Kreston Global ESG Committee member, Head of Technical and Compliance at Duncan & Toplis
Stuart is a FCA qualified chartered accountant with more than 10 years of practical accounting and audit experience.
He leads the technical developments for Duncan & Toplis. This covers audit, financial reporting and maintaining quality of work.
He has recently been appointed to Duncan & Toplis’ operations board and become a member of the ICAEW’s influential Ethics Advisory Committee. Stuart also sits on the Kreston Global ESG Committee.
ESG in 2023: how the latest regulation changes affect accountancy and audit
January 19, 2023
Both nationally and globally, standards are being developed to make ESG reporting accurate, consistent and reliable.
With global temperatures in 2022 hitting record levels, and existing inequalities deepening as a result of economic crisis, the need to take action on environmental, social and governance (ESG) issues is ever more pressing.
Accountants will need to meet those regulations depending on their jurisdiction, as well as respond to demand for rigorous scrutiny of organisations’ ESG performance.
Historically, a major challenge for ESG reporting has been a lack of consistent, agreed standards. In 2021, EY estimated that the number of ESG regulations and standards had nearly doubled in the previous five years, with more than 600 provisions in place globally.
Without a clear and comprehensive standard to follow, it’s hard to compare and effectively assess organisations’ ESG performance – or to be certain that the information they report is based on sound data. Among other challenges, this has led to the problem known as ‘greenwashing’, where companies misrepresent their ESG credentials (knowingly or not) to appear more environmentally and socially responsible.
But developments are underway to manage this.
Two major sets of ESG standards are currently in development: the European Sustainability Reporting Standards (ESRS) in the EU, and two new International Financial Reporting Standards (IFRS), applying internationally.
With both expected to be finalised in mid-2023, this should help to pull together requirements from different advisory bodies, so that ESG reporting is more consistent and accurate.
Regulation has been developing elsewhere, such as the guidance introduced by the UK’s Taskforce on Climate-related Financial Disclosures, as well as new rules proposed by the Securities and Exchange Commission in the US. But for the purposes of this article, we’ll focus on ESRS and IFRS S1 and S2.
ESRS includes 12 draft standards in total, two of which cover general requirements, while the other 10 focus on specific ESG matters.
These take what’s known as an ‘inside-out’ approach to reporting, looking not only at the financial impact that ESG matters might have on an entity, but also at the impact its own activities have on the wider environment or a wider scope of stakeholders.
To reflect this, they use the concept of ‘double materiality’ to determine which information companies must disclose. This includes impact materiality (issues that affect the wider world) as well as traditional financial materiality (issues that affect the company’s value).
In November 2022, the EU Council approved the corporate sustainability reporting directive, which requires certain entities – making up about 50,000 companies in total – to disclose detailed information on their ESG impacts in line with ESRS.
We can expect the standards to become mandatory for more companies in the years to come. At this stage, it also looks like entities that operate in the EU will be included if they meet certain criteria, even if they’re based outside of it.
The International Sustainability Standards Board (ISSB) has drafted two standards, IFRS S1 and S2, covering general and climate-related disclosures.
Compared to ESRS, these standards take more of an ‘outside-in’ approach, focusing mainly on the financial impact of ESG matters on an entity’s enterprise value. These only use traditional financial materiality.
These international standards will not be mandatory – instead, requirements will be mandated by individual jurisdictions.
When these standards come into force, accountancy firms will need to meet the ESG reporting requirements that legally apply to their jurisdiction.
That’s the absolute minimum firms will need to do, and it won’t apply to all businesses at once – but in reality, stakeholders will start to put pressure on firms of all sizes and all industries to report their ESG activities, and operate their business in an ESG-positive fashion.
Mid-tier accountancy firms are already starting to see more and more questions from potential new clients asking what ESG policies and procedures they have in place, and to back up those policies and procedures with data.
For example, take a large entity that has detailed ESG policies in place and needs to report on its wide-scope carbon emissions. If that entity is looking to appoint a mid-tier firm as its auditor, it would want to know as much as possible about that firm as one of its suppliers.
Firms also need to ensure that their knowledge of ESG reporting requirements is up to date so they can advise their clients. This is an ever-growing area, and firms will miss an opportunity if they cannot provide this service.
Accountancy firms – and auditors especially – are also well-placed to support businesses in their efforts to avoid greenwashing. Auditors are used to critically analysing information, taking a sceptical view where needed, and reporting their findings and opinions. They may already be highlighting ‘other information’ that they know is not consistent with financial data as part of the audit report.
These skills are key to preventing exaggerated or inaccurate environmental reporting.
Greenwashing isn’t always intentional, so firms can help to advise their clients on what might be classified as greenwashing and steer their reporting away from it – another much-needed service for increasingly ESG-conscious clients.
Get in touch to talk about how ESG regulation is changing audit reporting.