The regulatory climate for ESG

The regulatory climate for ESG

By Laura Hay, CPA, CAE, OSCPA executive vice president

Environmental, social and governance (ESG) reporting is on a rapid rise because of investor interest and an increasing body of research demonstrating a positive correlation between ESG measures and financial performance.

Enterprises are realizing that ESG reporting is an effective approach for communicating purpose, connectivity and impact, as well as their capacity for long-term value creation. So, the potential is not limited to reporting current information about management’s activities and plans for addressing risks related to ESG matters as part of assessing the financial position of the organization.

In a world of significant change, businesses are driven to provide more information, and investors and employees are seeking more accountability, creating an opportunity for both internal and external financial advisers to contribute to long-term organizational success. The concept of integrated reporting focuses on value creation across resources and capitals that contribute to thriving and self-sustaining organizations.

International integrated reporting

Global harmonization in value reporting and its integration with traditional financial reporting has risen to an economic imperative. In November, the IFRS Foundation announced announced that the Value Reporting Foundation (VRF) and the Climate Disclosure Standards Board (CDSB) would be consolidated into the IFRS Foundation this year. Supported by the G7, G20 and International Organization of Securities Commissions, the consolidation’s goals include developing a shared understanding of how enterprise value is created, preserved or eroded over time.

A combination of three VRF resources have been adopted in more than 70 countries:

1. Integrated Thinking Principles

2. Integrated Reporting Framework

3. Sustainability Accounting Standards Board (SASB) Standards

The IFRS Foundation is forming a new International Sustainability Standards Board (ISSB) to develop a comprehensive global baseline of high-quality sustainability disclosure standards. An independent body, the ISSB will work in close cooperation with the IASB to provide comprehensive information to investors and providers of capital.

The ISSB will develop IFRS Sustainability Disclosure Standards, with the objective of high-quality, transparent, and globally comparable sustainability disclosures that are compatible with the financial statements and specialized for various industries. They will build upon the existing frameworks, so companies may continue using the VRF and CDSB frameworks and guidance.

ESG reporting in the United States

In the United States, the SEC requires public companiesto disclose certain ESG information if it is material to anunderstanding of the business. Such disclosures includeclimate and human capital risks. In 2010, the SEC issuedguidance on how U.S. securities laws and regulations mayrequire disclosures of climate-related information.

In July, SEC Chairman Gary Gensler said he wants mandatorydisclosures of climate risks and diversity, and that he wantsthe agency to move with urgency on these directives.

The SEC proposals, on the regulatory agenda for early 2022,may address:

• The entity’s plans to address climate risks and governance.

• Climate targets and progress toward achieving the targets.

• Greenhouse gas emissions.

• Workforce and board diversity.

As many entities consider how to incorporate new measuresof value in traditional financial reporting, upcoming standardsare responding to these disclosures and the auditor’sconsideration of the overall environment in which the entity operates. The following Statements on Auditing Standards(SASs) are effective for audits of financial statements forperiods ending on or after Dec. 14, 2023:

SAS No. 143, Auditing Accounting Estimates and Related Disclosures

SAS No. 144, Amendments to AU-C Sections 501, 540 and 620 Related to the Use of Specialists and the Use of Pricing Information Obtained from External Information Sources

SAS No. 145, Understanding the Entity and its Environment and Assessing the Risks of MaterialMisstatement

The AICPA has issued other guidance on ESG in the FinancialStatements Practice Aid, to assist in evaluating how ESGrelatedmatters may affect the financial statements. Thepractice aid addresses:

• Responsibilities of Management – including assessing industry, regulatory and entity-specific factors in the context of the overall environment in which the entity operates.

• Responsibilities of Those Charged with Governance – including obtaining information about management’s assessment of ESG-related risks, its plans for mitigating those risks and future risks and opportunities.

• Responsibilities of the Auditor – ESG risks may affect the auditor’s determination of materiality, the auditor’s understanding of the entity’s environment and internal controls, and the risk assessment.

CPAs advising boards have recommended/asked:

• Keeping a spot on the agenda for ESG risks andopportunities.

• Is the finance function integrated in connecting the requirements of stakeholders with relevant metrics and disclosures?

• Does the organization have the data it needs to assess how ESG is affecting the business?

• Is there appropriate assurance regarding the reliability of that data?

• Is the board interpreting the data to provide insight and foresight?

• Is the organization clear on its ESG strategies and how it will measure success?

Policy responses to valuation, obsolescence, supply chainand increasing costs of insurance are only some examplesof changes in the regulatory landscape, pointing to an everincreasingneed for the profession to engage with lawmakersand regulators and continue to drive transformational change.

We can no longer have a compliance mentality – inan environment of enduring change the profession isdemonstrating agility in anticipating, recognizing andresponding to new risks and possibilities.

Laura Hay, CPA, CAE is executive vicepresident of The Ohio Society of CPAs andstaff liaison to the Accounting Auditingand Professional Ethics Committees. Shecan be reached at Lhay@ohiocpa.com or614.321.2241.