How the EU is shaping the international landscape of climate-related disclosure
As early as the 2000s, and as law professor António Garcia Rolo notes in his contextual analysis of ESG legislations in the EU, lawmakers started to rethink the voluntary character of ESG disclosures and steer the wheel towards a mandatory compliance framework. The first major development was the Non-Financial Reporting Directive (NFRD) of 2014 through which the European Parliament mandated the disclosure of non-financial information. Under the NFRD, large public-interest companies with more than 500 employees have to publish information related to: (1) environmental matters; (2) social matters and treatment of employees; (3) respect for human rights; (4) anti-corruption and bribery; and (5) diversity on company boards.
A year after the European Parliament introduced the NFRD, the United Nations published its Sustainable Development Goals. In the same year, the Paris Agreement was signed. The first document is a global call for action to recognize that ending poverty goes hand-in-hand with tackling climate change and working to preserve oceans and forests. The Paris Agreement, on the other hand, is a binding international treaty on climate change that was adopted by 196 parties at the UN Climate Change Conference, COP21. The agreement has an overarching goal to pursue efforts to limit global warming to 1.5°C by the end of this century. Both documents have given a new impetus to both political and public discourse concerning sustainability and the measures that should be taken to achieve climate-related goals.
In 2019 and 2020, the European Commission introduced the Sustainable Finance Disclosures Regulation (SFDR) and the Taxonomy Regulation (TR). The SFDR seeks to improve transparency relating to sustainable investment products, prevent greenwashing, and increase investor comfort regarding sustainability claims made by asset managers, pension funds, and insurance firms. It aims to do this by imposing comprehensive sustainability disclosure requirements covering a broad range of ESG metrics at both entity and product-level. The Taxonomy Regulation (TR) complements both the SFDR and the NFRD by providing businesses and investors with a conceptual framework on how to read and comply with the two legislations. According to the authors of a 2022 report by the Bank of New York Mellon, the Taxonomy Regulation promotes a common language and a shared framework throughout the EU on how to identify economic activities that can be considered environmentally sustainable.
More recent is the Corporate Sustainability Reporting Directive (CSRD) that entered into effect on January 5, 2023. It applies to certain European and non-European companies such as those listed in the EU. The CSDR modernizes and strengthens already-existing rules about reporting requirements and forces the disclosure of information about the risks and opportunities arising from climate change, sustainability, and the impacts of corporate activities on people and the environment. According to corporate lawyers Matthew Triggs, Sarah Mishkin, and Thibault Meynier, the CSRD is a pillar in the EU’s ambitious focus on corporate sustainability as it overtly and forcefully aims to boost the green economy.
Taken together, the package of EU legislations since 2014 confirms the EU’s commitment to advancing sustainability through regulation that imposes mandatory and substantial disclosure requirements on companies operating in the European Union as well as many companies that have investors there or are part of an EU entity’s supply chain. Under the CSRD, in-scope companies must set clear ESG targets and annually publish their progress on these targets, as well as their transition plans. As a result, the focus on sustainability is no longer optional or voluntary, but mandatory, and must be embedded in the company’s long-term vision, strategy, and policies. While this trend is here to stay, some ESG experts, such as Mark Babington, caution against it. In a conference about ESG integration, held on November 21, 2023, the executive director of regulatory standards for the UK’s Financial Reporting Council expressed concern over the proliferation of ESG disclosures, arguing that boards of directors have to do extra work to understand reporting requirements and distil disclosures to the most essential and material information. He also insisted that mandatory reporting has real costs, especially for small and medium-sized businesses.
The US: Who’s afraid of climate-change disclosure?
When it comes to ESG regulations, there is a consensus that the United States has been lagging in comparison to Europe. According to corporate lawyers Carolyn Houston, Emily B. Holland, and Leah Malone, federal agencies have been slow to propose rules in this field, which has led some states to be more proactive through enacting state rules. For example, lawmakers in New York and California introduced bills such as Bill 897 in January 2023, Bill 4123 in February 2023, and Bill 253 in May 2023, that require corporations to regularly track and disclose the emissions they generate through their business activities. California’s Bill 253, titled Climate Corporate Data Accountability Act, targets all corporations, both public and private, doing business in California and with $1 billion or more in annual revenue. These corporations would be required to publicly report their Scope 1, 2 and 3 carbon emissions to an emissions registry which will review the disclosure if it was not already approved by a third-party auditor.
While there is support for such regulations, there is also a growing pushback against them. Opponents of ESG contend that ESG elevates politics over economics. For example, a letter sent by 19 state attorneys to the CEO of BlackRock on August 4, 2022, reads “our states will not stand for our pensioners’ retirements to be sacrificed for BlackRock’s climate agenda”. Some Republican states have gone as far as to legislate against ESG disclosure and investment. For example, in Florida, a legislation from May 2023 bars state fund managers and advisors from basing investment decisions on ESG factors. ESG is also drawing heat in Congress as Republican senators sent letters, in November 2022, to 51 law firms warning them that Congress will “increasingly use its oversight powers to scrutinize the institutionalized antitrust violations being committed in the name of ESG.”
Both the backlash and the aforementioned pro-ESG legislations in California and New York come ahead of the release of the Securities and Exchange Commission (SEC)’s anticipated climate disclosure rules, expected in 2023. The SEC’s proposals, released in March 2022, outlined requirements for companies to mandatorily report on (1) governance and management of climate-related risks; (2) present or future material impact of identified risks on the business; (3) how any identified risks have affected or are likely to affect the corporate strategy, business model, and outlook; and (4) their impact and that of transition activities on consolidated financial statements. The proposal also includes additional mandatory reporting on direct greenhouse emissions in Scope 1 and 2, and in Scope 3 if emissions are material or if the corporation has set an emissions target that includes Scope 3. Additionally, in May 2022, the SEC proposed a set of anti-greenwashing rules related to fund names and disclosures by advisers and investment providers.
As has been noted by corporate lawyers Laura McIntosh and David Katz, while the proposed rules are less onerous for reporting companies than the obligations imposed by regulations in Europe, it is possible that they represent only the beginning of a new era in the regulation of ESG disclosures in the US. Research by business professors Mark Egan and Malcolm Baker showed, in December 2022, that despite the political backlash in the United States, investor enthusiasm for ESG continues to increase. Coupled with the influence of the EU, investor enthusiasm for ESG is likely to drive the SEC to add more mandatory disclosure proposals.
Canada: The time is ripe for forceful legislation
On January 19, 2022, in response to the increasing risk of greenwashing, the term used to describe conveying misleading information about how a a product or an activity is environmentally sound, the Canadian Securities Administrators (CSA) published the Staff Notice 81-334 – ESG-Related Investment Fund Disclosure. Because Canada does not have a federal securities regulator, and because each province and territory has its own securities regulatory authority, the introduction of ESG goals into securities regulation is a matter of consensus between the local authorities. The CSA plays a key role in coordinating initiatives on a cross-Canada basis.
Notice 81-334 targets investment fund managers and portfolio managers who use ESG considerations whether substantially or peripherally by requiring them to provide detailed disclosure about the fund’s name, its investment objective, its investment strategies and how the ESG criteria are applied when selecting investments. The notice is a great step forward as it clarifies the regulatory expectation of the level and methods of disclosure that is required for ESG strategy. Additionally, the Office of the Superintendent of Financial Institutions (OSFI), an agency that oversees and monitors federally regulated financial institutions in a manner that promotes the stability, safety, and soundness of the financial sector, introduced, in March 2023, the B-15 Climate Risk Management guideline. The guideline will require federally regulated banks and insurance companies to account for climate change in their governance practices and financial disclosures about GHD emissions. By 2024, approximately 400 financial institutions and 1,200 pension plans will need to comply with the guideline, while smaller institutions will have until the end of 2025. Although the guideline focuses on reporting requirements for financial institutions, it is expected that its effects will be wide-ranging. Interviewed by the Canadian Lawyer on July 27, 2022, former Vice-Chair of Ontario Securities Commission Wendy Berman said that such disclosures by banks and insurers “will have a significant impact on how Canadian businesses manage and report on climate-related risks and exposures.”
Equally important is the National Instrument 51-107 – Disclosure of Climate-related Matters, which was proposed by the CSA on October 18, 2021. The proposed instrument promises the most important requirements relating to climate change in Canada as it mandates climate-related disclosure around four core elements: (1) governance, (2) strategy, (3) risk management, and (4) metrics and targets. Although still a proposal, will it become effective, the instrument would apply to most reporting issuers. However, and as noted by ESG specialists Laura Roberts and Conor Chell, the requirements proposed by the CSA under this instrument are not all mandatory since reporting Scope 1, 2, and 3 GHG emissions would be done on a “comply or explain” basis. This makes Canadian ESG proposals less rigorous than the mandatory disclosure proposals currently pending in the US.
Towards Mandatory Compliance
Scholars such as Sarah Barker, Cynthia Williams and Alex Cooper, argue that ESG considerations should be seriously considered by all market players. To them, ESG considerations and shareholdism are not mutually exclusive. Rather, ESG maximizes profit through risk-management and therefore loss-prevention. To disclose the impacts of a business on the environment, they explain, is to be aware of climate-related risks that may pose a financial threat to the company in the future. Accordingly, disclosing is an incentive to implementing preventative and environment-friendly policies and targets. In February 2023, Mark Carney, former governor of the Bank of Canada and the Bank of England, told a Montreal audience that corporations and governments have “undervalued” the benefits of being transparent about how a changing climate will affect revenues, profits, and the economy. According to surveys conducted by U.S. public relations and marketing consultancy Edelman in 2021, it is even largely believed that companies that prioritize ESG integration represent better opportunities for long-term returns than those who do not.
Such findings militate in favor of mandatory compliance that does not grant a leeway to companies to opt out of reporting. By definition, mandatory compliance obliges companies to consider climate change not as an option or a possibility but as a reality. This is of great importance especially that most companies worldwide tend to opt out of reporting if compliance is only voluntary. When disclosure is mandatory, no matter what corporate managers think about the merits of a regulation and its effectiveness, they must comply with the prescriptions in question.
On June 26, 2023, the International Sustainability Standards Board (ISSB) released its long-awaited International Final Standards on Sustainability (IFRS S1) and climate-related financial disclosures (IFRS S2), collectively referred to as the “Standards”. The IFRS S1 outlines requirements for disclosure of sustainability topics related to financial information, and the risks and opportunities a company faces in light of such topics. The IFRS S2 requires companies to disclose information pertaining specifically to climate-related risks and opportunities. The mandatory Standards are intended to provide a global framework for comprehensive, comparable, and consistent reporting instead of the current vague, incomplete or inconsistent data and metrics.
Notably, the Standards mark a departure from the “alphabet soup” of voluntary and mandatory reporting regimes but only in countries that will choose to adopt them. Although the Standards benefit from significant support, including from the International Organization of Securities Commissions (IOSCO) and the G7, of which Canada is a member, it is not clear whether Canada will adopt them in their entirety and if their mandatory character will be kept intact. In a statement issued on July 5, 2023 by the CSA, the Canadian agency commended the ISSB for developing the Standards and voiced its intention to conduct consultations to “adopt disclosure standards based on ISSB Standards”. As much as this is encouraging, it still remains unclear whether the Standards will be transposed to Canada or merely serve as an inspiration for less rigorous, and maybe less forceful, Canadian standards.
Beyond disclosure
As governments move towards mandatory disclosure, some scholars insist that disclosure should not be the be-all and end-all of corporate responsibility, but rather a way and a tool to incite structural corporate change. Business expert and columnist Harry G. Broadman views disclosure as an intermediate step to transforming corporate behavior, arguing that mandatory ESG reporting and disclosure “simply are NOT substitutes for both embracing and actualizing sustainability within businesses’ operations”. The introduction of reporting obligations, as legal scholar Iris Chiu argued in a chapter published on June 15, 2020 in the Cambridge Handbook of Corporate law, is a mechanism that ensures minimum intrusion in corporate life and governance. Such a mechanism focuses on the external monitoring of corporate behavior rather than imposes deep self-reflection and fundamental changes to such behavior.
Conclusion
In addition to disclosure requirements, sustainability and ESG should be integrated at the level of corporate decision-making. To achieve this, scholars and analysts have been calling for a redefinition of the directors’ fiduciary duty to explicitly encompass ESG factors. In 2019, the Canadian Expert Panel on Sustainable Finance urged the federal government to clarify the concept of fiduciary duty in a way that includes non-financial issues. Recommendation 6 of the panel’s final report states: “Clarify the scope of fiduciary duty in the context of climate change.” A September 2021 report by the Institute of Sustainable Finance indicates that only moderate progress had been made on this recommendation while, paradoxically, this was the second most frequently cited recommendation that experts said should be implemented in the short-term.
In Europe, a 2020 study on directors’ duties and sustainable corporate governance found that, without policy intervention, the social norm of shareholder primacy would remain unchallenged and continue leading directors to focus on short-term profit maximization for the shareholders, rather than on making businesses more sustainable in the long run. The study recommends the introduction of a new directive providing an EU-wide reformulation of directors’ duties and company’s interest. In Canada, while article 122(1.1) in the Canada Business Corporations Act (CBCA) mentions the environment and the long-term interests of the corporation as factors to consider when looking at the corporation’s best interests, an amendment adding weight to—and broadening the scope of application of—ESG factors within the ambit of the CBCA would be useful.
Environment and climate-related disclosures are here to stay. It appears now of essence that legislators and regulators act worldwide by enforcing their enshrinement within legal frameworks. While still voluntary, some disclosure requirements are becoming mandatory to incite self-reflection and awareness vis-à-vis sustainability. A more stringent milestone that would transform this awareness into more structural action could be achieved through redefining the directors’ duty to explicitly encompass acting responsibly and sustainably.