ESG Refocused: The Clock Is Ticking on Mandatory Sustainability Reporting

In today’s world, business activities are scrutinized like never before, especially as it relates to environmental, social, and governance (ESG) practices. As such, corporate responsibility on sustainability reporting has come closer into focus, transforming from a point of concern to a business imperative.

Of course, aiding in this shift are the plethora of new requirements on the horizon. This year, sustainability reporting is expected to begin moving from voluntary to mandatory, with requirements dictating how companies measure and report their ESG metrics. For example, the United States Securities and Exchange Commission (SEC) finalized its climate-related disclosures rule in March 2024, and California has already enacted two statewide climate bills in 2023.

While mandatory requirements don’t impact all organizations, it pays for everyone to be prepared, even those that aren’t required to report, notes Elizabeth Sloan, CPA, a managing director in the ESG and sustainability services practice at Grant Thornton LLP in Chicago.

“Many entities are reporting ESG and sustainability information voluntarily to provide their stakeholders with a greater understanding of their values and how they operate,” Sloan says. “The voluntary reports are helping stakeholders understand what’s important beyond just the bottom line.”

THE SHIFTING LANDSCAPE

The roots of sustainability reporting lie in corporate social responsibility (CSR), which has evolved into environmental concerns. Today, the marketplace is in its third wave.

“The first wave of CSR efforts focused on giving back to society and was manifested in donating to charities, sponsoring community events, and supporting nonprofits,” says Anthony DeCandido, CPA, a partner and co-leader of the sustainability service solutions practice for RSM US LLP in New York City. “CSR reports from this era frequently resembled glossy brochures, showcasing the company’s philanthropic efforts rather than reflecting its operational impact on society and the environment.”

According to DeCandido, the second wave—marked by the transition from CSR to ESG reporting—saw the alignment of sustainability with corporate strategy, as organizations came to recognize that long-term success and risk management are linked to responsible environmental and social practices. But for some, the reporting may not have been applicable to their business.

“In the second wave, organizations realized the importance of ESG risk at an enterprise level, so many groups rushed to prepare reporting that may or may not have had a heavy level of relevance to their stakeholder group,” DeCandido says.

Today, as organizations navigate the third wave of reporting, the landscape is vastly different, focusing on how ESG reporting aligns with a broader societal shift toward sustainability and accountability.

“Many global businesses and businesses of certain profiles now need to do compliance reporting, and that’s a very different wave of reporting than we’ve seen in prior years,” DeCandido adds.

TOP FOUR REPORTING REGULATIONS

Today, four ESG and sustainability reporting regulations (currently in place or coming soon) have been deemed the most impactful. These include:

1. SEC Final Rule on Climate-Related Disclosures. The final rule, which impacts SEC registrants, was issued on March 6, 2024. Under the final rule, registrants are required to disclose the material impact of climate-related risks and the effects of severe weather events and other natural conditions within the footnotes of their financial statements. Additionally, certain registrants will need to disclose Scope 1 and/or Scope 2 greenhouse gas emissions, if material.
   
   
2. Corporate Sustainability Reporting Directive (CSRD). This new mandate was released on Jan. 5, 2023. It modernizes and strengthens the rules around the social and environmental information companies must report. The directive originated in Europe and impacts European entities, but also extends to organizations based in the U.S. and multinationals that do business in Europe. With the first CSRD reports due in 2025, companies whose fiscal year ends Dec. 31, 2024, should be prepared to provide accurate information from different parts of the organization to support the new assurance requirements.
   
   “CSRD metrics are broader, expanding past climate,” DeCandido says. “To me, they’re some of the more material metrics that companies are rushing to report on.”
   
   These metrics include security and privacy; diversity, equity, and inclusion; governance and environmental waste; employee engagement; stakeholder engagement; and more.
   
   Notably, both the SEC’s disclosure and CSRD rules impact wide-ranging companies that provide various general products.
   
   
3. Sustainable Finance Disclosure Regulation (SFDR). This regulation is based on a transparency framework. By setting out how financial market participants must disclose sustainability information, this regulation helps potential investors make informed choices about working with companies and projects that align and support their sustainability objectives.
   
   “The SFDR is built around avoiding greenwashing and preventing companies from trying to promote that they have green and sustainable investment products when they’re not actually green or sustainable,” Sloan says.
   
   
4. Federal Acquisition Regulation Climate-Related Disclosure Rule. This rule would require some federal contractors to disclose their greenhouse gas emissions and climate-related financial risks and set science-based targets to reduce those emissions.

“Not every organization would need to report on all these rules and regulations,” Sloan says. “However, even though the rules are all different, they do contain some overlaps, and there’s some interoperability between the requirements.”

Importantly, organizations should determine which of the above ESG and sustainability regulations apply to them now to protect themselves from any risks associated with inaction. These risks may include reputational damage (e.g., noncompliance may result in customers, investors, and other stakeholders viewing the organization as irresponsible). Additionally, organizations may risk experiencing lost business opportunities, decreased market share, and a decline in stock price.

STATES ARE TAKING ACTION

In addition to global and federal ESG reporting activities, state legislatures are also weighing in. Some states are moving forward with requirements of their own, while others are pushing back.

California, for example, has two climate-related reporting rules in place, which require both in-state and out-of-state businesses doing business in the state to disclose their carbon emissions and climate-related financial risks. One is the Climate Corporate Data Accountability Act (Senate Bill 253), which requires large businesses operating in California to publicly report their greenhouse gas emissions. The other is the Climate-Related Financial Risk Act (Senate Bill 261), which mandates that companies disclose the threats they face because of climate change. Both bills were signed into law on Oct. 7, 2023.

Though still in its infancy, lawmakers in Illinois are also working on similar legislation.

Sheila Millar, a partner at Keller and Heckman LLP in Washington, D.C., leads the law firm’s consumer protection regulatory practices. She envisions a complicated landscape in the world of ESG reporting.

“The two California laws have gotten a lot of attention and are the subject of a legal challenge by the U.S. Chamber of Commerce,” Millar says. “While the SEC rule applies to publicly traded companies, California’s laws and their financial benchmarks aren’t limited to only publicly traded companies—they apply to private entities as well.”

Millar adds that the U.S. Chamber of Commerce and a variety of California business organizations have filed a lawsuit against the state over its new corporate climate disclosure laws, claiming the reporting requirements violate First Amendment rights by forcing businesses to engage in subjective speech.

Importantly, the U.S. Chamber’s challenge could potentially spawn further court challenges, legal questions around the scope of First Amendment rights, and obligations for communicating about ESG.

“I think the ongoing ESG and anti-ESG laws will continue to be a complicating factor,” Millar says. “I fully expect that we’re going to see more ESG laws in 2024 legislative sessions, as well as more anti-ESG measures coming through.”

Although regulations are still forming and working their way through the courts, Sloan stresses it’s crucial for organizations to get prepared now as it’ll take some time to gather the information needed to report in a timely manner: “We highly encourage entities to start looking at emerging rules and regulations at the state level to gain an understanding of what might impact them both directly and indirectly. Some of the reporting encourages entities to work with their entire supply chain, so it’ll be important for them to think through how they fit into that bigger picture.”

OVERCOMING CHALLENGES: A MULTIDISCIPLINARY APPROACH

Sloan points to ESG and sustainability reporting as a multidisciplinary effort for organizational leaders to examine their business practices and determine what they want and need to report on and where to get that information: “You may seek information from your traditional finance function in the organization, but also your HR, tax, legal, and risk teams. You can also look to your customer sales, supply chain, and other groups you normally wouldn’t contact that can all fit into ESG and sustainability reporting.”

DeCandido acknowledges that climate reporting is relatively new, and some organizations struggle with either reskilling existing talent or identifying new talent in the marketplace that are equipped to handle ESG and sustainability requirements. To combat this, he suggests leaders offer learning opportunities and professional development for employees.

“That’s the human component,” he stresses. “It’s good for business and has all kinds of positive effects. When your people feel more engaged, they’re more likely to stay with you. And engaged employees are likely to result in better customer experiences, broader commerce activities, and more profits down the line.”

Of course, DeCandido admits that some of the technical requirements are difficult, and even the best and most sophisticated businesses don’t always have the in-house expertise to handle the reporting, particularly global companies tasked with aggregating data from varying locations and disparate systems.

Because rules are constantly changing, and others aren’t yet final, Millar cautions this can further complicate internal reporting.

“The first step to overcoming these challenges is to understand the business imperatives that come with ESG reporting,” Millar says. She advises organizations to put systems in place to report truthfully and with transparency to avoid overstating the good things they’re doing.

Despite the challenges, DeCandido predicts a bright future for ESG and sustainability reporting and says it’ll become part of organizations’ strategic landscapes: “The future is a world where ESG is just another language business leaders speak.”

DeCandido also says the day is coming when business leaders will be talking about the usefulness of nonfinancial metrics just as much as financial metrics.

“There’s not a person out there who would say having more useful, relevant data isn’t helpful in leading a business,” he stresses. “If you can present some of the qualitative aspects of what you do so your stakeholders will be better informed, that’ll simply lead to better business decisions.”

Related Content:

• Beyond Compliance: Creating Sustainability Goals That Make a Difference: How can organizations, led by their finance teams, look beyond looming SEC requirements, and create lasting ESG goals that truly make a difference? According to experts, it’s about finding the right balance.
• ESG: A Roadmap to Value Creation: With continually evolving frameworks and numerous data points to navigate, the road to incorporating an effective ESG strategy into any business model is a foggy one. But a carefully charted roadmap can reveal a clear path to long-term value creation. Here’s what today’s accounting and finance professionals need to consider if they want to drive their organizations toward sustainability and success.