Battening Down: The Future of Sustainability Reporting in Canada

Recently, there's been much focus on when regulators and standard setters (e.g., Canadian Securities Administrators (CSA), Securities and Exchange Commission (SEC), European Union (EU), International Sustainability Standards Board (ISSB) and others) are likely to finalize their ESG reporting requirements. For now, reporting remains largely voluntary, though it's worth noting that nearly all Canadian public companies already externally report ESG information today. That's because key stakeholders (investors, lenders, employees, customers, and others) have already begun to incorporate it into their decision making. Some investors, such as CPP Investments and BlackRock, have publicly declared their willingness to walk away from deals if potential investees don't meet targets or take ESG seriously. With these rising stakes, companies are thinking not only about what ESG information to report, but also how, by whom, and with whose oversight. There are three key reasons why we believe audit committees and finance functions should (and will) play a central role:

1.  As more and more stakeholders pay attention, the risks of reporting are increasing.

While it might seem obvious, the difference between voluntary and mandatory reporting is an important nuance given the incremental rigor the latter often attracts (e.g., internal controls, management certifications, internal and external audits, and so on). This is stressed even more when considering the increasing number of examples of challenges that can arise. In the US, the SEC's Climate and ESG Task Force within the Division of Enforcement has already charged multiple top-tier banks for failing to follow policies and procedures, making misstatements and omissions around ESG investments and related reporting; similar charges have been laid against companies in other industries like mining, automotive and consumer products. In Canada, we're starting to see the Competition Bureau issuing fines for 'greenwashing', including one recently levied against a major coffee company for making false claims about the recyclability of its coffee pods. While the financial penalties may be onerous (typically in the millions), the potential severity and long-lasting impacts to a company's brand, reputation and ultimately value, are even more concerning.

2.  Finance and audit committee ownership brings natural synergies and benefits.

Today, there's considerable variability in terms of which executives are being tasked with producing climate and sustainability disclosures, as well as the committees of the board responsible for overseeing them. For instance, the former often includes the chief sustainability officer, chief financial officer, chief legal officer, investor relations or others; while the latter may include the sustainability committee, compensation committee, governance committee and so on. There are a few good reasons to expect these responsibilities might migrate to finance and the audit committee over time, including:

• one of the audit committee's current primary roles is to provide oversight of financial reporting, and audit and internal controls (in other words, to ensure reliability of external reporting);
• doing so would accelerate development of reporting by leveraging existing infrastructure, established processes, and governance and controls that already exist within finance, rather than building them separately elsewhere in the organization; and
• it aligns with the fact that ESG and financial reporting are inextricably linked, by embedding the reporting for both in a single function rather than reconciling between multiple ones.

The last point is especially important. So much so, in fact, that securities, prudential and audit regulators alike (including the CSA, Office of the Superintendent of Financial Institutions (OSFI) and Canadian Public Accountability Board (CPAB) have been pressing on it lately. Their interest is primarily in understanding how commitments and estimates reported in relation to ESG align with assumptions that underpin financial estimates like goodwill and impairment assessments. The relationship between these is also what led the SEC to include the following in its proposed climate-related disclosures: specific footnote disclosures in the audited financial statements about the impacts of climate-related risks thereon, a requirement to identify a climate-related risk expert member of the board of directors, and attestation requirements for climate-related reporting consistent with that required for financial statements and internal controls over financial reporting today.

3.Reporting, internal controls and auditing are important skills too.

While it's true that most audit committees and finance teams aren't experts in ESG, the same could also be said of areas like valuation, taxation, systems, and others. And, similarly, experts in those areas tend not to be proficient in audit, internal controls, and reporting (nor do they generally strive to be). Instead of delegating to the ESG experts the entirety of the process of gathering, compiling, controlling and ultimate reporting, the responsibility and oversight of ESG reporting is deepened through their involvement as specialists. After all, reliable reporting is as much about what is being reported on as it is about how the reporting is produced. Understanding things like frameworks and requirements, internal controls, governance, etc. are all tenets of high-quality reporting. Today, that leaves companies with a choice: either replicate these requirements within the ESG function or leverage the ESG experts by driving the reporting into areas where they already exist (such as finance). While previous reporting journeys like Sarbanes-Oxley and International Financial Reporting Standards (IFRS) implementation gave multiple years after issuance to comply, companies have already begun to make disclosures voluntarily. Additionally, in some cases the (soon to be finalized) requirements are calling for new ones as early as next year. That's not a lot of time to get smart on things like data, systems, and processes and controls (to name a few).

Long and short, implementation timelines and the fact that companies are already being held accountable for reporting mean that things need to evolve fast. One way to do that is by leveraging finance and audit committees. Not only do they already play roles in producing and ensuring reliability of external reporting today, but doing so would also allow those who have ESG knowledge to focus on areas that others can't.

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