Materiality and Standardization As more companies , both large and small , around the world voluntarily created sustainability reports , stakeholders looked for standardization in reporting to better facilitate comparisons . The GRI and CDP questionnaires were instrumental to get companies to collect data for and report on non-financial topics . But they were largely sector agnostic and as such compelled companies to report on metrics that were not always relevant to their business . Banks don ’ t usually face water use risks for example . Rather than count gallons of water used , banks should monitor for relevant risks , like data protection and cybersecurity .
Investors wanted an increased focus on materiality in reporting . Materiality refers to the risks and opportunities to a company ’ s business model and operations that will drop to the bottom line .
In 2011 , The Sustainability Accounting Standards Board ( SASB ) responded to investors ’ interests in identifying financial material metrics by industry . SASB identified 77 distinct industries and mapped corresponding risks most likely to affect an entity ’ s cash flows , access to finance and cost of capital .
The specific list of risks for each of the 77 industries SASB identified varied greatly , but 75 of the industries counted climate change as one of their most material risks . In 2017 , TCFD or the Task Force on Climate-related Financial Disclosures was formed by the G20 Financial Stability Board . TCFD set out a robust reporting framework to outline a companies ’ preparedness to climate change through corporate governance , strategy , metrics and targets , and climate scenario analysis . The climate risks were split into physical and transition risks .
For example , in real estate , there are physical risks if a property is in an area with significant heat or water stress . Keeping a property rentable in Phoenix or Austin , Texas , may require significant additional investment in air-conditioning . There are also transitions risks which refer to emerging competition or regulatory policies that could require increased or unanticipated capital expenditure .
Nearly 50 cities around the U . S . are rolling out building performance standards ( BPS ) that require commercial , public and multifamily buildings to consume less energy and invest in energy efficient systems ( See Exploring Building Performance Standards . Institute for Market Transformation ( 2020 ); imt . org / how-we-drive-demand / building-policies-and-programs / exploring-building-performancestandards ).
On average the BPS enable buildings to reduce energy use in buildings by over 20 percent . Investors and financial advisors may not yet be aware of these changes , but building owners are and are evaluating investment or disposal of their real assets through this lens .
Many of these voluntary frameworks — initially requested by investors , consumers , nonprofits , lenders and management — have been used as the foundation to form new regulation .
• In March 2024 , the SEC Enhancement and Standardization of Climate- Related Financial Disclosures was finalized after a two-year process including the consideration of over 16,000 comment letters , the vast majority of which were in support of the rule . The final rule is based on the CDP and TCFD voluntary frameworks requiring large companies to report on Scope 1 and Scope 2 emissions if financial material to their business .
• The California Climate Corporate Data Accountability Act SB 253 ( October 2023 ) builds off the voluntary reporting CDP questionnaire requiring companies to report greenhouse gas emissions across their value chains including Scope 1 , Scope 2 and Scope 3 emissions .
• The California Climate-related Risk Disclosure Act SB 261 ( October 2023 ) follows the TCFD framework requiring companies to detail how they are managing climate-related financial risks and opportunities to operations .
• The EU Taxonomy in Europe includes many aspects of GRI , CDP , TCFD frameworks in the multilayer reporting requirements for both companies with the Corporate Sustainability Reporting Directive ( CSRD ) and financial services with the Sustainable Finance Disclosure Regulations ( SFDR ). Accounting firms have seized the opportunity to help corporates manage these new reporting requirements . PwC and Deloitte have built sustainability reporting teams . EY started EY Carbon to advise institutional clients with risk management and modelling transition plans .
Accountants and auditors identify the material topics for their client ’ s business and the corresponding metrics to track through a materiality assessment . Voluntary frameworks are used as starting points cross-referenced with existing or pending regulation to cover all potential areas for non-financial reporting . Accountants help put in place reliable processes to collect and manage data , ensure data quality and standardize procedures . The data ranges from employee turnover to carbon emissions . For some clients , they tie it together and provide analysis and explanation of financial and non-financial data .
Helping Clients With ESG Investing Understanding how non-financial voluntary reporting has evolved should go a long way to demonstrating ESG is not the same as values-based investing . ESG is about companies articulating and proactively designing their strategy for long-term value . SRI is about aligning portfolios to clients ’ values . Helping your clients understand the difference will help them be better investors and help you streamline your practice .
Clients who are concerned about climate change or corporate malfeasance could be well served by a model portfolio of ESG ETFs or mutual funds . Clients with strong personal preferences on alcohol , tobacco , etc . would require a lengthier discovery process and custom portfolios .
It ’ s helpful to remind clients that ESG is not a political movement or an attempt to stymie corporate independence or profits . Non-financial reporting is about greater transparency , better prices and better decision making for market participants . This is why ESG approaches to monitor business risks and investments will persist .
Sarah J . Adams is chief sustainability officer and co-founder at Vert Asset Management . You can reach her at sarah @ vertasset . com . Glenn Freed , Ph . D ., CPA ( Florida ) is a chief investment officer at Fortress Wealth Management and chair of the CalCPA PFP Committee . You can reach him at glennfreed @ fortress-wealth . com . www . calcpa . org JULY 2024 CALIFORNIA CPA 13