Environmental, Social, Governance (“ESG”) – three words we have heard a lot about lately. “ESG” serves as a catch-all term to refer to three interrelated concepts of good corporate citizenship, and these concepts have broad applicability. For any organization, it is worth considering what your environmental impact and sustainability efforts currently look like; what your strategies are for equitable social participation (such as pay equity, diversity and inclusion, or employee benefits); and what your strategy is to maintain an accountable governance structure that acts in the best interest of the entity’s stakeholders, including owners, employees, and the public.
Far from being just a tag line or political shibboleth, ESG-awareness (and the questions it represents) are important to customers, investors, lenders, and employees. It is worthwhile to ask these questions, not just because they might make or break your next contract negotiation or funding round, but because having clear answers can demonstrate an up-to-date risk assessment mindset and better prepare your organization for future challenges and opportunities.
The importance of this model of risk-preparedness is not controversial: in fact, everyone from unions to business owners to the SEC have been considering whether stakeholders should receive more direct reporting on these concepts. There are a range of proposals, including a current SEC request-for-comments about required ESG disclosures in public company filings. However, most attempts at a broad reporting framework to date have been voluntary.
But why should there be a reporting framework at all? Surely one could object that these concepts are too subjective to apply a one-size-fits-all approach. While the details are still very much a work in progress, the common denominator appears to be that organizations should treat information related to environmental, social, or governance risks as “decision-useful” to financial statement users, and therefore material for disclosure. There are two main approaches being discussed, one that fits within existing financial reporting frameworks, and one that would require something entirely new.
The first approach is the one taken by the Staff of the Financial Accounting Standards Board. FASB Staff recently shared an educational paper (linked below under “Resources”) on the role financial accounting standards might play in ESG-conscious reporting. Their approach treads very lightly, in line with FASB’s role as standard-setter rather than trend-setter. Instead of proposing a new “Statement of Functionalized Carbon Emissions” (which would be an interesting exercise), the FASB Staff summarize the ways that broad risks such as climate change, pay inequity, or money laundering directly relate to more familiar disclosure concepts like contingencies, goodwill impairment, or going concern. With relevant ASC topics and subtopics cited along the way, this paper is a helpful reminder that companies and their accountants need to consider all relevant risks throughout the financial reporting process. FASB Staff ultimately propose the ESG model, much like the COSO Framework, as a helpful framework for assessing risks within existing accounting guidance.
Meanwhile, the SEC and IASB are exploring avenues of more direct disclosure requirements – the second approach as previewed above. Such disclosures would be both quantitative and qualitative, and most would probably be non-financial in nature. However, without enforceable disclosure requirements, “ESG Reporting” in the United States has largely taken the form of a self-completed report card of nonfinancial measurements. It should not come as a surprise that these report cards usually have good grades!
Perhaps the most promising avenues for transparent ESG reporting are external certification programs like the Certified B Corp program and disclosure frameworks with directly measurable criteria proposed by the Global Reporting Initiative (“GRI”) and the Sustainability Accounting Standards Board (“SASB”).
We have all seen the “LEED Certified” placards in the lobbies of new buildings. Organizational equivalents are programs like the B Lab’s “Certified B Corporation,” which allow for a 3rd party verification process with measurement against clear standards for environmental stewardship, social responsibility, and governance accountability.
Just as FASB, IASB, and SEC all provide qualitative and quantitative disclosure requirements, GRI and SASB have both proposed industry-specific metrics (both financial and nonfinancial) and qualitative disclosure topics. These are self-reported and voluntary, but hundreds of companies voluntarily comply each year (https://www.sasb.org/company-use/sasb-reporters/). These do not come with audit opinions and are essentially a specialized “Management Discussion and Analysis” document. However, because these frameworks provide for many concrete, measurable standards, it is easy to see how companies could obtain an independent attest-type report to back up their sustainability reporting. Their Materiality Map provides a user-friendly resource to see some industry-specific examples.
The direct relevance and usefulness of sustainability reporting can vary by industry and region. In addition, the cost-benefit constraint present in the FASB Conceptual Framework applies here, too – some information may be theoretically available but cost-prohibitive to compile and disclose. However, companies that prioritize the risks addressed by sustainability reporting are not just better informed to address current risks but also better prepared for future opportunities.
“Intersection of Environmental, Social and Governance Matters with Financial Accounting Standards” (March 2021); https://fasb.org/cs/ContentServer?c=Document_C&cid=1176176379917&d=&pagename=FASB%2FDocument_C%2FDocumentPage
SEC Request for Comments on Climate Change Disclosures – https://www.sec.gov/news/public-statement/lee-climate-change-disclosures
“A Practical Guide to Sustainability Reporting Using GRI and SASB Standards” (April 2021); https://www.globalreporting.org/about-gri/news-center/gri-and-sasb-reporting-complement-each-other/
SASB Materiality Map – a demonstration of industry-specific disclosure metrics; https://materiality.sasb.org/
SASB Reporting Archive – an index of organizations who actively participate in SASB disclosures with references to issued SASB-compliant reports; https://www.sasb.org/company-use/sasb-reporters/.
Background on Certified B Corp program – https://bcorporation.net/