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  • An Accountant’s Guide to Climate Change and ESG (Environmental, Social and Governance)
Article:

An Accountant’s Guide to Climate Change and ESG (Environmental, Social and Governance)

20 September 2021

1. Why is climate important, and why are investors now so interested in climate risk?

Climate change has been accelerating during the first part of the 21st century, primarily driven by increasing emissions of greenhouse gas (GHG) which traps heat in the atmosphere and raises the average surface temperature. These changes are linked to changes in weather patterns that threaten the sustainability of both individuals and corporations across the planet.

Following calls from the United Nations Intergovernmental Panel on Climate Change (IPCC) to reduce GHG emissions, 196 countries signed the Paris Agreement in 2015, a legally binding international treaty on climate change. The Paris Agreement contains an undertaking to limit future increases in global temperatures to well below 2 degrees Celcius (2°C), preferably to 1.5 degrees Celcius (1.5°C) as compared to pre-industrial levels.

With the world emerging from the COVID-19 pandemic, many governments, including the Government of Malaysia, have reaffirmed their commitment to the Paris Agreement and undertake necessary steps to limit global warming.

These efforts are anticipated to bring significant changes in government policies and regulations, such as environmental taxes or carbon taxes which would especially affect businesses that continue to operate in the “status quo” without considering ESG factors. Consequently, in order to meet these impending policies and regulations to reduce GHG emissions, inexorably fundamental changes to business operations would be needed in the near future. We expect significant improvements in the areas of efficiency of use and production of electricity and energy in tandem with government regulations and investors’ expectations, all of which would affect returns on investment and risks measurement.

The investing community have expressed significant interest in the ‘what’ and ‘why’ corporations deal with ESG matters, as well as the ‘how to’ apply ESG methods as an integral systematic process of sustainable investing, especially in the medium and long term. Both value- and values-motivated investors could apply 6 different methods for incorporating ESG considerations into their decision-making: exclusionary screening, best-in-class selection, thematic investing, active ownership, impact investing, and ESG integration.

It is worth noting that institutional investors, such as insurance companies, Employees Provident Fund, pension and social security funds, which are major sources of funding for corporations, have investment horizons of between 20 to 30 years. Accordingly, these investors expect their investee companies to have a long term sustainable and profitable future that are not mutually exclusive.

IPCC Climate Report 2021

Time is running out, according to the UN IPCC, the world’s leading climate experts formed in 1988 and charged with preparing comprehensive reports on the state of our knowledge of climate.

In its new climate report released in August 2021, the IPCC states that things are poised to get worse if GHG emissions continue and makes it clear that the future of the planet depends, in large part, on the choices that humanity makes today.

 

2. What is ESG?

ESG is not entirely new, as it has been an evolving area of increasing focus over the last decade that was previously not structurally well defined.

There are several lenses to examine ESG, one of which involves ESG as an ongoing programme integrated into business activities and investment initiatives with 3 domains – environmental, social and governance.

An alternative lens involves ESG as decision-making processes about future viability of businesses with a more conceptual understanding around it. There could be specific factors and metrics about ESG matters that are often interlinked, which is not one thing in particular.

ESG invariably also reflects our human values and principles, which is a key part of every organisation’s decision making.

However, ESG is clearly neither a public relations exercise nor a marketing stunt to clothe our organisations. ESG is about long term sustainable value creation or erosion that can often be measured by corporations and facilitate investment decisions by capital market participants.

 

3. What are the reporting frameworks out there?

The ESG reporting landscape is often referred to as an ‘alphabet soup’ because there are numerous reporting frameworks, many of which are voluntary and overlap in terms of intent and content.

Although there is no globally endorsed comprehensive reporting framework for ESG reporting at this moment, existing ESG frameworks require reporting on Environmental metrics (the E), and have different levels of focus on the Social (S) and the Governance (G) elements of ESG.

Some of these current non-financial reporting frameworks include:

3.1 Global Reporting Initiative (GRI)

The Global Reporting Initiative developed the GRI Sustainability Reporting Standards, which represent the most widely used reporting framework by companies and organisations globally in producing their sustainability reports.

Since its establishment in 1997, the GRI has launched four generations of GRI Reporting Guidelines (G1, G2, G3 and G4) and, as of October 2016, produced the GRI Sustainability Reporting Standards (or the GRI Standards). The GRI Standards are developed by the Global Sustainability Standards Board (GSSB), an independent experts group, and hosts a disclosure database on their website of sustainability reports collated from many organisations over the years.

The GRI Standards embed the principle of materiality as the cornerstone of ESG reporting and detail the approaches to management reporting and disclosure for a range of material topics relating to economic, environmental or social matters.

3.2 CDP (formerly the Carbon Disclosure Project)

Launched in 2000, CDP is a non-profit that operates an international disclosure system for companies, cities, states and regions to disclose environmental information to their stakeholders covering climate change, forests and water security questionnaires.

CDP currently offers three questionnaires (Climate Change, Water, and Forests), each of which is scored using different methodologies.  Each questionnaire includes general questions alongside sector-specific questions aimed at high-impact sectors. The scoring of CDPs questionnaires is conducted by accredited scoring partners trained by CDP.

According to CDP, more than 9,600 companies have publicly disclosed through CDP in 2020. CDP named over 300 companies in its 2020 ‘A List’ for environmental transparency and action.

3.3 Climate Disclosure Standards Board (CDSB)

CDSB was formed at the World Economic Forum’s annual meeting in 2007. CDSB is a consortium of global business and environmental organisations, including CDP, Ceres, The Climate Group, The Climate Registry (TCR), International Emissions Trading Association (IETA), World Council for Business and Sustainable Development (WCBSD), World Economic Forum (WEF) and World Resources Institute (WRI).

CDSB members are committed to the integration of climate change and environmental information into mainstream corporate reporting. CDSB advances its mission through the development of an international reporting framework for use by companies when making certain disclosures in, or linked to, their mainstream financial reports. The CDSB Framework is designed to elicit information that can be built into investor analyses of financial and environmental risks related to climate change. 

3.4 Value Reporting Foundation = SASB + IIRC

In November 2020, the Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting Council (IIRC) announced an agreement to merge and form the Value Reporting Foundation (VRF).  

3.4.1 Sustainability Accounting Standards Board (SASB)

Established in 2011, SASB is an independent non-profit organisation that sets industry-specific standards to guide the disclosure of financially material sustainability information by companies to their investors. SASB standards are intended as a guide for voluntary reporting use by public companies in making disclosures on material sustainability factors in Forms 10-K, 20-F, and 40-F as required by existing regulations in the United States. The SASB has categorised its 77 standards pursuant to its Sustainable Industry Classification System across the following sectors:

  • Consumer Goods
  • Extractives & Mineral Processing
  • Financials
  • Food & Beverage
  • Health Care
  • Infrastructure
  • Renewable Resources & Alternative Energy
  • Resource Transformation
  • Services
  • Technology & Communications
  • Transportation

SASB is designed to help provide investors with the ESG disclosures needed to facilitate investment decisions. SASB metrics are selected to be verifiable, which is critical for accountants. 

Asset management companies such as BlackRock, Goldman Sachs, Morgan Stanley, as well as manufacturing giants such as GM and Nike use SASB Standards to disclose ESG metrics.

3.4.2 International Integrated Reporting Council (IIRC)

The IIRC is a global coalition of regulators, investors, companies, standard setters, the accounting profession, academia and NGOs with a mission to establish integrated reporting and thinking within the mainstream business practice as the norm in the public and private sectors. The IIRC developed the Integrated Reporting 'IR' Framework, a set of guiding principles and content elements to govern integrated corporate reporting.

3.4.3 Value Reporting Framework (VRF)

The Value Reporting Foundation merges the SASB and IIRC into a credible international organisation that maintains the IR Framework, advocates integrated thinking, and sets sustainability disclosure standards for enterprise value creation. This merger directly responds to calls from global investors and corporates to simplify the corporate reporting landscape, providing the market with a clear solution for communicating about the drivers of enterprise value. The merger will also advance the work of CDP, CDSB, GRI, IIRC and SASB in their published statement of intent detailing their desire to work together and with the International Financial Reporting Standards (IFRS) Foundation to develop a comprehensive corporate reporting system.

3.5 Task Force for Climate-Related Disclosures (TCFD)

The TCFD was created in December 2015 after the G20 Finance Ministers asked the Financial Stability Board (FSB) to evaluate the connection between climate-related issues and the financial sector. Since the FSB is an international body that makes recommendations to the global financial system, this push towards climate-related finance represents a watershed moment in climate reporting.

TCFD recommendations provide a common international framework for companies and investors to explicitly translate information about climate change in financial metrics, falling squarely within the ‘E’ of ESG reporting.

TCFD recommends disclosures on 11 questions clustered under 4 categories: governance, strategy, risk management and metric, for companies, banks, insurers and investors. TCFD considers investors to be both users and the issuers of climate-related disclosures for which these disclosures should take place in companies’ and investors’ regular financial filings.

3.6 IFRS Foundation

On 30 September 2020, the Trustees of the IFRS Foundation published a Consultation Paper on Sustainability Reporting.

The Consultation Paper sets out the views of the Trustees on how the IFRS Foundation could contribute to the development of consistent, global requirements for sustainability reporting. The Trustees advocated a provisional approach of creating an International Sustainability Standards Board (ISSB) within the governance structure of the IFRS Foundation, alongside the existing International Accounting Standards Board (IASB).

The intended objective of the proposed ISSB would be to develop and maintain a global set of sustainability-reporting standards, with an initial focus on climate-related risks whilst broader ESG issues may be considered in the future.

4. There are so many frameworks. Which one should we adopt?

The current reality is that ESG reporting is a complex space, with a variety of existing reporting frameworks that could pose challenges for businesses intending to adopt multiple frameworks.

In addition, there is a lack of consistency in the principles underlying these frameworks that makes comparability of metrics between entities and different jurisdictions challenging.

Corporations should consider their target audience in considering the framework(s) to be applied for reporting purposes in the current absence of a single standard that meets the needs of all stakeholders including investors, financial institutions, civil society, policymakers and regulators. Although many reporting frameworks are primarily aimed at investors (e.g. TCFD), other reporting frameworks seek to engage a broader audience (e.g. CDP reports).

Overseas, investor attention appears to be coalescing around SASB and TCFD disclosures. In the UK, the Financial Reporting Council requires UK companies to use the TCFD framework for climate risk disclosures and SASB Standards for industry-specific risks.Similarly, Blackrock, a global leading asset manager, expects corporations to publish reports in accordance with TCFD Recommendations and SASB Standards.

In Malaysia, financial institutions licensed by Bank Negara Malaysia (BNM) are expected to begin measuring exposures based on the Climate Change and Principle-based Taxonomy (CCPT) issued by BNM for internal risk management and supervisory purposes over the course of 2021 and adopt TCFD Recommendations for climate-related disclosures.

5. What is the ESG landscape in Malaysia?

Malaysia has pledged to reduce the intensity of its GHG emissions by 45% (compared to 2005 levels) by 2030, in support of the Paris Agreement.

5.1 Bursa Malaysia

Bursa Malaysia in partnership with FTSE Russell launched the FTSE4Good ESG Index in 2014 with the aim of providing more visibility and profiling of ESG-compliant companies.

5.1.1 FTSE4Good ESG Index

The FTSE4Good ESG Index uses the overall rating from FTSE Russell’s ESG Ratings and rates the ESG exposure and performance of a company on multiple dimensions. This involves analysing companies under 3 pillars (E, S and G) and 14 ESG themes, with over 300 indicators.

5.1.2 Sustainability Reporting Guide

Bursa Malaysia issued the Sustainability Reporting Guide in 2015 to guide listed issuers on how to embed sustainability in their organisation and help to identify, evaluate and manage ESG risks and opportunities. The second edition, released in 2018, includes case studies, references to the United Nations Sustainable Development Goals (SDGs) and TCFD Recommendations as well as guidance on IR.

5.2 Bank Negara Malaysia (BNM)

BNM issued the CCPT in April 2021 to assist licensed financial institutions classify economic activities that contribute to climate change, mitigation and adaptation.

BNM, in collaboration with the Islamic Finance industry, also introduced value-based intermediation (VBI) which aims to deliver the intended outcomes of Shariah through practices, conduct and offerings that generate positive and sustainable impact to the economy, community and environment, consistent with the shareholders' sustainable returns and long-term interests.

5.3 Securities Commission Malaysia (SC)

SC launched the Sustainable and Responsible Investment (SRI) Roadmap in November 2019, which aims to chart the role of the capital market in driving Malaysia’s sustainable development. The SRI Roadmap contains 20 strategic recommendations to holistically develop a facilitative SRI ecosystem in the Malaysian capital market.

5.3.1 Malaysian Code on Corporate Governance (MCCG)

SC issued the first MCCG in 2000 before revising the MCCG in April 2017 with enhancements to the ecosystem for sustainable and responsible investment in Malaysia.

In April 2021, SC issued another updated MCCG, which includes addressing the urgent need for companies to manage ESG risks and opportunities, with emphasis on strengthening board oversight and the need for collective action by boards and senior management.

5.4 Joint Committee in Climate Change (JC3)

JC3 is a platform established in September 2019 to pursue collaborative actions for building climate resilience within the Malaysia financial sector. JC3 is co-chaired by BNM and SC with members comprising senior officials from Bursa Malaysia and 19 financial industry players as well as relevant experts.

12 JC3 members have committed to early adoption of the CCPT, in advance of expectations for financial institutions regulated by Bank Negara to classify and report their lending and investment activities in line with the CCPT from July 2022 onwards.

6. What role does the accountancy profession play?

The accountancy profession plays a critical role in facilitating financial and non-financial reporting for businesses to meaningfully communicate ESG metrics and implications to various stakeholders.

This is underscored by the overwhelming support for the IFRS Foundation to strategically formulate the ISSB as a peer to the widely-accepted and respected IASB, thrusting global sustainability standards to the forefront in the same manner as IFRSs were several decades ago.

Our financial discipline and understanding of interoperability between financial and ESG information forms a bedrock for corporate reporting purposes that leads to meaningful decisions in the capital markets and ecosystem.

The accountancy profession would do well to take this opportunity to reinvent itself beyond double entries and pivot on lending a helping hand to save our planet by accounting for ESG metrics.