Sustainability Strategy Needs Global Standards
Professor Gaizka Ormazabal
IESE Center for Corporate Governance, Academic Director
Many boards of directors become overwhelmed when dealing with ESG. This is due not only to the complexity of the issues, but also to the diversity of criteria to be used, as well as the ratings and rankings available. Calls for defining global standards are getting louder. But “is there a path to global sustainability standards?” This is the pressing question that Erkki Liikanen, Chair of the IFRS Foundation Trustees, recently addressed in his keynote speech at the Global Financial Regulatory Symposium organized by the CFA (Chartered Financial Analysts) Institute.
Investors around the world increasingly demand a global baseline of sustainability-related disclosures to facilitate comparability for investment decision making. The IFRS Foundation’s initiative to create a unified guideline has received support from the G7 Finance Ministers, from global regulators in the form of IOSCO, from investors and corporates around the world, and from other standard-setting organizations. However, the development of these standards faces at least two challenges.
The first one is at a jurisdictional level. Public policy in each country determines sustainability-related priorities, and governments determine what information companies within each jurisdiction are required to report. For example, the EU’s proposed Corporate Sustainability Reporting Directive is a key element of the EU’s Green Deal policy framework. Different jurisdictions in America or Asia will establish different policy approaches with varying reporting requirements.
The second challenge is to reach an agreement on the approach underlying the common rules. One view is that sustainability standards should focus on investors and the capital markets. This was also the initial focus of many institutional investors who wanted to know in detail the different environmental and social risks of their investees. Various sustainability initiatives have taken this approach, including the Task Force on Climate-related Financial Disclosures, the Value Reporting Foundation (incorporating the SASB and the IIRC), and the Climate Disclosure Board. In contrast, other existing standards take a multi-stakeholder perspective, the GRI Standards being the most well-known example. This second approach has also been embraced by the EFRAG (the European Financial Reporting and Advisory Group) which, under the mandate by the European Commission, recently undertook preparatory work for the elaboration of possible EU non-financial reporting standards.
A prime example of the differences between the two approaches is the concept of “materiality” underlying the disclosure rules. Under a focus on investors and the capital markets, a piece of information is deemed material (and therefore subject to mandatory disclosure) “if its omission or misstatement could influence the economic decisions of users” (IASB Framework). Note that this idea is in stark contrast with the definition of materiality in the GRI framework: “Material Aspects are those that reflect the organization’s significant economic, environmental and social impacts; or that substantively influence the assessments and decisions of stakeholders” (GRI, G4 Reporting Principles and Standard Disclosures). This second definition is frequently referred to as “double materiality” because it encompasses information that is relevant not only for shareholders, but also for other stakeholders (accordingly, the former definition is often referred to as “single materiality”). This is also the preference of the EU regulation on corporate reporting.
According to Liikanen, the IFRS Foundation (which is responsible for the international accounting standards used in many countries around the world) plans to overcome these challenges by working with jurisdictions to ensure compatibility between this global baseline and their own initiatives. The proposed path to global sustainability standards also includes a consolidation of the organizations behind the reporting initiatives with a focus on investors and capital markets (i.e., SASB, IIRC). The IFRS Foundation has also proposed to establish a new International Sustainability Standards Board within the governance structure of the IFRS Foundation.
Liikanen argues that this approach would provide global comparability for investors in a way that allows jurisdictions to combine the global standards with their own additional requirements. However, he also concedes that success is by no means certain. To begin, the IFRS has adopted an approach based on single materiality, which is different from the idea of double materiality embraced by the Corporate Sustainability Reporting Directive and EFRAG. Liikanen also acknowledges that the path to global sustainability standards will require political will, compromise and flexibility from all parties — including the IFRS Foundation. As such, whether this path will take us to a much-desired green economy at the pace we need is an open question. Let’s tuned for future developments. In the meantime, boards of directors should work deeper on key issues of single materiality and start getting ready for future requirements regarding double materiality.
