This episode features Osler’s Andrew MacDougall, partner, Corporate, in a discussion about the International Sustainability Standard Board’s proposed standards focused on sustainability and climate-related disclosures. The proposals are designed to provide the market with a complete set of sustainability-related financial disclosures, as well as setting out specific requirements for the identification, measurement and disclosure of climate-related financial information. Andrew and Pat discuss the ISSB’s proposed standards and where they fit within the world of ESG disclosure, all with a view to the ISSB’s request for public comments due at the end of July 2022.
PATRICK WELSH: Welcome to the ESG Explorer podcast brought to you by Osler, Hoskin, and Harcourt. This show explores all things ESG, Environmental, Social, and Governance, that are impacting Canadian businesses. This podcast is for the curious, not just for the converted. I am Patrick Welsh, a partner in Osler's Regulatory, Environmental, Indigenous, and Lands group. Now, let's go exploring.
On March 31st, 2022, the International Sustainability Standards Board, or ISSB, issued two proposed standards called exposure drafts for public comment. The first exposure draft is entitled general requirements for disclosure of sustainability-related financial information and according to the ISSB, sets out the overall requirements for disclosing sustainability-related financial information about all of the companies significant sustainability-related risks and opportunities to provide the market with a complete set of sustainability-related financial disclosures. The second exposure draft is entitled climate-related disclosures, which sets out the specific requirements for the identification, measurement, and disclosure of climate-related financial information. The consultation period closes on July 29th, 2022.
To help us understand the ISSB's exposure drafts and what they might mean for Canadian businesses, I'm delighted to welcome Andrew MacDougall. Andrew is a partner in Oslo's corporate group and is a recognized expert in corporate governance, executive compensation, and shareholder activism matters. He leads Oslo's corporate governance practice, was a staff member of the Toronto Stock Exchange report on corporate governance, served on the Risk Oversight and Governance Board of the Canadian Institute of Chartered Accountants, and is an inaugural fellow of the American College of Governance Counsel.
Andrew co-authored Osler's leading annual reports on diversity disclosure practices in Canada. And most recently, Andrew has advised clients on the rapidly evolving world of ESG disclosure. Thank you for joining me, Andrew.
ANDREW MACDOUGALL: Glad to be here, Patrick.
PATRICK WELSH: Terrific. Well, first off, let's start with the most basic of questions. What is the ISSB?
ANDREW MACDOUGALL: So issuers have been faced with a plethora of sustainability reporting frameworks to choose from, each of which has a different focus. And some of them differ in their approach to determining things like what information is or is not material for reporting purposes. Many years ago, the IFRS Foundation was established to develop globally-accepted accounting standards. And it established the International Accounting Standards Board, which sets international financial reporting standards that are used for accounting purposes in many parts of the world, including Canada.
In September of 2020, the IFRS Foundation issued a consultation paper on sustainability reporting and received feedback that there is a growing and urgent demand for global sustainability reporting standards. In the spring of last year, the IFRS Foundation announced its intent to establish the International Sustainability Standards Board, ISSB. And immediately, the G7 finance ministers and central bank governors all expressed their support for the ISSB. And the International Organization of Securities Commissions has been an enthusiastic supporter of the establishment of the ISSB.
Now, while all this was happening last year, the International Integrated Reporting Council and the Sustainability Accounting Standards Board merged to form what they called the Value Reporting Foundation. And in November of last year, the IFRS Foundation announced that it would work to consolidate the Value Reporting Foundation with the ISSB. The establishment of the ISSB was actually announced in November of last year, and it has offices in Frankfurt, which is the seat of the board and the office of the chair, and in Montreal, Canada.
And so far, only the chair and the vice chair of the ISSB have been appointed. But although the ISSB has not fully formed, it decided to get an early jump on its work. And in March of 2022, the ISSB launched a consultation on its first two proposed standards.
PATRICK WELSH: That's terrific. And those proposed standards are called the exposure draft. So at a high level, what do they propose to require?
ANDREW MACDOUGALL: Well, the first exposure draft sets out the general sustainability reporting disclosure requirements. It's intended to serve as a consistent launch pad for the development of standards on specific topics. And it sets out certain fundamental concepts.
One of these is the determination that information is material for ESG disclosure purposes if it could reasonably be expected to influence decisions that the primary users of financial statements would use and make on the basis of reporting. The importance of this is that it eliminates some of those demands for granular information that special interest groups might want. And it aligns the reporting on sustainability with the interests of those who make capital allocation decisions.
And another aspect of the first exposure draft is that the decision is to require reporting for the corporate group on the same basis as for financial reporting. So if you are reporting consolidated entity's financial statements, you'll report a consolidated entity's sustainability measures. And yet another is the decision to allow for flexibility in the location of where disclosures should be made in accordance with ISSB standards and to permit cross-referencing between documents.
And the second standard is not actually that surprising for it to have been chosen in light of the widespread stakeholder interest in climate change. The second standard is focused on climate-related disclosure requirements. And the climate-related disclosure proposes to require disclosure of certain climate-related information, and it builds on the task force for climate-related financial disclosure final report, TCFD's final report. And well, it's not that surprising that this has been chosen because a large number of companies have already begun to align their voluntary disclosure with the TCFD recommendations. And there's been announcements in New Zealand, the UK, and Japan about requiring public companies to report in accordance with TCFD.
But the exposure draft here on climate disclosure does go into a little bit more detail than what the TCFD report proposed. And it also encompasses industry-specific required disclosure, leveraging the prior work of the Sustainability Accounting Standards Board that focused on developing standards that are relevant to particular industries. So it will be a more meaningful level of disclosure in terms of industry by industry variation than what TCFD might have enabled on its own. And it's also largely taken advantage of thinking that's occurred since the TCFD report came out back in 2017.
PATRICK WELSH: Now, it seems like there's a focus on climate-related issues at the outset and that these appear to be prioritized. Do you agree with that? These drafts are-- there's a distinction between sustainability and climate.
ANDREW MACDOUGALL: That's absolutely correct. I think of all of the ESG issues out there, the one that has really taken hold in consciousness is climate, mostly because of the strength of the imperative. Something needs to be done in order to avert disaster. The fact that climate has been identified as one of the top worldwide risks by the World Economic Forum for multiple years now, and the growing interest both by governments and regulators to focus on this area and by investors, both retail and institutional on the importance of addressing the risks and opportunities as we move through a transition to a lower carbon environment has really made this issue front and center and given it a priority above and beyond other ESG-related topics. So it isn't a surprise that this is the first focus.
PATRICK WELSH: That makes sense, and that's consistent with statements from the ISSB. In particular, ISSB chair, Emmanuel Favor, has stated that if we are told by the IPCC, which, by the way, is the Intergovernmental Panel on Climate Change, which is a body of the UN responsible for advancing knowledge of human-induced climate change, that global emissions should peak at the latest by 2025, then yes, indeed it means that probably a disproportionate amount of effort should be put first on climate, then probably climate-related topics, and then on broader topics of ESG. Do you think it's disproportionate? Or is that an appropriate way to characterize things?
ANDREW MACDOUGALL: Yeah, I think it is probably a fair characterization. It really does need emphasis. In all of these areas, one of the challenges is prioritizing where you're going to devote your time, effort, and resources. And the answer is that climate has moved up on the list of priorities for all organizations and individuals as a result. So I would describe that at--
PATRICK WELSH: And so why is this happening now?
ANDREW MACDOUGALL: So there is a strong and it's a growing demand by investors for investment opportunities that are focused on generating positive investment returns. And they're also looking for investments that generate positive benefits more generally. And while the investment industry is adjusting to this demand, it's a bit of a Wild West out there, with many different rating agencies that adopt inconsistent approaches to gathering and assessing data and applying ratings.
There are also many different investment opportunities that are marketed as being green or ESG investments. But when you look more closely at the portfolios, they tend to align more with a broad-based portfolio of investments as opposed to ones that are truly focused on climate or other ESG elements.
There's also a bit of a disagreement on what constitutes a green investment strategy. Is it an investment in a business that is just carbon light? Or is it an investment in the progressive players of carbon-intensive industries, where the greatest opportunity to make progress on climate actually resides? And all of these various inconsistencies have led to allegations of greenwashing by companies and greenwashing by investment funds.
So a global standard on sustainability reporting should hopefully bring greater consistency, greater comparability, and enable investors to make more informed investment decisions. It may not cover every detail an investor would like, and it won't eliminate greenwashing concerns. But it should help build confidence in ESG reporting and enable companies that are actually making climate and ESG a priority stand out from those companies in their industries that do not.
PATRICK WELSH: I understand, and this wide divergence is becoming increasingly reported. For example, I draw our listeners attention to an investigation by The Globe and Mail that was published in April of 2022 that compared ESG ratings from six different third party, eight ratings agencies, and The Globe found a wide divergence in ratings for some companies. The Globe noted that what gets scored and how often accounts for the difference, it can be unclear in some instances whether ratings are meant to show a company is living up to its environmental and social claims or if investors are adequately protected from financial risk if it doesn't.
Researchers at MIT Sloan School of Management have also researched the divergence in ESG ratings among six providers and have found that correlation among ratings for individual companies ranged from 38% to 71% for an average of 61%. And this is compared with an average of 92% among credit ratings agencies. I understand there's quite a bit of consolidation that these ISSB standards are trying to reflect, you mentioned, TCFD. I understand that SASB is also part or incorporated into these draft standards. Can you briefly discuss some of this consolidation?
ANDREW MACDOUGALL: So there has been a great deal of work to try to pull the standards together. And as I mentioned, some of the organizations have merged their standards deliberately. And these are the organizations that have typically focused more on the information that is useful to investors for making decisions. And that's clearly the primary focus behind the ISSB standards as well, the goal being to reduce at least the volume of different standards out there. And that itself will bring some enhancement to consistency.
Where do we go in terms of this? I do think ISSB is the front runner here in terms of a repository for standards because it's got an existing framework under the IFRS Foundation for accounting. And a good deal of what we're reporting is going to require the utilization of much of the infrastructure behind financial reporting but it being applied now to reporting of metrics that are related to climate.
So there was a great deal of consistency there. The World Economic Forum established a group with the support of all of the accounting firms. And that group is also working with the ISSB for enabling the standards. In fact, I mean, the reason why these standards came out so quickly out of the ISSB is they were largely the product of work that had already been undertaken by the Value Reporting Initiative. And therefore, there was a useful starting point with a great deal of thought and consultation already behind it that the ISSB could leverage.
PATRICK WELSH: It seems like there are so many consultation periods that have either just recently ended or are currently ongoing. So for example, the Canadian Securities Administrators published proposed national instrument 51-107 disclosure of climate-related matters. That comment period ended in January of 2022.
The US Securities and Exchange Commission published proposed rule changes to enhance and standardize climate-related disclosures for investors. That comment period is ending on May 20th, 2022. And as I mentioned earlier, the comment period for these proposed exposure drafts ends in July of 2022 as well. So what should companies be doing now, given all these comment periods and competing comment periods and competing directions?
ANDREW MACDOUGALL: It's important to take a look at where the trajectory is going here. And the Canadian Securities regulators' proposals were very important, sort of moved the dial here. But the ISSB standard actually goes beyond them in many important respects.
And when you think that the Canadian Securities Administrators through their participation in the International Organization of Securities Commissions has been a broad supporter of the ISSB, you can expect that the CSA will need to reconsider their approach in light of the ISSB proposals and will have to think about the timing of when the ISSB proposals might become final. And I could very well see the Canadian Securities Administrators have a desire to try to align Canadian reporting standards with a worldwide standard as articulated by the ISSB. So I think it'll be important from that perspective.
When you look at the US, which has gone its own approach, the proposal is out of the SEC are very prescriptive proposals. And take a slightly different approach from the ISSB proposals. And the US proposals are to require climate reporting from all domestic US issuers and all foreign private issuers in the United States.
They've asked for a comment on whether Canadian issuers that access the US markets through the Multijurisdictional Disclosure System, MJDS, should also be subject to the SEC proposals. And I wouldn't describe the Canadian proposed standards as being frankly comparable to the SEC proposals. I think the SEC proposals go quite a ways beyond where the Canadian proposals were. So I think there's a real risk that the SEC in looking at the Canadian standards as they stand right now or proposed right now would be inclined to subject Canadian issuers to their proposals just like they would with foreign private issuers as they proposed.
However, if the ISSB proposals are finalized, and if they're adopted in some key jurisdictions, then there's also a very real prospect that the SEC proposals will get revised and allow issuers that are foreign private issuers or MJDS Canadian issuers to use the ISSB standards rather than the SEC ones. So coming back to it, I think there's a very good likelihood the ISSB standards will become important for our clients that are interested in accessing the US markets.
And because they're so important, I do think that our clients should take advantage of the fact that these are proposals that are out for comment and consider making submissions to the proposals. These climate disclosure rules are an inevitability, and this is the best opportunity that companies have to ensure that standard setters are informed of the company perspective. We can happily help companies with making such submissions.
PATRICK WELSH: And what other types of ESG disclosure-related questions are you seeing from clients, Andrew? Is there uptake on these comment requests? Do these questions-- are they situated in different contexts? What are you seeing on the ground?
ANDREW MACDOUGALL: So ESG has clearly hit the boardroom table. And we are also seeing increased ESG disclosure from our clients. In this year's proxy circulars, for example, clients have not only addressed the mandatory diversity disclosure requirements that are applicable to TSX listed issuers and companies incorporated under the Canada Business Corporations Act, but many of our clients have described how ESG considerations are incorporated into their board and management governance practices and disclosed that in their proxy circular.
Our clients have also been revising their board mandates and the charters of their board committees to specifically address ESG considerations, such as climate change that may not have been specifically referenced before in their framework. At the same time, our clients are also increasingly consolidating and expanding their reporting on ESG matters in separate ESG reports that they're providing on a voluntary basis. And they are subjecting those reports to a far more rigorous review than they were. So we are looking at quite a number of these ESG reports.
And, Patrick, there-- it's surprising the number of common errors that we see over and over again in these reports. For example, often these reports contain forward-looking information. They've got targets or goals that they are seeking to achieve in the next year, 5, 10 years or climate goals that stretch up to 2050.
But the report often fails to include a cautionary statement about forward-looking information, or it does. It includes the same cautionary statement that is used for financial reporting instead of revising that to reflect the nature and the purpose of the disclosure contained in the ESG report. Often, we also see hyperbolic language. Companies are fond of trumpeting their successes.
But ESG is a journey. And it's a journey of continuous improvement. And the language has to be reflective of the recognition that things can and should continue to progress. So it's important to not state that you've reached the pinnacle when there is another mountain to climb. And also, the language has to avoid describing a standard that the company simply won't be able to live up to. There are people that are reviewing disclosure out there, and they will look at these statements and will take advantage of that in social media to point out inconsistencies between the company's actual practices and what its stated practices are.
And one of the other areas that we typically focus on is the importance of flagging that the standard of disclosure in the ESG report differs from the standard of disclosure that's being used for financial reporting. In particular, what is worth disclosing in the ESG report is made on a basis that's different from the assessment of whether information is material for reporting under securities laws.
And lastly, there is an over tendency in this-- I think this is frankly human nature to focus on all the good news but failing to, at the same time, acknowledge that there are areas of weakness or that there are areas that haven't received as strong a priority. And it is important to acknowledge that there were choices being made here. A report that's all sunshine and rainbows is not nearly as credible as one that acknowledges the hard choices that have to be made in allocating time, energy, and capital to ESG matters.
So there's a great deal of value from obtaining an external legal perspective on disclosure. And it can often be important to buttress external counsel's views on the appropriateness or not of disclosure if a viewpoint from external counsel is provided because there can be internal resistance to changes in the language that have been drafted by people that have been involved in producing the report. And so we can add some value from that perspective as well.
PATRICK WELSH: That makes sense. Companies are trying to do the right thing by disclosing or even making statements about their ESG initiatives, but it is not without risk.
ANDREW MACDOUGALL: You're quite right in that there needs to be a greater focus on the fact that the disclosures that are being provided here are publicly available disclosures subject in the case of a publicly traded company to the same standards of liability that exists for all of their public disclosure, whether it's in a core document for financial reporting purposes or outside of a core document. And in addition, people need to be sensitive to the fact that social media really does enable dialogue to occur with individuals that are very much focused on holding companies accountable for the statements that they make. And those individuals will flag the inconsistencies between a company's stated position and its actual practices.
PATRICK WELSH: That's helpful considerations, Andrew. Now, as we've talked about throughout this episode and we will continue to talk about, this is a rapidly evolving area. There are a plethora of resources out there, as you mentioned. Do you have any recommended reading for our listeners? What's your best source for ESG-related information?
ANDREW MACDOUGALL: So to get a good introduction into the area, I do think it's worth taking a look at, from a climate perspective, the booklet published by the World Economic Forum on how to set up effective climate governance on corporate boards. I think it gives you a very good introduction. The Climate Governance Initiative has also issued a primer on climate change, directors' duties, and disclosure obligations that's worth looking at.
And then the Institute of Corporate Directors and Chapter Zero Canada have actually created a course on climate change that is designed to build directors' climate competency and equip them with knowledge and tools and strategies for dealing with climate. The Toronto Stock Exchange has a very good publication that provides an introduction into ESG reporting that is also generally available.
Those are all good publications worth taking a look at. They give you the higher level approach and thinking to approaching the topic. And I think that's an important basis because you have to start from the higher level, and then work your way down into the details rather than responding to every single little detail that somebody might be requesting in some a survey or other requests that the company may be receiving.
PATRICK WELSH: Great suggestions, Andrew. And on that note, as we mentioned, the ISSB is itself has requested comments to be provided by the July 29th, 2022. The ISSB has indicated that they plan on considering comments in the second half of 2022 and are aiming to finalize the requirements by the end of 2022. So it sounds like there is a lot to look out for in the near term and that I expect that you and I will be having more conversations on these topics in the days, months, and years to come.
ANDREW MACDOUGALL: This is a rapidly evolving area, Patrick. So there is definitely going to continue to be more conversations and focus on it.
PATRICK WELSH: Fantastic. Well, thank you very much again for your time, Andrew. And thank you for listening, everyone.
Thanks for listening to this episode of the Osler ESG Explorer podcast. This podcast is presented by Osler, Hoskin, and Harcourt LLP, a leading national law firm with a singular focus-- your business. We advise clients on an area of domestic and cross-border legal issues, drawing on the expertise of over 400 lawyers to provide the answers you need when you need them.
To access any resources discussed in today's episode and to listen to other episodes, visit us at osler.com. Be sure to listen and subscribe to the ESG Explorer podcast on Apple, Google, or Spotify. Until next time, I'm Patrick Welsh.
The content in this podcast is for general information only and does not constitute legal or other professional advice. Specific advice should be sought in connection with your circumstances. The views expressed are those of the guests and participants and not those of Osler, Hoskin, and Harcourt LLP. For more information about Environmental, Social, and Governance matters, please visit our website at osler.com