Given the steady stream of coverage on various platforms—from national newspapers to CPABC’s online Newsroom—you’re probably well versed on environmental, social, and governance (ESG) issues by now.1 In fact, you might be sick of hearing about ESG. Maybe you even agree with some of the backlash.2 Nevertheless, you would be wise to stay current on ongoing developments in this area, because the factors that are driving the focus on ESG—including public concerns about climate change, social justice issues, and equality—aren’t going to disappear.
The term ESG is often used interchangeably with sustainability, and ESG- or sustainability-focused investments have played an important role in public markets for many years now, with global sustainable investments reaching US$35.3 trillion in 2020—an increase of 15% from 2018—according to the Global Sustainable Investment Alliance (GSIA).3 The GSIA also identified Canada as the market with the “highest proportion of responsible investment assets at 62%.”4
In addition, ESG issues are increasingly being taken into account by other providers of capital, including banks and credit unions, and by insurers.
Just as CPAs have an important role to play in managing our organizations’ financial risks and staying up to date on new developments, it is now equally important that we stay apprised of the impact of the evolving world of ESG management and reporting on our organizations. An organization’s approach to ESG could, for example, have a bearing on its ability to secure a loan or insurance coverage, meet reporting requirements to trade on stock exchanges, or get approval for projects.
Global reporting standards are being developed
The increased focus on ESG has created a growing appetite for high-quality, reliable, and comparable ESG data. Unfortunately, it has also led to a proliferation of standards for reporting on performance, and this “alphabet soup” of standards has made it challenging for reporting companies, their providers of capital, and other stakeholders to compare organizations and consistently measure performance. Needless to say, this has led to considerable confusion and frustration. But there is good news.
In 2021, the International Financial Reporting Standards Foundation created the International Sustainability Standards Board (ISSB) and tasked it with developing a set of common ESG reporting standards to be used globally. The ISSB will use a similar approach to that of the International Accounting Standards Board, which sets global accounting standards. This is a major step forward. Furthermore, Canada will play an important role, as the ISSB has set up a regional hub for the Americas in Montreal.
The ISSB recently published two exposure drafts: one for general sustainability reporting requirements and the other focused specifically on climate-related reporting. Final versions of the standards are expected to be published by the end of 2022. The ISSB is currently working closely with different jurisdictions to encourage them to include these global requirements as part of their own standards. Ultimately, however, it will be up to the regulators in each jurisdiction to determine how the ISSB standards are implemented once they are finalized.5
Proposed disclosure requirements could affect both public and private companies
As it relates to public markets, the Canadian Securities Administrators (CSA) and the US Securities and Exchange Commission (SEC) have also made recommendations on ESG disclosures. In Canada, the CSA has provided guidance to improve ESG-related disclosures for public issuers. In the United States, the SEC has proposed requiring their registrants to provide specific climate-related disclosures, as well as regular reports on matters including governance of identified climate-related risks and risk management strategies; material impacts on the registrant’s business and financial impacts over various time horizons; the impact of climate-related risks on business strategy, model, and outlook; and climate-related scenario planning and transition plans.6
Although the proposed changes to the CSA and SEC rules would apply only to public companies, demands for ESG reporting will likely have an impact on private companies as well, because many private companies are part of the value chain of public companies that are subject to the CSA or SEC rules. For example, if a public company is required to disclose their Scope 3 emissions (which include greenhouse gas emissions from all companies within their value chain), their vendors—which may very well include private companies—will need to co-operate and report on their own metrics.
Banks, credit unions, and insurers are taking ESG into account
We’re also starting to see banks and credit unions make more climate-related commitments and develop more defined reporting standards. One industry-led initiative is the Net-Zero Banking Alliance, which unites banks around the globe that are committed to aligning their lending and investment portfolios with net-zero emissions by 2050. Using science-based targets, this alliance, which represents 40% of the world’s banking assets, aspires to promote a standardized framework and implement de-carbonization strategies and peer learning.
Insurers are also starting to take ESG issues into account, especially as these issues relate to climate risks that have very direct impacts on their industry.7 Some Canadian insurers have taken significant losses from climate-related natural disasters like forest fires and floods, for example, and some global insurers have stepped back from insuring Canadian projects related to fossil fuels.
Moreover, the financial industry is facing increasing regulatory pressure. Earlier this year, it was announced in Canada’s 2022 Federal Budget that banks and insurers will be required to publish climate disclosures starting in 2024, and that the Office of the Superintendent of Financial Institutions “will also expect financial institutions to collect and assess information on climate risks and emissions from their clients.”8 In short, companies of all sizes may soon need to demonstrate their management of ESG risks in order to access capital.
Managing ESG factors supports more than the bottom line
In keeping with the adage that “What gets measured gets managed,” measuring ESG-related risks often leads to better management of both financial and non-financial risks. Indeed, even though ESG factors are commonly referred to as “non-financial factors,” they can ultimately have a material financial impact on a company.
Consider, for example, a company that needs an environmental permit to build a mine, expand a port, or start a real estate project. In each of these scenarios, the company’s ability to secure the environmental permit will require reporting on the potential ESG impacts of the project on both the local communities and the environment. And the company’s success in obtaining the environmental permit will have a significant financial impact on its bottom line, even though the permit itself may not appear in the company’s financial statements.
Accordingly, companies that recognize the risks and opportunities of ESG factors and manage them appropriately stand a much stronger chance of getting their projects approved. This will help them generate greater value for shareholders while also providing positive benefits to a range of stakeholders that may include employees, the local community, suppliers, and customers.
Considerations continue to evolve
The last decade has seen a meaningful rise in the importance of ESG factors, and the push for sustainability will likely continue, regardless of its detractors. The creation of new standardized sustainability reporting benchmarks creates an excellent opportunity for CPAs, as our profession is well positioned to play an important role in this rapidly evolving area.
Andrew Sweeney, CPA, CA, CFA, is a vice-president and portfolio manager at PH&N Institutional, a division of RBC Global Asset Management Inc. He thanks Lisa Leong McPhee, senior marketing manager at RBC GAM, for her contributions to this article.
1 Lori Mathison, “The Importance of Having an ESG Strategy,” CPABC Newsroom, March 17, 2022.
2 Jeffrey Jones, “ESG is facing a political and market backlash. Will it survive?” Globe & Mail, July 9, 2022.
3 Global Sustainable Investment Alliance, Global Sustainable Investment Review 2020, July 18, 2021.
5 IFRS, “ISSB Establishes Working Group to Enhance Compatibility Between Global Baseline and Jurisdictional Initiatives,” April 27, 2022.
6 US Securities and Exchange Commission, “SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors,” March 21, 2022.
7 Tim Quinson, “Insurers Risk Financial Harm By Covering Oil and Gas Firms: Green Insight,” Bloomberg, August 25, 2021.
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