International sustainability and ESG (Environmental, Social, and Governance) standards are in the works.
At the behest of G20 leaders, the IFRS (International Financial Reporting Standards) Foundation has created a global baseline of disclosure obligations, requiring companies to document their sustainability information and resilience to climate risks and opportunities.
They are seeking feedback on their draft proposals until July 29, 2022, and are targeting implementation by the end of the year. All comments are available to view on the IFRS website.
If adopted by the Canadian Securities Administrators, all publicly traded companies in Canada will be bound by the requirements. This will be onerous, time consuming, and costly; therefore, companies must get prepared.
There is no escaping, even for privately held companies. Beginning in 2024, the Canadian federal government will require that banks and insurance companies disclose climate-related risks and exposures, including that of their clients. Canadian banks have also set emissions reduction targets for their energy portfolios, burdening oil and gas companies with an obligation to disclose sustainability and climate data.
The Cost of Disclosure
The concern about increasing climate-related disclosure requirements is real. In addition to the time and people resources needed, a recent study noted that corporate issuers on average are spending $677,000 per year on climate-related disclosure activities, with the largest cost categories including greenhouse gas (GHG) analysis and disclosure ($237,000 on average), climate scenario analysis ($154,000) and internal climate risk management controls ($148,000).
Institutional investors are spending on average $1.372 million annually to collect, analyze, and report climate data. The major spend categories for the investors included external ESG ratings, data providers and consultants ($487,000 on average), in-house, outside counsel, and proxy solicitor analysis ($405,000) and internal climate-related investment analysis ($357,000).
This is in line with the US Securities and Exchange Commission’s (SEC) own estimates of the costs to comply with its new requirements. They predict first year costs of $640,000, and ongoing costs of $530,000 per year.
Potential risks to the oil and gas industry include:
1. The overall compliance costs of mandatory sustainability disclosure will be burdensome, especially for small- to medium-sized businesses.
2. The cost of assurance or audit requirements.
3. Investment in emissions-intensive industries could be deterred.
4. Mandatory emissions reporting – Scope 1, 2 and 3 – will be onerous and will increase liability if there are material gaps or misstatements in reported data or missed targets.
5. Integrated reporting, requiring sustainability information be reported at the same time as the financials, will set strict deadlines that cannot be moved.
The Benefits of Global Sustainability Standards
If done well, the IFRS Standards have potential to create reporting consistency allowing for ease of comparability. Currently, with only voluntary standards in place, companies can choose which standards they use and which topics they want to report. This sometimes, rightly, leads to accusations of cherry picking and greenwashing.
International standards will provide a roadmap for sustainability disclosures, helping companies navigate their new, often uncertain, ESG journey.
If every company and industry is judged equally and fairly, Canadian oil and gas has an opportunity to showcase that it is being a good corporate citizen and is working to improve its already stringently regulated environmental practices. Although, there is an overt bias in the Standards against fossil fuels.
Disclosers are required to explain how sustainability-related risks and opportunities are linked to information in the general-purpose financial statements. This will obligate disclosure of assumptions, estimations, and uncertainties in the data. Presumably highlighting known, but not talked about, issues with wind and solar energy.
Having standardized rules gives businesses and investors certainty. Consequently, comprehensive information helps inform and build trust in the information reported.
Issues with the Proposed Standards
“Sustainability” is not clearly defined. Without an agreed upon definition of this important term, it will be a challenge for companies to confidently disclose their sustainability and ESG information without fear of liability from unintentional errors.
The oil and gas industry should be paying particular attention to the requirement to measure and report absolute gross (not net) Scope 1, 2, and 3 emissions, as well as the intensity of those emissions, calculated using the Greenhouse Gas Protocol. Upstream and downstream Scope 3 emissions are typically a company’s largest source of emissions as they are indirect and outside their control. For those involved in oil and gas production, Scope 3 includes the combustion of the product by consumers.
For a company to be able to state compliance with the IFRS Sustainability Disclosure Standards, the company must comply in its entirety. Ignoring Scope 3 emissions will jeopardize compliance and may put the company offside of the securities regulators.
Although, it isn’t apparent what the consequences will be for companies that don’t meet their future targets, there may be legal implications. There has been a rise in climate-related shareholder activism and ESG-related litigation in the United States and that could be exacerbated by these global Sustainability Standards.
The Standards are industry-specific, which means that energy, and oil and gas in particular, have a higher likelihood of being targeted with stringent reporting requirements compared to industries deemed more desirable or progressive, such as wind and solar.
Scenario analyses, computer climate simulations, are a component of the ClimateDisclosure Standard. These are a costly exercise, upwards of six figures, that require companies to have a crystal ball to peer into the future to determine how their business will be impacted by climate change.
The requirements for ESG and climate-related disclosures are becoming more and more burdensome and costly; therefore, it is important for companies to have a say. The opportunity to provide feedback and influence the final IFRS Sustainability Standards is open until July 29, 2022.