Why ESG Reporting is Needed to Ensure Global Financial Stability

Global Financial markets have not recovered since the pandemic, with an ongoing war in Ukraine and rising inflation. Headlines are focusing on the collapse of Silicon Valley Bank, the second biggest in US history. Federal agencies had to convene on a weekend to decide on preventative measures to halt the contagion of large-scale bank runs. Reports are painting a stark picture for banks from other parts of the globe, involving staggering figures.

The current banking crisis overshadows another looming risk to global financial systems. Just days before the first signs of a banking crisis, the US Financial Stability Oversight Council (FSOC) convened about this risk. Their finding was that “Climate change is an emerging and increasing threat to America’s financial system that requires action”.

How Financial Stability Relates to ESG Disclosure

The US concluded for the first time in 2021 that climate change will cause shocks to the financial system. This FSOC investigation found that there was a 500% increase in the annual number of billion-dollar disasters over the past five years. They recommended several actions to be implemented to mitigate this risk.

The impact of climate change in the long run is seen as a financial security risk globally, but it will require a planned transition. Over $100 trillion of assets revolving around fossil fuels is estimated to be at risk, due to disruptive technologies and shifting government policies.

Environmental, social and governance (ESG) disclosure on a corporate level is a critical component of effective risk management. That is why regulators around the globe are implementing new rules requiring companies to disclose sustainability risks, in line with existing requirements for other risks.

Controversy Surrounding New Regulations

The US Securities and Exchange Commission (SEC) proposed a controversial new regulation in 2022, which is expected to be adopted by 2023. It will require publicly traded companies to disclose how their operations affect the environment. It is encouraging firms to disclose more detailed information about their climate strategies, to increase transparency.

The EU Taxonomy provides a structured frame of reference and a common understanding of economic activities that contributes to environmental goals, such as climate change mitigation or circular economy objectives. It is linked to the EU’s existing Non-Financial Reporting Directive (NFRD), and its revision, the Corporate Social Responsibility Disclosure (CSRD), effective from 2023.

The EU is currently leading the way with the concept of double materiality. This means considering both the impact of the outside world on a company, as well as a company’s impact on the outside world. It is rooted in the view that the world beyond finance can be material, and therefore worth disclosing.

Shifting Towards International Standards

A big shift is needed, before investors will be able to compare companies using not just finance, but also sustainability criteria. A new global standard is currently under development, to be released by 2023. The International Sustainability Standards Board’s (ISSB) held a recent symposium on their progress, and leverage frameworks such as SASB (Sustainability Accounting Standards Board), GRI (Global Reporting Initiative), and Task Force on Climate-related Financial Disclosures (TCFD).

Both the EU and US announced that they will align with ISSB. Several other countries, including China, Nigeria, and the UK indicated that they are adopting the ISSB approach.

What it Means for Australia & New Zealand

Maintaining investor confidence is crucial for smaller countries and Australia & New Zealand are not isolated from global economic stability trends. New Zealand passed a world first regulation in 2021, with reporting requirements from 2023. Their new Climate-related Disclosure (CRD) requires listed companies, insurers, banks and investment managers to report on how they will be affected by climate change. Disclosure is based on an independent accounting body, which, in turn, is based on TCFD.

Sustainability-related disclosures is also a hot topic for Australia’s Securities and Investment Commission (ASIC). Voluntarily reporting on TCFD is already recommended and mandatory disclosures will most likely be aligned with ISSB from FY 2024-25, after public consultation.

The Outlook for Business Leaders

Regulators need to protect investors from greenwashing and create financial security, while shifting investments to where they are most needed to facilitate an orderly transition. We can expect to see continued expansion and refinement of these reporting requirements over time. Companies who do not act on addressing current and future environmental concerns, could face challenges to get access capital or suffer reputational damage.

Digital reporting practices and assurances are stipulated from the outset in some of the new regulations. The biggest obstacles are data availability, quality, and fulfilling new levels of audit scrutiny. More granular and meaningful data is needed at critical points in operations to make decisions and steer a business towards KPI targets.

Most of the new rules also mandate reporting on scope 3 emissions, which is beyond the boundaries of a single corporation. Voluntary standards are currently lacking, as it uses estimates. A significant shift is expected in this area, with groundwork being done by the World Business Council for Sustainable Development (WBCSD) Pathfinder Framework.

On How to Get Started

Leaders are acutely aware of the need for scalable technology solutions. They ask two essential questions: ‘How can we leverage what we already have’ and ‘how can we keep up with change’?  By leveraging sustainability solutions that are fully embedded into ERP solutions, like SAP, additional workloads are minimized. Not only does this produce audit-ready data, but it also allows data-driven, fact-based decisions.

To find out more, talk to your SAP account team or visit sap.com SAP Sustainability Control Tower