Navigating the Sustainability Reporting Landscape

Christopher Tower:

You get the little knock on the door, and it'll be one of your largest customers. And that customer will say, private company. I noticed you have no disclosures on your website about sustainability.

It does not appear that you have any direction. And by the way, we've just done our ESG strategy, and we can't work with companies that are not aligned.

Narrator:

Welcome to Accounting for the Future, a BDO Canada podcast for financial leaders to navigate change, and achieve business growth. We'll uncover the challenges financial leaders may not have dealt with yesterday, but we'll definitely have to manage for the future.

Armand Capisciolto:

Hello and welcome to Accounting for the Future. I'm your host, Armand Capisciolto. BDO Canada's National Accounting Standards partner and leader of Accounting Advisory Services. In this two-part conversation, I'm joined by Andrew Buchanan, BDOs global head of IFRS and Corporate Reporting, and Christopher Tower, BDO USA's, ESG Services and Strategy Leader.

Today in part one of our conversation, we will be discussing sustainability reporting in Canada, the US, and Europe. Andrew and Christopher, welcome to Accounting for the Future.

Christopher Tower:

Thank you, Armand. It's good to be here. Very excited to have this conversation.

Andrew Buchanan:

Thanks, Armand. Pleased to be here.

Armand Capisciolto:

This is going to be an interesting discussion. This is an interesting topic and there's a lot of activity related to the topic of sustainability reporting right now. For someone like me who is actually following the topic, I will admit it's a little confusing.

In Canada, the Canadian Securities Administrators issued proposed rules on climate related disclosures in late 2001. Or 2021, sorry. Late 2001, that would hopefully be finalized by now if they issued them then. The US, the Securities Exchange Commission issued proposed rules on climate related disclosures earlier this year. And in Europe, under the Corporate Sustainability Reporting Directive, there are proposed EU sustainability reporting standards. And lastly, the IFRS Foundation established the International Sustainability Standards Board and they have recently issued proposed IFRS sustainability disclosure standards.

So Andrew, as someone who is responsible for keeping the entire BDO Global Network up to date on sustainability reporting requirements, at a high level, what do you say when someone from a BDO member firm asks you why they need to care about what's happening in all these different jurisdictions?

Andrew Buchanan:

Nice question, Armand. Well, what we're seeing in a number of major jurisdictions are proposals for sustainability reporting where the scope will extend beyond listed entities. So if you're a multinational, you need to be on top of what the currents and forthcoming requirements will be because your subsidiaries may be required to make disclosures.

As part of some proposals for sustainability reporting, companies are also going to be required to provide information that relates to their overall supply chain. And already we're seeing companies starting to ask customers and suppliers for their sustainability credentials. And I think we're likely to see a shift towards lower carbon entities and away from higher emitters because it's going to improve a reporting entity's, publicly reported green credentials.

That's then going to affect strategic decision making. If you need to shift your products or services to become lower carbon to remain competitive in your market. Multinational groups will again need to be in top of this. But even if you're a domestic company or group, it's likely that you'll have suppliers or customers in other jurisdictions.

If I bring the focus narrower to a purely domestic company or group with no foreign suppliers or customers, you still can't ignore international developments because standard setters and regulators are watching what's happening elsewhere and considering what we should do in response.

You mentioned the Canadian Securities Administrators and their proposed rules in climate related disclosures. And these are very much based in the recommendations of the Task Force and Climate Related Financial Disclosures, or TCFD, and it's that framework which forms a basis for proposals for climate related disclosures in multiple jurisdictions as well as at the International Sustainability Standards Board.

Armand Capisciolto:

Lots to think about, Andrew. And introducing our first acronym of the day, TCFD for everyone, so remember that. Task Force and Climate Related Financial Disclosures. When I think about all of this for us in Canada, obviously we're watching what's happening around the world, but we have this neighbor South of our border, and many Canadian companies are listed in the US. I believe Canada has the highest number of foreign private issuers on US markets. And many companies do business with companies in the US as the US is our largest trading partner in Canada.

But when I look at the Canadian rules, I look at the US rules and they only relate to listed entities to public companies.

Christopher, why should private companies care about the requirements set by securities regulators? 

Christopher Tower:

Armand, we have a new tagline. A private company you can run, but you cannot hide. And the reason, it's a tagline I start with a lot of presentations on ESG. I use it because there are some really significant drivers that are putting huge pressures on private companies.

The first one I'll start with is competitive pressures. When you think about the landscape, if you have public company competitors and other competitors that are not public companies that are voluntarily disclosing, for every competitor that discloses, it gives a customer an opportunity to decide, hey, I would actually like to work with that company because I like what they're focused on. I like where they're heading.

Another area that's putting a lot of pressure on companies attracting capital, debt financing, and equity financing. So, if you think about the private equity community, and it's been really widely known in the press that the PE community is focusing on ESG as a real value creation strategy. If you want to look for capital in the private equity markets, you're going to need to focus on ESG because it is one of the gating due diligence items that PE are focused on, and lenders right now are starting to focus.

Probably one of the biggest drivers besides some of the other stakeholders like employees and regulators and all these others take over, probably the biggest one are your customers. You just have to wait for that day. You get the little knock on the door, and it'll be one of your largest customers. And that customer will say, private company. I noticed you have no disclosures on your website about sustainability. It does not appear that you have any direction. And by the way, we've just done our ESG strategy, and we can't work with companies that are not aligned.

That movement that drive by a private company's largest customers coming in will motivate them to move. Unfortunately, it may be a little late because if they don't start now, they won't be ready for that knock at the door.

Armand Capisciolto:

Yeah, it's really interesting, Christopher, 'cause that knock on the door when you say, well, we haven't thought about it yet, you're too late. They've already found that additional supplier.

They've moved on. It's a really interesting one for companies. Don't wait for that knock. You have to be anticipating that knock on your door.

Christopher Tower:

The other concept when you add to that, it's really brand image, maintenance support, defense, defensive brand. There's all these concepts of value creation that can really happen with a strong, well-executed ESG strategy. But one of the biggest value propositions is supporting the brand and making sure your brand is resilient and it has a good reputation in the marketplace.

Think about some of those garment manufacturers that didn't think too carefully about who they're sourcing materials from and where they were sourcing materials from. And think about the impact when that became publicly disclosed that they have sourced materials that have slave labor, modern slave labor, or unfair labor practices involved. Brand image is another key driver in companies focusing on this.

Armand Capisciolto:

Very interesting. Andrew, the EU is interesting with their proposals because unlike the Canadian and US proposals, which are again focused on the listed companies, but as Christopher explained, others need to be aware of them. The EU requirements are broader. Can you explain what entities will have to apply with the EU requirements?

Andrew Buchanan:

Sure. And you're right that where we're going in the EU means that a far, far broader scope of companies will come into mandatory reporting. Let's have a look at it.

In the EU, we've got the proposed Corporate Sustainability Reporting Directive, another acronym, the CSRD, which will replace the existing non-financial reporting directive, NFRD. And that latter one applies only to large, listed entities. Those are with more than 500 employees. The scope of the CSRD will be much wider, and it's going to include not just listed entities but unlisted entities as well. And it's all companies that meet two out of three size criteria: more than 250 employees, over 40 million euros of turnover, and over 20 million euros of total assets. Not actually all that big.

And as result, the number of companies that are estimated to be within the scope of the requirements will increase from just under 12,000 for the NFRD to just under 50,000 for the CSRD.

We've also got reporting requirements. 

Armand Capisciolto:

Wow. That's a lot, Andrew.

Andrew Buchanan:

It's huge. Absolutely huge.

Armand Capisciolto:

Can I just pause for one second, Andrew? 'Cause I need to translate English into North American English. Turnover for our North American listeners is revenue. I just wanted to make that clear for people. Sorry, Andrew. I'll let you continue.

Andrew Buchanan:

I'll speak North American next time. I apologize for that. We have hugely expanded reporting requirements though because there are 13 exposure drafts for European sustainability reporting standards currently out for comment. And these have got extensive and very detailed proposed requirements.

So, coming back to why this is relevant, it means for any non-EU group that has subsidiaries in an EU member state that meet the size criteria, the EU specific reporting requirements will apply to each of those subsidiaries individually. There may be some scope exemptions but based on what we've seen, and the legislation's being finalized over the coming weeks, there may not be all that much relief because either the whole group would have to make disclosures that are equivalent to those required in the EU, or the information that would've been disclosed by the subsidiaries would need to be included in the group's consolidated corporate report. For non-EU groups, including any Canadian companies with subsidiaries and EU member states, this is a very, very big deal.

Armand Capisciolto:

Yeah, and it's one... I'm glad we got to talk about that a little bit 'cause I don't think it's something that many Canadian companies are thinking about. People don't think about the regulations in other jurisdictions and it's really important.

What I'm hearing from this discussion so far is regardless of what jurisdiction you are in, you need to consider the implications and requirements of all the jurisdictions you do business with, which makes it challenging. Right? I feel like it's the pre IFRS world a little bit. Right now, we basically from a public company financial reporting standpoint, we have US GAP or IFRS. We're down to two and they're very much aligned in many ways. But before that we had many national gaps.

It seems like we're in a similar place. Is this where the IFRS Foundation comes in, Andrew? When they established the International Sustainability Standards Board is kind of creating these globally accepted standards? Is that what the goal is to kind of avoid that situation where there’s are all sorts of different requirements and different jurisdictions?

Andrew Buchanan:

Well, that's certainly what we hope is going to happen because for companies having multiple gaps is not helpful. It takes a lot of time and it's very costly. To give a bit of context though, at the moment, if I look at sustainability standards, we've got what many people call an alphabet soup of sustainability disclosure standards. Lots of different frameworks that don't have mandatory requirements, so companies can pick which ones they want to use and greenwash themselves.

The IFRS Foundation consulted on whether it should form an International Sustainability Standards Board to bring a bit of rigor to all this, to which the response was a very strong yes. And the formation of the ISSB has got the support of a range of regulators and other organizations, including IOSCO, the Financial Stability Board, the G7 and the G20.

But it was recognized that when you look at different jurisdictions, there are different stages in the implementation of sustainability reporting requirements. Some are quite well-developed; others are just starting. And different jurisdictions might have specific local reporting needs. So to deal with that, the ISSB is developing what's been turned a global baseline of requirements. And these like IFRS Accounting Standards are focusing on the needs of primary users of corporate reports, investors, lenders, and other creditors. And they'll require disclosures that are relevant to enterprise value.

So the idea is that globally, jurisdictions will adopt the ISSB baseline and then add on specific local requirements if they want. As an example of wider scope in the EU, sustainability reporting is going to go beyond enterprise value and it's going to be based on what's termed double materiality. And that looks not only at how sustainability affects a company's own enterprise value, but also the company's wider effects in the environment and society.

But having said that, if I look at the EU exposure drafts, they're structured differently from the ISSB exposure drafts and at least at the moment are not constructed on a global baseline plus approach. However, at the end of April, the IFRS Foundation announced it was forming a working group that would enable dialogue for enhanced compatibility between ISSB exposure drafts and jurisdictional initiatives. And hopefully, the membership includes representatives from major jurisdictions that includes both the EU and the US, as well as the UK, Japan, and China.

The overall objective is to discuss compatibility to make sure there's an effective building blocks approach and reduce the cost of compliance for companies. That group is just getting going. And in addition, as another group to facilitate bringing all this together, the IFRS Foundation is going to create a Sustainability Standards Advisory forum, and its purpose will again be to facilitate dialogue with people from a broad set of jurisdictions. 

Coming back to the overall question, we're seeing some continued fragmentation at the moment, and we don't really know whether there's going to be convergence to the extent of a global baseline everywhere, but we're still within the consultation periods for the ISSB, EU, and GUS proposals, and there's a lot of work being undertaken, which is aimed at trying to get that consistency. Whether we're actually going to see that being achieved is a different question. The jury's out on that one.

Armand Capisciolto:

Yeah, so it was great news to see that they've created those groups to get the different jurisdiction working together because I think the cost of compliance for an organization that's operating in multiple jurisdictions can be extremely high if that doesn't happen.

Christopher, Andrew mentioned the ISSB standards, or the IFRS Sustainability Disclosure Standards that are being proposed are focused on the providers of capital. Focused on investors, which seems consistent with the SECs proposals of being investor focused. If a company wanted to comply with, again, everything's a proposed stage, comply with the proposed ISSB standards, would that be consistent with complying with the proposed SEC requirements?

Christopher Tower:

Well, why don't we ... First, definitely the SEC standards are investor focused. That's the frame or the lens the SEC always takes when it proposes standards. But before I answer your question about be consistent, let's dig in for a few seconds to what the SEC proposed climate standard is. It's got some unique aspects to it and some of them are different than what's being proposed by the ISSB.

At the core, the SECs proposals, it's split. It's got impacts in the footnotes of the financial statements and impacts with respect to the four part of the document. They've proposed updating REG S-K, which is the regulation that covers the four part to put critical climate related information in there. And that guidance proposes disclosing climate risks that public companies face, and the material impacts these risks are reasonably likely to have on financial statements, business operations, and value chains, and how any identified climate related risks have affected or likely to affect a registrant and strategy business model outlook.

Now, when you think about it, that's a mouthful. And it is something that US registrants are not used to disclosing. Interestingly, climate risks have a pretty broad definition. Physical risks be acute and chronic and transition risks, regulations, technology, market changes to mitigator, adapt to climate related risks. And this has some consistency with the ISSB.

More interestingly, which is consistent with the ISSB proposal is this concept of short-term, midterm, and long-term. That is including the SEC proposal, but it is something wholly new to SEC rulemaking. They've never had a three-term perspective in SEC rules. That's another item that's going to drive reporters, registrants crazy.

Interestingly enough, in the SEC's request for comment, there is a specific question in the request for comment that addresses your question would complying with the ISSB requirements and disclosing under that, would that satisfy the S E C? And the question that the SEC asks is for people to comment whether if you're an FPI, Foreign Private Issuer, and you report under IFRS and then you make your disclosures under ISSB, would that comply?

They're not asking if other issuers that are not FPIs could use ISSB disclosures. They're basically the only focused on FPIs and those who report under our IFRS for the obvious reasons. Based upon my inquiries of competitors, the CAQs draft letter, the AICPAs draft letter, our own draft letter, I think the broader community is very supportive of saying that if you are an FPI and you do file with the SEC using IFRS your financial basis for financial reporting, you should be able to satisfy the disclosures using ISSB proposed standards.

Armand Capisciolto:

And that's really good news. Especially for us in Canada. Again, a number of foreign private issuer companies that are kind of based in Canada, a lot of multi-jurisdictional filers companies listed on both Canadian and US exchanges. I know I was happy to see the question asked and hopefully the fact that they asked that question leads to a place where that is acceptable.

Andrew and Christopher, thank you very much. I and our audience appreciate your time and expertise. I'd also like to thank you, our listeners, for tuning in today. Join us next week for part two of this conversation where we'll dive deep into specific key requirements of sustainability reporting in Canada, the US, and Europe. I'm Armand Capisciolto, and this has been BDOs Accounting for the Future. Please let us know if you found this topic interesting and useful and remember to subscribe if you liked it. I'll see you next time.