It’s almost a cliché to describe the progress towards globally consistent environmental, social and governance (ESG) reporting by companies as a journey. But it seems the most appropriate analogy for the process of developing ESG reporting standards. And as for that journey, our research shows that wealth managers agree on the destination, but not the route.
Asset managers’ views on proposed ESG reporting standards tend to differ depending on which side of the Atlantic they are based. But even then, managers within the same region often have very different opinions on important elements of these standards.
In March 2022, in response to investor demand for “high-quality, globally comparable sustainability information for the capital markets”, the newly formed International Sustainability Standards Board published two draft ESG reporting standards. the other on climate-related disclosures.
The drafts were closed for public comment at the end of July. The ISSB aims to set a “global baseline” – an internationally consistent minimum standard for disclosure of corporate sustainability reports to investors – that would also help companies meet the requirements of national regulators.
In our latest paper, we examine the responses to the draft standards from 20 wealth managers based in the United States and Europe, responsible for over $40 trillion in assets under management. This type of analysis helps us to better understand the underlying thinking behind asset managers’ ESG approaches.
As Morningstar’s own response to the ISSB states:
“Wealth managers invest worldwide; They absolutely need some international convergence to be able to report meaningful aggregated information to end users.”
By and large, wealth managers fully agree. Every comment letter we reviewed mentioned that they either ‘support’, ‘welcome’, ‘applaud’ or ‘agree that there is a need’ for the ISSB’s efforts in this regard.
Two key issues
Despite broad agreement on the ultimate goal, asset managers’ opinions vary widely on the key areas addressed by the draft standards. Opinions differ on two key issues in particular: the definition of “materiality” and the scope of mandatory disclosure of greenhouse gas emissions. These were also the key dividing lines in the SEC’s earlier consultation on its proposed climate rule.
This divergence suggests that a “global baseline” may be difficult to achieve without significant changes in approach from the ISSB or other standard-setters, most notably the SEC and the European Commission, which have also recently consulted on their own climate and sustainability reporting standards becomes.
1) How should materiality be defined?
According to the ISSB’s proposals, a company would “disclose material information about all material sustainability-related risks and opportunities to which it is exposed […] in connection with the information required for users of general financial reporting to assess enterprise value.”
This approach is often referred to as “single materiality” or “financial materiality” because it primarily considers the financial impact of ESG risks and opportunities on a company. The climate rule proposed by the SEC also uses a single-materiality approach.
This is in contrast to the dual materiality approach proposed in the European Commission’s draft standards, which considers the financial impact on the business and the business’s impact on the environment and society in general.
We can divide the wealth managers’ responses into three groups. Respondents who generally commented on materiality either:
- agree with the ISSB’s proposal for a materiality approach focused on enterprise value;
- Prefer a flexible approach that uses a definition of materiality aligned with the definition of each local jurisdiction; or
- advocate a “double materiality” approach.
There is no clear, predominant view among the 20 respondents, but many seem to recognize the major differences in approaches between US and European regulators on this issue and are aware that the single materiality approach used in the US is evolving probably won’t change.
Several, mostly US-based managers agree with the ISSB’s enterprise value approach, including Capital Group, Dimensional and Vanguard. Five of the largest US managers – BlackRock, Invesco, Northern Trust, State Street and T. Rowe Price – all advocate “a more flexible approach that would allow companies to apply the same standard of materiality that they apply to financial reporting today” . as State Street puts it.
Most European managers in our sample support a dual materiality approach. One of them, DWS, believes that “without this, the needs of both investors and other stakeholders will not be met” and is not alone in this view. Abrdn, Allianz, Amundi and Schroders, and PGIM in the US all have similar views.
2) Greenhouse gas emissions: what should be disclosed?
The Greenhouse Gas Protocol, an existing voluntary reporting framework, separates greenhouse gas emissions into direct emissions (Scope 1), indirect emissions related to electricity consumption (Scope 2), and other indirect emissions related to goods and services that the reporting company produces or uses ( Scope 3).
The draft ISSB climate standard proposes that companies should be required to report Scope 1, 2 and 3 emissions. This differs significantly from the SEC’s proposal, which requires only Scope 1 and 2 reporting. The SEC only requires Scope 3 disclosures in certain circumstances. This increases the risk of further divergences in the reporting of Scope 3 emissions. This is also reflected in the statements made by asset managers on the subject.
Most of the 20 respondents agree that disclosure of scope 1 and scope 2 emissions is essential. The only exception is Dimensional, which believes that companies should only report greenhouse gas emissions if climate change is financially relevant to the company.
Support for Scope 3 reports is less, but still significant. Eight of the 20 managers – including BNP Paribas, Capital Group, Legal & General and Northern Trust – say they believe Scope 3 reporting is “necessary for investors to have a full picture of transition risk and investment risks.” and opportunities,” as Wellington puts it.
Several other respondents – including BlackRock, Invesco, State Street, T. Rowe Price and Vanguard – believe that Scope 3 emissions disclosure methods are not mature enough to require all companies to make mandatory disclosures at this time.
Some of these firms suggest that Scope 3 disclosures should only be required where material; others suggest deferring them until more robust measurement methods are available.
What is the future of the ISSB’s proposals?
Given this wide range of opinions, we can be sure that the ISSB will carefully consider its next steps. The asset managers’ call for the ISSB to expand its collaboration with other regulators and standard-setters adds another dimension to this body to consider.
The ISSB intends to finalize the new reporting standards by the end of this year. Hopefully by then we will have a much clearer idea of how a global baseline for ESG reporting might be achieved.
Lindsey Stewart is a CFA charterholder and director of investment stewardship at Morningstar