The rise of mandatory climate disclosures

Mandatory disclosures on sustainability are increasingly taking over from voluntary disclosures. For example, the Task Force on Climate-Related Financial Disclosures (TCFD) is mandatory for premium listed FTSE 100 companies.

Singapore has some of the most advanced mandatory disclosure regulations in place with a focus on environmental risk. Europe is also leading the way in sustainability regulation; the EU has a Corporate Sustainability Reporting Directive (CSRD), and the UK is developing its own Sustainability Disclosure Requirements (SDRs). In the US, the SEC has proposed all publicly listed firms should disclose their emissions footprint.

“The trend we are seeing is that there is going to be more sustainability regulation and mandatory reporting for corporates, and the big shift we see coming is a requirement to approach sustainability reporting with exactly the same detail and rigour as the financial reporting required by companies,” says Jamie Pitcairn, technical director, circular economy and sustainability, for consultants Ricardo.

Strict guidelines, audited information and robust approaches to sustainability reporting are going to increase in the near future. And data supporting the reporting requirements is going to be key.

Challenges of mandatory disclosures

There are a number of data challenges around mandatory disclosures. The meaningfulness of disclosures will largely depend on the usefulness of the information being disclosed.

Leon Kamhi, head of responsibility at Federated Hermes, comments: “There is relative consensus on the need to disclose Scope 1 and 2 emissions. We are also of the view that disclosing Scope 3 emissions is key as often a company can have a significant impact on the carbon being emitted in its supply chain and by its customers – sometimes more than the suppliers and customers themselves.”

According to Pitcairn, data is causing problems with TCFD disclosures where corporates can struggle to access the data they need to assess and understand their climate risk. Without that data, investors often feel unable to make climate-related decisions.

Stephen Metcalf, head of sustainable investing, RBC Wealth Management, agrees that data availability and sourcing simple quantitative metrics are the biggest challenges.

“While there’s plenty of ESG data out there, finding data that is truly material to these risks can be difficult, such as isolating a set of data points that measure the physical risk in your portfolio. These are complex issues which cannot always be classified neatly,” Metcalf explains.

Meanwhile, there are also challenges relating to credibility, as CO2 emissions are typically not measured, but estimated. Raphael Pitoun, portfolio manager at Trium Capital, comments: “From our experience, many companies already use specialised third-party providers for verification purposes, but we have limited trust in them as they do not bear any liability. What we need is a proper auditing framework similar to what we have for financial metrics.”

The measures required for mandatory disclosures

TCFD recommendations can be used to measure mandatory climate disclosures using metrics such as governance to oversee climate-risks and the company strategy.

A March 2020 Marrow Sodali survey of institutional investors found that 81% of respondents recommended that companies use the Sustainability Accounting Standards Board framework to enhance their ESG, and 77% of respondents recommended the TCFD framework for climate-specific financial information.

Scope 1 and 2 greenhouse gas emissions offer a relatively robust methodology, but many companies can have an impact that goes far beyond this narrow scope. Pitoun explains: “Current mandatory reporting schemes appear to us as too vague with respect to Scope 3 (or indirect) emissions.

“Their credibility can be undermined by this vagueness that will ultimately lead to greenwashing.”

At the risk of falling foul of mandatory disclosures, some firms may err on the side of caution and over-comply. This is a risk Neaaz Mozumder, investment stewardship analyst at Legal & General Investment Management America, foresees – of simply over-disclosing and overwhelming the end-users.

Mozumder concludes: “Longer-term, now that government bodies would oversee certain disclosures, it might be a slower process to iterate and improve upon those disclosures as the market evolves. Nonetheless, we are supportive of it.”