrelated information in disclosure channels such as sustainability reports, or even centralised single access points, which can reduce information costs and thereby information asymmetries. Like other sustainability information, the usability of deforestation-related disclosures critically depend on its accessibility. As deforestation-related information is currently seldom available on the firm level, it is not commonly published through disclosure channels such as firms' sustainability reports or ESG data providers. The currently-drafted sustainability disclosure proposals indicate the development of publicly accessible databases and efforts towards digital tagging, which would provide convenient disclosure channels for information users. We thus recommend deforestation data to be integrated and considered in these efforts.

Links to other standards and frameworks: We recommend the SEC, ISSB and EFRAG to seek first or further exchange with the team of the Accountability Framework Initiative42 and the disclosure platform CDP Forests43 regarding their developed set of synthesisedstandards to account for deforestation. CDP Forests and GRI have recently added metrics on extent of conversion linked to operations and supply chains, in alignment with the Accountability Framework. Forthcoming guidance by the Accountability Framework, Science Based Targets initiative, and Greenhouse Gas Protocol on holistic land use change accounting and reporting will provide further clarity on best practice. Similar to other sustainability issues, it will be crucial for the standard-setters SEC, ISSB and EFRAG to consult and build on the in-depth experience, which has been built by experts in the specific topic of deforestation.

REMARKS BEYOND THE BUILDING BLOCKS

Our analyses are built on our extensive engagement with, and observation of, the standard setting processes of the SEC, ISSB and EFRAG. Beyond the analytical comparison and recommendations based on the building blocks, we use this section to highlight areas where we see room for procedural improvement, in particular with regard to (i) diversity of experts involved, (ii) interjurisdictional cooperation, and (iii) empowerment of effected stakeholders. In terms diversity of experts involved, we urge standard setters to actively reach out to and involve experts from different disciplinary backgrounds in the development process. Currently, the standard setting groups are mainly composed of experts with business backgrounds, specifically in the areas of finance and accounting. The effective development of sustainability disclosure standards urgently requires in depth input of experts from environmental and social studies, such as experts on biodiversity and sustainable land use. Only an interdisciplinary development process will deliver standards that enable the disclosure of risks, opportunities and impacts of firms’ activities on people and the environment. Furthermore, we observed that younger generations and marginalised groups are currently under-represented in the standard-setting boards. While we acknowledge that a certain level of experience

42 The Accountability Framework Initiative (AFI) supports companies in achieving supply chains free from deforestation, conversion, and human rights violations. Companies and other stakeholders can use the Framework as a tool to assess company policies and systems against consensus-based principles and best practices, as well as a resource to support improvement processes 43 CDP Forests defines high deforestation risk commodities and countries and provides a menu of key performance indicators that companies with tropical commodity supply chains, financiers with high deforestation risk investments, and forestry asset managers can use to generate standardized and comparable disclosures

is necessary, we view it as essential to increase the (generational) diversity of the standard-setting bodies, as these actors will face the consequences of limited accountability due to unambitious disclosure standards. Similarly, we highlight the importance of increased inter-jurisdictional cooperation, as we observed a lack of active consultation of and integration of upstream perspectives in the standards’ development process. In the context of the ESRS development process, for example, it is important for the EFRAG to cooperate with jurisdictions that are connected with the EU through close economic and commercial relations, and that are connected to many EU-based firms’ supply chains. Brazil, for instance, plays an important role in the successful implementation of the European Green Deal, as many European firms import goods from Brazilian producers. For the disclosure regulations developed in the EU to work effectively and with the regulations in place in other jurisdictions, it is necessary for public and private actors in the EU to have a good understanding of existing and proposed regulatory frameworks and initiatives in these countries. Brazil represents a very relevant example of such a country, as it is one of the most important countries in which high-deforestation risk commodities are produced. An intensive exchange of information and knowledge between the EU and Brazil on sustainable finance regulations and how it impacts the production of forestrisk commodities can lead to greater cooperation and integration between these jurisdictions and facilitate effective implementation by market actors.

44 Additionally, we urge standard setters to think critically about stakeholders that will be affected by the standards, and how to empower them through the standards’ design choices. Rather than imposing difficult and unrealistic disclosure obligations on, for example, smallholders in other countries, standard-setters could think about mechanisms that integrate local knowledge in a manner that considers the local realities of these stakeholders. We see a high and not yet explored potential to better include know-how and insights of local institutions with geographical proximity to upstream activities, as highlighted for example through our recommendation for the development of local verification schemes under building block “assurance” in our deforestation exemplification. This could also foster structural strengthening of people and institutions in remote areas by granting them access to business opportunities arising from the need for companies to provecompliance with disclosure standards. This aspect links to our recommendation regarding the importance of interdisciplinary perspectives in the development process because such approaches can only be developed through interdisciplinary exchange between disclosure and sustainable development experts.

CONCLUSION

The three disclosure standards should fulfill the need for more transparency about material sustainability impacts, risks and opportunities across different sectors and actors. While they all agree on the pertinence of corporate environmental and other sustainability information for investment and financing decisions, our analysis shows that along the lines of the seven ESG building blocks, they still vary vastly across key characteristics. By comparing the three consultations per building block, we were able to systematically identify ambition gaps. We find that among the three proposals, the ESRS standards are most ambitious for “disclosure content”, “materiality”, and “links to other standards and frameworks” . Regarding “mandatory vs. voluntary” and “assurance”, the ESRS and SEC standards stand out in their level of ambition and leave room for improvement for IFRS. All three disclosure standards show efforts in developing towards a single access point (subsumed under building block “disclosure channel” , which

44 Bridging sustainable finance and sustainable land use initiatives to reduce deforestation: An overview of EU and Brazilian legislation(2022) link

we regard as beneficial and see as a potential to collaborate and proceed. Regarding “scope

” , we formulate suggestions for all three proposals, suggesting to consider the sustainability related impacts in establishing the scope. This analysis of key characteristics of disclosure standards shows clearly that most room for improvement lies with the IFRS standards. The SEC standards, which only focus on climate so far, are more ambitious for several building blocks. The most comprehensive requirements can currently be found with the ESRS standards. Nonetheless, it is important to keep the different roles and agendas of the SEC (investor protection), ISSB (establishing a global baseline) and EFRAG (reporting under the CSRD) in mind. The results of our analyses lead us to believe that the future of sustainability reporting standards can develop in two directions: i) a race to the bottom with narrow and static disclosure standards or ii) a situation of international cooperation and global convergence towards widely applicable and future-proof sustainability standards. It is especially important to prevent a race to the bottom, by understanding and clearly communicating that the IFRS standards aim to become the global baseline of sustainability reporting standards. Thereby, the IFRS standards will play an important role in communicating the minimum level of the global ambition of international disclosure standard-setting, while this leaves room for the other standards to aim for more comprehensive and useful standards. The next months will be crucial in setting the international stage and for the determination which of the two scenarios becomes most dominant. This will also affect the ambition of the ESRS standards. It is crucially important to push for the recommended design choices in the IFRS standards, while mitigating the risk of the ESRS standards being diluted down. Climate & Company raised these concerns during the 2022 consultation rounds and will continue to promote ambitious sustainability disclosure standard-setting in future dialogues among relevant actors, based on sciencebased arguments.