It's almost cliché to describe progress toward globally consistent reporting by companies on environmental, social, and governance (ESG) as a journey. But it feels like the most fitting analogy for the process of developing ESG reporting standards. And, as far as that journey goes, our research indicates asset managers agree on the destination but not the route.
Asset managers’ views about proposed ESG reporting standards tend to differ according to which side of the Atlantic they are based on. But even then, managers within the same region often hold very different opinions on important elements of those standards.
Destination Consistency
Responding to investor demand for “high-quality, globally comparable sustainability information for the capital markets,” the newly formed International Sustainability Standards Board issued two draft ESG reporting standards in March 2022. One focuses on general sustainability-related financial disclosures; the other on climate-related disclosures.
The drafts closed for public comment at the end of July. The ISSB aims to set a “global baseline” – an internationally consistent minimum standard of required disclosure for sustainability reporting by companies to investors – which would also help companies meet the requirements of national regulators.
In our latest paper, we examine the responses to the draft standards from 20 asset managers based in the United States and Europe and responsible for over USD 40 trillion in assets under management. This kind of analysis helps us better understand the underlying thinking driving asset managers’ approaches to ESG.
As Morningstar’s own response to the ISSB states:
“Asset managers invest globally; they absolutely need some international convergence to be able to report meaningful aggregated information to end users.”
On the whole, asset managers strongly agree with this. 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 their broad agreement on the end goal, asset managers’ opinions vary widely on key areas addressed by the draft standards. In particular, views diverge on two key issues: the definition of “materiality” and the scope of mandatory disclosures on 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” will be difficult to achieve without major changes in approach by either the ISSB or other standard-setters, particularly the SEC and European Commission, which also recently consulted on its own climate and sustainability reporting standards.
1) How Should Materiality Be Defined?
Under the ISSB’s proposals, a company would “disclose material information about all of the significant sustainability-related risks and opportunities to which it is exposed […] in the context of the information necessary for users of general purpose financial reporting to assess enterprise value.”
This approach is often referred to as “single materiality” or “financial materiality” because it primarily considers the financial impacts of ESG risks and opportunities on a company. The SEC’s proposed climate rule also uses a single-materiality approach.
This contrasts with the double-materiality approach proposed in the European Commission’s draft standards, which considers the financial impacts on the company and the company’s impacts on the environment and wider society.
We can divide the asset managers’ responses on this into three groups. Respondents commenting on materiality generally either:
- agree with the ISSB’s proposal for a materiality approach that focuses on enterprise value;
- prefer a flexible approach that uses a materiality definition that is aligned with the relevant local jurisdiction’s own definition; or
- advocate for a “double materiality” approach.
There isn’t a clear, prevailing view among the 20 respondents, but many appear to recognise the large variance in approaches between US and European regulators on this issue and are mindful that the single-materiality approach used in the US is unlikely to change.
Several, mostly US-based, managers agree with the ISSB’s enterprise-value-focused 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 for “a more flexible approach that would enable companies to apply the same materiality standard as they do for financial reporting today,” as State Street puts it.
Most European managers in our selection support a double-materiality approach. One of them, DWS, believes that “without this, the needs of both investors and other stakeholders will not be met,” and it is not alone in that view. Abrdn, Allianz, Amundi, and Schroders, as well as PGIM in the US, all express 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 use (scope 2), and other indirect emissions related to goods and services 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 is significantly different from the SEC’s proposal, which mandates reporting only on scopes 1 and 2. The SEC requires scope 3 disclosures only in certain circumstances. This raises the risk of further divergence in reporting practices regarding scope 3 emissions. This is also reflected in asset managers’ comments on the topic.
Most of the 20 respondents agree that scope 1 and 2 emissions disclosures are essential. The only exception is Dimensional, which believes that companies should only provide greenhouse gas emissions reporting if climate change is a financially material issue for the business.
Support for scope 3 reporting is lighter but still substantial. Eight of the 20 managers – including BNP Paribas, Capital Group, Legal & General, and Northern Trust – indicate that they believe scope 3 reporting is “necessary for investors to develop a full picture of transition risk exposure and to evaluate investment risks and opportunities,” as Wellington puts it.
Several other respondents – including BlackRock, Invesco, State Street, T. Rowe Price, and Vanguard – believe methodologies for disclosing scope 3 emissions are not sufficiently mature to require mandatory disclosure by all companies at present.
Some of these firms suggest that scope 3 disclosures should be required only where material; others suggest that they should be deferred until more robust measurement methods are available.
What Comes Next for the ISSB’s Proposals?
Given this broad range of views, we can expect the ISSB to give careful consideration to its next steps. Asset managers’ calls for the ISSB to extend its cooperation with other regulators and standard-setters add another dimension for this board to consider.
The ISSB aims to finalise the new reporting standards by the end of this year. Hopefully by then we will have a much clearer view of how a global baseline for ESG reporting could be achieved.
Lindsey Stewart is a CFA charterholder and Morningstar's director of investment stewardship
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