Julie Bell Lindsay is CEO of the Center for Audit Quality.
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Efficient and transparent capital markets are a critical component of modern daily life. These tools for economic growth make it possible for businesses to invest in the future. For example, when you open a new credit card account, finance a car purchase or put money into your 401(k), capital markets are on the other side of those transactions.
Because capital markets, and the businesses that tap into them, touch so many parts of our lives, it is important to maintain a dependable corporate reporting system that provides investors with the information they need to make informed decisions. Increasingly, in the U.S. and around the globe, investors are seeking actionable information on climate-related risks impacting businesses.
Whether motivated to reduce greenhouse gas emissions or to gain a better understanding of how climate-related risks are factored into business operations, it is indisputable that investors now expect to see standardized climate-related data represented in your corporate reporting framework. Larry Fink wrote in his annual letter to CEOs that companies have a "responsibility to shareholders, including through sound environmental, social, and governance practices and policies.”
New Proposed Regulations
In March of this year, the U.S. Securities and Exchange Commission (SEC) released proposed regulations to enhance and standardize climate-related information reported by publicly traded companies. Assuming the regulations are implemented in their proposed form, certain of the new disclosures will require third-party assurance to enhance their reliability. The advancement of this proposed rule is a clear indication that expectations for corporate reporting have grown and the value of assurance extends well beyond the traditional audit of historical financial statements.
While most publicly traded companies publish some form of climate-related information, the utility of the information to investors is limited because it lacks consistency and reliability. My company reviewed data from the S&P 500 and found that while 95% of companies have environmental, social and governance (ESG) information publicly available; they use many different standards and frameworks and primarily report information outside of SEC submission. Far fewer receive third-party assurance or verification on what they do make available. In fact, according to another analysis by my company into S&P's data, only 13% of the S&P 100 obtain assurance from public company auditors for their ESG information.
The investor calls for ESG data require clear standards for public companies and their management to follow. What information is most useful and how should it be communicated to provide investors with the information they need? There are multiple reporting frameworks and standards in the marketplace. Businesses are left guessing and investors are left with ESG details that cannot be compared.
In its proposal, the SEC took a step toward addressing these questions and needs with respect to company-reported climate information. By basing the new proposed disclosures on existing standards and frameworks—in particular, the Task Force on Climate-Related Financial Disclosures (TCFD) and Greenhouse Gas (GHG) Protocol—the SEC seeks to provide guidance and requirements for public companies as to the types of disclosure investors are seeking in this area.
The SEC further proposed to include some of the new disclosures in company financial statements, thus subjecting the information to audit by public company auditors and requiring certain company GHG emissions disclosures to be located outside of the financial statements and be subject to attestation.
Independent Attestation
For close to 100 years, the financial statement information provided by public companies has been required to be independently attested to by independent public company auditors. The demand for audits of a company’s financial position was driven by investors; they offered the capital required to grow and support businesses, and they needed an independent third party to provide an assessment of the financial information that management reported.
Twenty years ago, Congress passed the Sarbanes-Oxley Act (SOX) which extended the requirement for an independent attestation to a company’s internal control over financial reporting (in addition to company leadership’s own certification). This combined with the other reforms put in place by SOX—independent audit regulator via the PCAOB and stricter requirements on auditor independence, among others—established a firm foundation of protections for public company reporting.
Responding To New Regulations
Adjusting to new mandated reporting requirements will take time. The SEC’s proposal includes a transition period for firms to meet 10-K filing deadlines and phase in the new requirements. Public companies can use this transition period to prepare for mandated requirements through the actions listed above. While the proposed rule is debated, there are concrete steps my company has compiled that you can take to establish effective internal governance policies for their ESG reporting.
Public company audit firms can also help public companies prepare with a readiness assessment, which may be performed in advance of a review or examination of a company’s ESG information. Once a readiness assessment is completed, your company may obtain an independent view as to whether the selection of an ESG reporting framework, its reporting processes, internal controls, evidence available and governance related to ESG information provide attestation engagement at the desired level of assurance. As part of a readiness assessment, a practitioner will make high-level recommendations about ways to strengthen existing ESG disclosure practices.
A New Area For Corporate Reporting
While SOX remains relevant today, we have entered a new era for investors that requires expanding our understanding of corporate reporting. Establishing standards on climate and other ESG matters like human capital can bring consistent and comparable ESG information to investors and other capital market stakeholders clamoring for reliable information.
ESG has moved beyond a niche issue, and the saturation in the market of individualized ESG reports from businesses, estimated to be $53 trillion in managed ESG assets by 2025, tells us that this topic is not fading away. It is time to establish baseline rules that bring accountability, objectivity and standardization to enhance trust in ESG reporting, with climate disclosures as the first step. Public company auditors have seen first-hand the value that a disciplined approach to reporting can have on the quality of information companies report.
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