Navigating the Sustainability Reporting Landscape

Christopher Tower:

The SEC does have a view that if you have been reporting something, and reporting consistently on something, there's got to be a reason why you were doing so. And to modify that disclosure may be taking away something that is material to an investor. So if you aggregate, you got to have good reason and you could be inviting a comment letter from Corp Fin, which is the oversight of disclosure arm of the SEC.

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 am your host, Armand Capisciolto, BDO Canada's National Accounting Standards partner and leader of Accounting Advisory Services. Today, in part two of our conversation, we explore key sustainability reporting requirements proposed by the Canadian Securities Administrators, the US Securities and Exchange Commission, and the EU Corporate Sustainability Reporting Directive. If you missed part one of our conversation, please listen to episode number two in our podcast series before tuning in today.

With that, I'm pleased to once again be joined by Andrew Buchanan, BDOs global head of IFRS and Corporate Reporting, and Christopher Tower, BDO USA's ESG Services and Strategy Leader, to resume our conversation on this important topic.

So, let's switch gears a little bit. We got a little bit of the landscape. Let's start getting into the little bit of the specific requirements. And Christopher, you got a little bit into it already. Andrew mentioned earlier that both the Canadian SEC and International Sustainability Standards Board standards proposals are all based on the TCFD requirements. And when I think about it, although they are based, there are differences. And I think from a Canadian standpoint, I've referred to our Canadian proposals as TCFD-light.

Chris, you're having... Andrew, you might not understand this, but it's like the light beer of TCFD. Christopher, being in the US understands light beer. In the UK, obviously light beer is not something you like. But why I call it light is they've taken out some of the hard stuff. So, one of the key things in the TCFD requirements is disclosures of GHG emissions. And there's scope one, scope two, scope three emissions. And my question to Christopher will be in a second about what those scopes are. But what they've done in Canada has been to say either disclose or explain why you're not disclosing on the GHG emissions. Now, Christopher, from the SEC, are they requiring the disclosure of all three scopes? And could you also explain a little bit the difference between scope one, scope two, and scope three GHG emissions?

Christopher Tower:

Sure, Armand. So interestingly, this concept first appeared in the Greenhouse Gas Protocol when it was established in 2001. I guess when you think about scope one, two, three, it's the best to think of this as a way of categorizing the different kinds of carbon emissions a company creates, in its own operations and in its wider value change. So, let's start with scope one. These are the direct greenhouse gas emissions that a company makes from owned or controlled sources. For example, while running the boilers and buildings it owns or running vehicles it owns. Scope two are the indirect emissions from the generation of purchased electricity, steam, heating, and cooling consumed. Such as the electricity or energy advised for heating and cooling buildings it owns and operates.

When you think about scope three, scope three is a bit trickier. This category represents all the emissions the organization is indirectly responsible for up and down its value chain. For example, from buying products and services from its suppliers and from its products when customers use them. Emissions from lease facilities, business travel, cloud computing, and remote workforce, such as employees working from home. Emissions-wise, scope three is nearly always the big one.

So, the SEC proposal, looking at what the SEC is doing, the SEC is proposing a separate disclosure of scope one and scope two greenhouse gas emissions metrics, expressed both by disaggregated constituent greenhouse gases and in the aggregate. And in the absolute not including offsets. And in intensity terms. Scope three greenhouse gas emissions and intensity are also required if, and it's an if, if it's material to the registrant or if the registrant has set greenhouse gas emissions reduction targets or goals, that includes its scope three emissions. Now, for all those companies out there that have already set their goals, they're kind of wishing they maybe hadn't because they're going to have to include scope three. But they would've probably had to include them anyway, under the proposed rule, because it says if it's material. And if you, as a registrant, have set targets or goals, you're going to have to disclose certain information regarding those.

Of note, registrant to the US have different classifications. The smallest group is called the Small Reporting Company. And the proposed rules only require them to disclose scope one and two, as scope three is exempted for small reporting companies.

Armand Capisciolto:

Yeah, the scope three, it's really interesting. I've heard someone say that basically, the inclusion of scope three kind of takes the entire economy along for the ride, at least a big part of the economy along for the ride. Because there's very few entities that aren't part of the value chain of large public companies. We live in a very integrated society and that value chain is significant.

Andrew, the ISSB I think also requires disclosure of the three scopes and one of the other areas where the Canadian proposals are different from the TCFD is scenario analysis. Again, they're not requiring it. Could you explain, first of all, what scenario analysis is and is the ISSB requiring it in its proposals?

Andrew Buchanan:

Sure. And actually, it's worth starting with what scenario analysis is not, and it's not a financial forecast. Many people initially think it is, but instead, it's a process that you use to identify a potential range of outcomes for uncertain future events. And these are then linked into an assessment of the entity's own risks and opportunities that arise from those. So for the purposes of the ISSB's exposure draft for climate related disclosures, scenario analysis would be used to help in an understanding of how transition risk, so risks associated with the transition to a low-carbon economy, and physical risks, so risks associated with acute events such as tornadoes or wildfires and floods or longer term or chronic changes in weather patterns, might then affect an entity's business, its strategies, and its financial performance over time. And the scenarios that you use might include a number of potential global temperature increases and then an analysis of the potential risks and opportunities that come from each of these on the entity and its business activities.

However, the ISSB exposure draft does acknowledge that although scenario analysis in general has been used by a lot of entities in their risk management, climate change scenario analysis and its application of across industry sectors, is at a fairly early stage. So, while in some sectors, like natural resources, it's been used for quite a few years, in other sectors, like consumer goods or technology and communications, it's only really just starting. For the proposed disclosure requirements about an entity's resilience to climate change, coming out of those risks and opportunities, scenario analysis is required to be used unless an entity's unable to carry out a scenario analysis. And if that's the case, there's then a requirement to explain why it wasn't possible, together with disclosures based on alternative approaches. And these might be things like a qualitative analysis or single-point forecasts, maybe a sensitivity analysis, and stress tests.

Armand Capisciolto:

The fact that they're allowing qualitative analysis is I think, at least in the early days, is very helpful because this is a lot to take on for companies. So hopefully that's where the proposals end up. Christopher, what's the US saying on scenario analysis?

Christopher Tower:

So, the SEC proposal also requires disclosure of the scenario analysis concept that Andrew just explained. However, it's only if the company is actually utilizing or conducting such analysis. Registrants under the pursuant to the proposal, if they don't engage in scenario analysis, they will not have to disclose them.

Armand Capisciolto:

Interesting. So, a company that's already doing this, it's already part of their risk management, they would have to disclose it. But a company who isn't, they just say they're not doing it.

Christopher Tower:

Right.

Armand Capisciolto:

Okay. That's interesting. But you can only tell people what you're doing, you can't tell people what you're not doing.

So, Andrew, one of the other aspects that I find really interesting about the ISSB is they issued two exposure drafts, a general presentation exposure draft and a climate exposure draft. And a lot of our discussion to this point has been focused on climate, because that's what the Canadian rules are focused on, the US proposed rules are focused on. But in this general presentation standard, the I-double-S-B is saying, "You need to disclose information on all sustainability related risks", even though they don't have specific standards on those other sustainability risks beyond climate at this point in time. One of the things that I often wonder is, what are these other risks and is there any place that preparers, eventually auditors, others can look at to say, where's the guidance related to what they're going to disclose on these other risks?

Andrew Buchanan:

Sure. And there are some proposed requirements sitting in the exposure drive, so let's have a look at those. But if we start off, the environmental part of ESG does include a number of components in addition to climate, it's just that people are quite focused in climate at the moment. But within environmental, you've got things like the use of natural resources, you've got pollution and waste, and you've then got the entire topics of social and governance, for which we won't have ISSB standards in the immediate term. In fact, one of the consultation documents that we expect to see fairly soon from the ISSB is an agenda consultation, which would then be used to help it prioritize future projects. So, if you've said, although for specific topics we'll just have a climate standard to start with, the general presentation standard has this overall requirement for disclosure to be made of material and information about all significant sustainability-related risks and opportunity that an entity is exposed to.

It also has a hierarchy for the development of those disclosures. And this will be familiar in its structure to those who are used to applying IFRS accounting standards because it first requires relevant IFRS sustainability disclosure standards to be applied. If there isn't one of those, then there's the requirement to look at other sources to the extent the requirements there don't conflict with an existing IFRS standard.

And the other sources are set out in the exposure draft. Firstly, the metrics associated with the disclosure topics in the industry based SASB standards. You've also got the ISSB's non-mandatory guidance like the CDSB framework, application guidance for water, and biodiversity-related disclosures. And then you can look at the most recent output from standard setting bodies where the requirements are designed to meet the needs of primary users of financial statements. And then you could also look at metrics that are used at entities in the same industries or the same geographies. And in addition to filling the gaps with reference to established sustainability reporting frameworks, this means that there might be limited additional work required in the short term by those entities that already report in accordance with, for example, SASB standards or GRI.

Armand Capisciolto:

And just to pause on the acronym, SASB is the Sustainability Accounting Standards Board, which actually merged with the International Integrated Reporting Committee? Commission? I'm going to get my acronym wrong there. To become the Value Reporting Foundation, which then merged with the IFRS Foundation as part of the establishment of the ISSB. Just to continue the alphabet soup there with the acronyms. And GRI is the Global Reporting Initiative, if I have that correct.

Andrew Buchanan:

It is. What the folding in of the VRF into the IFRS Foundation means is that all of the intellectual property from SASB and from Integrated Reporting then goes into the foundation. So, there are a lot of building blocks there for the new board to work from.

Christopher Tower:

All those employees, they're all moving in. So, I was at the AICPA ESG symposium yesterday, actually day before yesterday, in New York. And I was talking to one of those key individuals and all of their business cards are changing and they're all moving in and that will be concluded I think in about 60 days, based upon talking with them.

Armand Capisciolto:

Okay. Christopher, one of the early examples we started talking... You brought up unfair labor practices and disclosure of that. So, does that mean that, in the US, the SEC rules, they go beyond climate or are they just focusing on climate right now?

Christopher Tower:

So, the current SEC proposal is climate only. Obviously, there are SEC rules that require disclosure material, material events, and material impact, near-term and long-term material uncertainties. But nothing, no standard that's actually deeply on point with respect to various area other areas of ESG. However, the SEC has announced that it will be issuing two more proposed regs this summer and one of them is expected to be on human capital. So best thing I can say is, stay tuned.

Armand Capisciolto:

Okay, interesting. More coming. Chris, sticking with the US rules here, one of the things that I found most interesting, because my day job is financial reporting and accounting, generally, is that in the US rules, there are... proposed rules, sorry. I got to remember, they're still proposal at this stage. There are certain disclosures that will actually go into the financial statements. And my understanding, in reading these, and I'll defer to you as the expert on the US rules is-

Christopher Tower:

Hold on one second, Armand. Did you all 500 and whatever pages of the proposal?

Armand Capisciolto:

No, no. I did not read all 510 pages. I'll say I read-

Christopher Tower:

You read someone's synopsis. You read someone's synopsis.

Armand Capisciolto:

Yes, I've..

Christopher Tower:

I am so saddened by this. I can't tell you.

Armand Capisciolto:

510 pages is a lot of pages. But there's a lot of great publications out there, including those from BDO US, summarizing the 510 pages, so people should go read those. But the one that really intrigues me is these disclosures on the financial statements and the way I have read the summaries of them, so I'm not saying that I have read the requirements, is that this would apply all entities reporting in the US regardless of what gap they use. It would apply even if they're a domestic issuer in the US applying US gap. But they would also apply to a foreign private issuer that's reporting under IFRS. Do I have that correct?

Christopher Tower:

Yeah, you most definitely do. Let's unpack what the requirement says. So earlier I spoke to SK, which is the cornerstone literature that the SEC has for disclosing in the four-part. And the portion of the document, the NDNA portion of document in front of the financials, Reg S SAGs is the guidance that the SEC has around disclosures of the financial statements. And the proposal actually proposes modifications to Reg X, which requires certain climate-related disclosures in the footnotes. So more specifically, as to the nature of those disclosures, companies would be required to disclose disaggregated information about the impact of climate-related conditions and events and transition activities on affected line items using a 1%-line-item threshold. Not 1% of total assets, not 1% of total revenues, but 1% of each line item evaluated. Further, disclosure would be required of the financial estimates and assumptions impacted by such climate-related events and transition activities.

By requiring these disclosures to be included on financial statements, they would of course be subject to audit by the independent auditor, independent registered public accounting firm, and they would fall within the scope of ICFR. So, if the company required attestation, and with respect to ICFR, the auditor would have to do that, which is a big deal. This proposal of 1% really represents a significant burden to the profession and to the reporters, to the registrants. It's a very low threshold. There's nothing in the literature, current accounting standards, auditing standards, and there's nothing in SEC rules that meet this threshold. It's the lowest threshold I've ever seen professionally. Right now, there's a lot of opposition to it by both the preparer and auditor communities, and it's still to be seen whether the SEC will keep this very low threshold. Of note, which is interesting, is there are attestation requirements too in the standard, similar to the CSRD.

Now, the ISSB doesn't, as Andrew's spoken about, doesn't actually have an attestation requirement around it. It's the standard round disclosure. The CSRD does, the proposals do, and the SEC rule does, too. So basically, it requires that attestation of scope one and two for all registrant types. And scope three a year later, except for SRCs, which are exempt. The initial attestation would be limited assurance and two years later, reasonable assurance would be providing... And Andrew, if I remember correctly, the CSRD allows for the prospect of reasonable assurance too, not mandates it right now, but allows it to come into dialogue. If I remember correctly.

Andrew Buchanan:

It does, although there are proposals that are on the table to have a timeline in place for that. So, it's a little bit up in the air at the moment.

Christopher Tower:

Got it.

Armand Capisciolto:

It's interesting, Christopher, you mentioned that the small reporting companies, the SRCs would not necessarily have attestation requirements related to the scope one and two. However, because certain disclosures, with the 1% threshold that you talked about before, are going to be included in the financial statements. Those would be subject to audit regardless of the size, the type of filer that the company is, right?

Christopher Tower:

Exactly. Yeah, everything in the footnotes, and there's no disclosure leniency for SRCs with respect to the footnote disclosures. It's only with respect to the greenhouse gas emissions. They get leniency by not having disclosed scope three, which is a lot of leniency, and they don't have an attestation requirement. So, the large accelerated filers, accelerated filers, non-accelerated filers have a greater burden than the SRCs.

Armand Capisciolto:

It's really interesting, the 1%. I've obviously been hearing a lot of the same thing you've been hearing about the dislike for that low threshold. Yeah, I've heard people joke that the only thing it's going to result in is a lot of aggregation of line items on the financial statements to get that threshold up. But obviously they still have to comply with the relevant financial reporting framework, but there might be pressure on it if that 1% threshold stays.

Christopher Tower:

The SEC also has guidance around the disaggregation on basic financial statements. So, I don't think you'd be able to get away with massive aggregation. Some registrants have disaggregated beyond what rules require, and therefore you may be right, they may decide to aggregate to the minimum that the rules currently require. However, the SEC does have a view that if you have been reporting something and reporting consistently on something, there's got to be a reason why you were doing so. And to modify that disclosure may be taking away something that is material to an investor. So, if you aggregate, you got to have good reason and you could be in inviting a comment letter from Corp Fin, which is the oversight of disclosure arm of the SEC, asking why did you put those 15-line items into one line item? So, I would advise caution if companies considering that.

Armand Capisciolto:

Yeah, for sure. So, Andrew, similar topic about these disclosures. Now, the ISSB doesn't say where the disclosures have to go. They do say they could be in the financial state if they wanted to. When you hear what Christopher just talked about, the disclosures the SEC is requiring in the financial statements, could you see that happening for companies following the ISSB standards in IFRS, including these in financial statements? Is this an option for them or... Because I believe there are similar requirements in the ISSB proposals. They don't have the 1% threshold, but there's similar themed disclosures. Correct?

Andrew Buchanan:

Yeah. And really when you look at, it to the extent that disclosures in financial statements that aren't intentionally required by IFRS don't conflict with the requirements of IFRS accounting standards or the conceptual framework, there wouldn't really appear to be any technical reason why the additional disclosures couldn't be in the financial statements. There may be some practical points around the question of orders and the rest of it. But the answer would really seem to be maybe it could be there. It's also worth bearing in mind though that the ISB also published educational material that sets out examples of where climate-related matters could be relevant in the context of the requirements of current IFRSs. And maybe as a simple example, the consequences of climate change could result in the carrying amounts for items of property plant and equipment being impaired or in reductions in their estimated useful lives.

As well as that, at its April 2022 meeting, the ISB decided to add a project to its work plan for climate related risks. And that's going to consider whether any targeted, narrow-scope amendments need to be made to the requirements of existing IFRSs as an example. There's currently a requirement to disclose information about assumptions that have been made about the future and other sources of uncertainty that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year. So, the question there would be, should the period of one year be changed, maybe to be the foreseeable future or to align with what we see in the ISSB proposals, say in the short, medium, and long term?

Armand Capisciolto:

Okay. Thanks for that, Andrew. So much to talk about, so little time to talk about it. Let's end by talking about time, and specifically timelines. In Canada, the proposed timeline for compliance with these proposed requirements is 2023 year ends for entities listed on the Toronto Stock Exchange and 2025 for venture issuers in Canada. Now those are the proposed timelines. As we all know, the clock is ticking, the calendar is moving. My personal opinion is 2023 is an aggressive timeline, but we'll see where that goes.

Christopher, what are the proposed timelines for the SEC requirements?

Christopher Tower:

Actually, they're fairly similar, but again in the SEC proposal, it's segregated by issuer type or classification as you may call it. So, in the US, we have large, accelerated filers, accelerated filers, non-accelerated filers, and small reporting companies. And there are others, but that's a mouthful in itself. For the large, accelerated filers, '23 year ends, which are filed in '24 for accelerated filers and non-accelerated fighters to fiscal 2024, filed in '25 and SRCs fiscal 2025, filed in '26. That's for the disclosure requirements and for the greenhouse gas scope one and two emissions. For scope three emission disclosures add a year. And with respect to the attestation requirements, the first year of attestation for large and accelerated filers are 2023 for large and 2024 for accelerated. And that's limited assurance in that first year... Excuse me, it's 2024 and 2025, and that's limited assurance in that first year and then, two years later, 2026 and 2027, reasonable assurance.

Armand Capisciolto:

That phased-in timeline similar to Canada. I think it's going to be very helpful for companies to build up the capacity to do this. And even scaling it within what's required in what years and when assurance is required and the level of assurance. It's very nice to hear that they're thinking about the challenges that this is going to present and sometimes doing it in stages helps alleviate those challenges.

Andrew, what about Europe and the ISSB? Have they set timelines, effective dates?

Andrew Buchanan:

There are indicative timelines, so let's take a look at them. Because at the moment we don't have any proposed effective dates for the ISSB standards and really the timing of adoption of those will depend on what jurisdictional regulators require. Having said that, the ISSB is working towards issuing final standards by the end of 2022, and assuming those standards meet the associated requirements is likely we'll see a statement from IOSCO shortly after that endorsing ISSB standards for use in cross-border transactions, in much the same way as we saw for IFRS 20 years ago, following which there was widespread adoption of IFRS accounting standards over a relatively short period. Some jurisdictions, those such as the UK, have already signaled that for sustainability standards they will follow an ISSB baseline plus approach. And my personal view on effective data is we might see for the first ISSB standards dates that aren't too far in the future, maybe even as early as 2024.

It's also possible that there will be some staging because the ISSB has asked in its consultation whether the climate standard should have an earlier effective date than some parts of the general requirement standard. In the EU, the original proposals were pretty aggressive because these were all companies within the scope of the CSRD, which have to comply with its requirements from years ending 31 December 2023 onwards. From what we're hearing, this is likely to go out a bit. So, what the expectation is at the moment would be that large, listed companies, so those within the scope of the current non-financial reporting directive, those with more than 500 employees, would adopt in 2024. With all other companies that meet the two out of three size criteria that are brought within the scope of the CSRD adopting in 2025. And then listed SMEs, small and medium size entities, might have a deferral to 2026.

Armand Capisciolto:

Okay, so more of the staged approach, or at least we're hoping for more of the staged approach. Thank you for that.

Andrew, Christopher, thank you very much. I and our audience appreciate your time, your expertise, and I'd also like to thank you our listeners for tuning in today. I'm Armand Capisciolto and this has been BDO's Accounting for the Future. Please let us know if you found this topic interesting and useful and remember to subscribe if you liked it. We'll see you next time.