Evaluating ESG disclosure requirements for FIs

March 2022 | FEATURE | BANKING & FINANCE

Financier Worldwide Magazine

March 2022 Issue

Environmental, social and governance (ESG) issues are climbing the boardroom agenda on the strength of greater political, customer and investor awareness. A variety of stakeholders, including regulators, are placing greater importance on ESG. Businesses, including financial institutions (FIs), are being compelled to align their business activities to a wider societal purpose, in service of existential challenges such as climate change.

The trend has extended to ESG-related disclosures made by FIs. Last year, the US Securities and Exchange Commission (SEC) made a series of public statements and took preliminary steps indicating that it would soon enhance its climate-related disclosure requirements for all public companies, including FIs, and not just those with the largest carbon footprints that attract the attention of large institutional investors and activist groups.

In June 2021, the US House of Representatives narrowly approved the ESG Disclosure Simplification Act of 2021. Among other things, the Act will require registrants to disclose ESG metrics in any filing requiring audited financial statements and in their proxy materials, their views about the link between ESG metrics and long-term business strategy, as well as a description of the process used to determine the impact of such ESG metrics on their long-term business strategy.

These efforts have been echoed in other jurisdictions.

In the UK, the Financial Reporting Council (FRC), following the decision of the Financial Conduct Authority (FCA) to open two separate consultations on enhancing climate-related disclosures to support the target of applying climate-related disclosures across the UK economy by 2025, has identified the need for a rigorous framework on ESG reporting. This framework aligns with financial reporting standards, in terms of which companies are required to give proper consideration to ESG issues in their annual reports, financial statements and audits.

Additionally, in November 2020, the UK government published its ‘Roadmap towards mandatory climate-related disclosures’, which aligned the UK with the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD).

In Europe, the EU Regulation on sustainability (environmental, social and governance) disclosures for certain financial services sector firms (SFDR) came into effect on 10 March 2021. The SFDR requires financial market participants and financial advisers to disclose certain ESG-related information in relation to the provision of their services and the marketing of financial products, using mandatory disclosure templates.

“With increasing regulatory and disclosure requirements facing FIs, many will likely need to invest more into how they communicate their ESG credentials to stakeholders.”

Following the UK’s exit from the EU, the UK government elected not to implement the SFDR or the Taxonomy Regulation in UK legislation, opting instead to establish its own domestic green taxonomy and ESG disclosure regime.

With increasing regulatory and disclosure requirements facing FIs, many will likely need to invest more into how they communicate their ESG credentials to stakeholders. To that end, it would be prudent for FIs to incorporate ESG reporting into existing processes for financial reporting, leveraging their competencies, controls and reporting architectures to meet investor-grade standards. Doing so will also help FIs differentiate themselves from competitors in the eyes of customers and other stakeholders.

But FIs are contending with differing standards and frameworks on enhanced ESG disclosures. These include Global Reporting Initiative (GRI) standards which have advanced sustainability reporting for years, and the Sustainability Accounting Standards Board (SASB) standards which provide detailed, industry-specific recommendations around the varying expectations of rating agencies.

Efforts are underway, however, to use common reporting metrics. The World Economic Forum, for example, has launched a move toward common ‘stakeholder capitalism metrics’. Based on existing standards, these have the goal of accelerating convergence among the leading private standard-setters and bringing greater comparability and consistency to ESG disclosures. The metrics are intended to improve how companies measure and demonstrate their contribution toward a more sustainable relationship with the planet.

Given the fast pace of ESG disclosure developments, PwC believes there are four priorities for FIs. First, decide on the broad framework and key metrics the FI will use. Second, define process and governance steps to have confidence in reporting. Third, carefully design reporting architecture and tools to effectively enable ESG reporting. Finally, develop a way to tell an authentic and coherent story.

When an FI makes a public pledge, such as achieving ‘net zero by 2050’, the way it outlines its plans to achieve that goal and measure progress will be important.

FIs must also evaluate whether their enterprise risk management and internal controls can adequately meet the rising demands of investors, customers and regulators on disclosure requirements. Embracing technology solutions, for example, can improve reporting processes and enable FIs to share results and areas of evaluation with market investors, consumers, employees and other stakeholders.

It is natural to assume that the reporting process will become easier in time, particularly as disclosures becomes more standardised and regulated across jurisdictions. In the meantime, FIs can take action to prepare by elevating ESG priorities across their organisation.

Richard Summerfield