Global Sustainability Regulations Are Here!
The sustainability disclosures of tomorrow will look like the financial disclosures of today: global, standardized, and comparable. How did we get here? And how big of a deal is this?
What do global leaders want from the economy? I’d say their top objectives are economic growth and financial stability. The problem is that growth requires changes that are inherently destabilizing. We oscillate between expansions and depressions, booms and busts. Jobs and industries are created and destroyed. The next big thing — be it a tulip, Beanie Babies, or a cryptocurrency marketplace — could be worth a fortune one day and nothing the next.
The global push for financial stability takes many forms. In 2009, the G20 created the Financial Stability Board (FSB) to identify systemic risks to the financial sector and recommend policies to mitigate these risks.
In 2015, the FSB turned its gaze to climate change. It established a Task Force to “help identify the information needed by investors, lenders, and insurance underwriters to appropriately assess and price climate-related risks and opportunities.” That was also the year of the legally binding Paris Agreement, which committed us to holding “the increase in the global average temperature to well below 2°C above pre-industrial levels” and pursuing efforts “to limit the temperature increase to 1.5°C above pre-industrial levels.”
I was working in corporate sustainability in 2015. I followed the Paris negotiations by the day but didn’t learn about the Task Force until 2017, when it released the very-boring-sounding-but-important Recommendations of the Task Force on Climate-related Financial Disclosures(TCFD). These recommendations focused on four areas: Governance, Strategy, Risk Management, and Metrics and Targets. While the Paris Agreement spoke to how we’d fight climate change as a global community of nations, the TCFD recommendations focused on the more prosaic task of having companies disclose their climate risks and opportunities to investors. Investors can’t forecast future cash flows if they don’t know how an increase in heat waves or floods is expected impact a company.
From Alphabet Soup to ISSB
The TCFD was not the only NGO or international organization working on climate disclosures. In fact, there are a slew of competing-yet-somewhat-complementary corporate disclosure frameworks and recommendations.
This had several negative effects, the two most important of which were:
Making sustainability inaccessible to most folks but covering simple concepts with jargon and highly specific reporting requirements that required deep edge case expertise;
Focusing sustainability work on reporting instead of impact reduction (you can’t drive change if 80% of your time is spent understanding, trying to influence, and responding to reporting demands).
Last month (June 2023), we learned that standardization and simplification is finally coming. This alphabet soup will be replaced by a single, global baseline for sustainability disclosures (though places like the EU will demand more of companies). The standardization is being led by the IFRS Foundation, the friendly people behind the International Accounting Standards Board (IASB) that standardized the financial disclosures and reporting framework adopted by over 140 jurisdictions. The sister organization to the IASB for sustainability is the International Sustainability Standards Board (ISSB). After a few drafts and a long period of public comments, the ISSB released its first two standards in June.
These standards will “allow companies and investors to standardise on a single, global baseline of sustainability disclosures for the capital markets, with any additional jurisdictional requirements being built on top of this global baseline.” In particular, they cover the same four areas as the TCFD:
Governance – focused on the processes, controls, and procedures companies use to manage and oversee sustainability-related risks and opportunities.
My Take: it’s critical to ensure that the lines of authority and control are clearly established.
Strategy – focused on how a company plans to change its business model, strategy, resource allocation, production processes, products, or workforce to respond to climate risks and opportunities.
My Take: this is the “what does this mean for us?” part. Today, businesses can answers these questions with jargon-laden nothingness. I hope that these requirements will push companies to answer these questions with more specificity and rigor. Such an outcome would provide investors with more useful information. In addition, building tools to enable these types of strategic assessment will be a massive opportunity for entrepreneurs.
Risk Management – focused on how companies implement those strategies by developing processes to identify, assess, and manage climate-related risks and opportunities.
My Take: a strategy without risk management and implementation only exists on paper; risk management without a strategy is a box-checking exercise that yields minimal benefit. I like how these two requirements will work together.
Metrics and Targets - focused on the how companies measure, monitor, and manage climate-related risks and opportunities. This needs to include progress towards meeting climate-related targets like a science-based target.
My Take: metrics and goals are critical. I was thrilled when an early draft of the ISSB Standards required carbon disclosures for Scope 1-3, and saddened when the final document delayed the Scope 3 requirement for a year (for now) because it’s hard for companies to effectively measure. This matters because Scope 3 can account for >80% of corporate emissions, so a disclosure requirement that doesn’t require Scope 3 is kind of missing the point. For metrics to really matter, the need to include everything that’s critical and there needs to be a mechanism to hold companies accountable for not meeting their goals.
What Does This All Mean for Me?
Accurate accounting does not cause a business to be ethical or wise. Instead, it provides a shared mental model for investors and others to understand and assess the aggregate activities of that company. While accounting standards do not prevent reckless behavior in the economy, they let us know when companies are taking big bets, which allows us to either lean in with them or take our money elsewhere.
We shouldn’t expect standard sustainability disclosures to decarbonize the world on their own. The task is too big, complex, and critical to leave to companies alone. We desperately need governments set emissions reductions targets, sign treaties, invest in energy research, and help innovations overcome the “valley of death.”
What sustainability disclosure standards can do is force all public companies to seriously think about how climate change will impact them. The hope is that once investors and companies understand how climate change will impact their businesses, firms will feel pressure to reduce their climate risks, and that as part of this de-risking, they will decarbonize, which will benefit us all.
I’m rooting for this outcome, but I have another hope: that this standardization changes the role of sustainability in companies. Imagine a future in which corporate sustainability looks a lot like corporate finance, split between accounting and strategic management. We’d have sustainability accountants that measure and report on carbon emissions and other sustainability impacts in a auditable, standardized way. I’m confident that the ISSB standardization will make this a reality in the next five years.
But let’s thinking bigger. Accounting for carbon won’t reduce how much of it we emit. More exciting is the possibility that the business leaders of tomorrow will have sustainability partners like they have finance and HR partners today. These sustainability partners will partner with leaders to assess the sustainability risks and opportunities of any new product, business line, or investments under consideration. Maybe these sustainability strategists will become so central to business success that they’ll become the CEOs of tomorrow. Maybe sustainability will just be how business is done, because it’s the best way to do it over the long haul.
I like that vision :)