FOCUS IN ACTION

All of these issues present an argument for some level of governmental regulation of sustainability disclosures, and the EU has taken the clear lead. With the goal of assisting all stakeholders in evaluating the non-financial performance of large companies, the EU launched the Non-Financial Reporting Directive (NFRD) in 2014. This law, which applies to public companies with more than 500 employees, requires that certain ESG information be disclosed in a statement, as part of a company’s annual public reporting obligations. In April 2021, the Commission adopted a proposal for a Corporate Sustainability Reporting Directive (CSRD), which would build upon the NFRD. Some proposed changes include requiring an audit of the reported information, extending the directive to all large companies (not just public), and aligning the report with EU sustainability reporting standards. 

The EU has implemented several additional initiatives in recent years, including the Sustainable Finance Action Plan (SFAP) and the EU Taxonomy. These complex, multi-stage directives lay the blueprint for regulatory changes in line with the European Green Deal and the region’s goal of achieving a climate neutral economy by 2050. The SFAP gave way to the Sustainable Finance Disclosure Regulation (SFDR). Effective as of March 2021, the SFDR requires sustainability-related disclosures for financial market participants, as well as the obligation to disclose adverse impacts on sustainability factors at both the entity and product level. The EU Taxonomy is a classification system that seeks to define which economic activities are ‘sustainable’. Under this regulation, both financial firms and non-financial firms will be mandated to disclose alignment with the taxonomy, with some starting in 2022. The hope is that both of these initiatives will help promote sustainable investment, help companies become more sustainability-focused, and protect investors from greenwashing.   

In the U.S., federally mandated sustainability disclosure requirements are lagging. However, this is expected to soon change. The Biden administration has made it clear that climate and ESG-related risk disclosure is a top priority. The SEC is undergoing a review and intends to release updated guidance on mandatory climate and ESG disclosures later this year, building on its 2010 climate disclosure guidance. Although the 2010 guidance led to a dramatic increase of companies mentioning climate change and/or emissions in their 10-Ks in the year following the issuance, the enforcement and oversight has subsequently dwindled. In September 2021, the Division of Corporation Finance released a sample letter it may send to companies asking for specific climate information to be included in future annual filings. Some asks include:

• Disclose the material effects of transition risks related to climate change that may affect your business, financial condition, and results of operations, such as policy and regulatory changes.
• Please revise your disclosure to identify material pending or existing climate change-related legislation, regulations, and international accords and describe any material effect on your business, financial condition, and results of operations.
• If material, provide disclosure about your purchase or sale of carbon credits or offsets and any material effects on your business, financial condition, and results of operations.

The letter sends a clear message: companies must begin disclosing more comprehensive and financially material climate-related information in annual filings. It’s important for companies to take this seriously, and as preparation for the impending SEC rule making on corporate disclosures. 

Other countries around the world are also implementing or strengthening ESG regulations. According to a late 2021 study conducted by the European Corporate Governance Institute, nearly 30 countries have mandated ESG disclosures. In Australia’s 2003 Corporate Governance Principles and Recommendations, listed entities are recommended to “disclose whether it has any material exposure to environmental or social risks, and if it does, how it manages or intends to manage those risks.” Expanding its 2013 regulation for listed companies to detail emissions, diversity and human rights, the UK recently announced new Sustainability Disclosure Requirements. The UK has also committed to implementing mandatory reporting aligned with the TCFD. In China, new laws will strengthen its Environmental Information Disclosure Act of 2008.  Effective 2022, entities will be required to annually report on carbon emissions, pollutant generation, environmental management, and contingency planning for environmental emergencies.