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How European and global sustainability standards for corporate reporting can and will converge

Richard Howitt  Senior Advisor / Frank Bold

· 6 minute read

Richard Howitt  Senior Advisor / Frank Bold

· 6 minute read

The drive for global sustainability standards for corporate reporting remains strong, even as full convergence remains elusive

The roadmap to global sustainability standards has evolved very quickly over the past two years. Indeed, the pace of movement from the work of the Technical Readiness Working Group on prototypes towards the formation of the International Sustainability Standards Board (ISSB) and then to proposed requirements issued for public comment has been remarkable. In contrast, it took international financial reporting standards a decade to take hold.

In addition to the convergence of sustainability standards with the ISSB, the European Union also has moved quickly. Indeed, the ISSB and the EU are the two primary frameworks where stark variations exist. As with financial reporting, investors are intended to be the primary users of reports produced under ISSB standards, whereas the European standards seek reports aimed at both investors and a wider range of stakeholder groups.

Yet, both parties’ demand for uniform standards is high, and the drivers for convergence and divergence remain strong.

The conception for the ISSB is that it will form a common baseline of standards to ensure consistency and comparability around the world. Different regions could add standards according to this approach — including Europe — where they have different policy goals. The ISSB is seen to be very much driving the development of the new sustainability standards.

Forces of divergence

Drivers of divergences build out from the differences in the core purpose and audiences. ISSB is exclusively focusing on investors, while the EU is taking a broader approach. This difference runs through other factors driving divergence, such as:

      • Definitions of materiality — The different definitions of determining the materiality in what should be reported by companies between the European and global standards have been seen by some as the biggest obstacle between the two. European standards are being developed based on the double materiality principle, where disclosure is required both from the point of view of financial impact on the company and on the impact of the company on society and the environment. To put it simply, the global standards are based on an enterprise value creation or financial materiality approach, in which sustainability impacts are measured in terms of the effects on the financial position and prospects of the company itself.
      • Differences in standards — The Big Four accounting and consulting firm EY has said that it believes divergence to be inevitable, pointing to the stricter environmental and social standards which exist in Europe compared to the rest of the world. This perspective suggests that the European approach is needed to secure higher standards, whereas the need to secure acceptance across the world puts the global standards at risk of being drawn to the lowest common denominator.
      • Areas of initial focus — The ISSB has made an explicit commitment to starting with climate disclosures, whereas the EU is seeking a more comprehensive approach, putting emphasis on the interdependence between different environmental, social and governance (ESG) impacts from companies, while also providing a robust climate standard itself.

Forces of convergence

The accelerated pace towards standard-setting for corporate sustainability reporting is a result of both the urgency of sustainability challenges and in particular in a huge change in investor opinion in favor of making it happen. In a survey commissioned while I was at the former International Integrated Reporting Council, no fewer than 82% of investors supported standardized sustainability reporting backed by regulation.

This pressure is not simply for standardization as a process, but it will be exerted on both the ISSB and the European Union in finding consistency between each other in achieving it.

Moreover, by 2025, one-third of global investment assets and more than half of European-based assets are predicted to be in dedicated ESG funds, where understanding sustainability performance is key not simply for better risk assessment, but to a clear requirement for what beneficiaries need and expect. In addition, expect the science of measuring impact and of linking it back to financial performance to further develop at pace, which means old uncertainties about the reliability of sustainability information and overall information integrity are fast disappearing.

The apparent disparity between regulatory forces behind the two initiatives may also be smaller than first appears. The International Financial Reporting Standards Foundation was chosen as a home for international sustainability standards, precisely because its financial reporting standards are already adopted in 144 countries worldwide. Finance Ministers and Central Bank Governors from 40 countries — ten of which were from within Europe — welcomed the formation of the ISSB. Regulators as much as investors, may be a force for convergence.

Three models to convergence

Three models to secure greater consistency and collaboration between the European and global standard-setting initiatives exist to move forward. These include:

1. Cooperation model — Reasonable options to encourage cooperation between the ISSB and EU under a cooperation model include: common intellectual property; joint consultations to coordinate both the timing and some of the content of their respective consultations; or the negotiation of a high-level agreement to commit to collaboration, in order to clarify and agree to their respective roles.

2. Governance model — At the same time, the two bodies could take action to move to a governance model. This would involve developing respective conceptual frameworks for both initiatives in close collaboration, creating a joint technical coordination mechanism, or establishing an independent mechanism for assessing equivalence between the different sets of standards. This should also include the ability to resolve disputes between them.

3. Path to convergence model — The ISSB and EU could also put forward a path to convergence, and there are multiple ways to do so. First, both could agree to an explicit commitment to convergence. Another option is around the concept of interoperability, which simply means that standard-setters work for the two sets of standards to be as complementary as possible. Finally, they could commit to a principle of reciprocity, which would focus on mutual respect, the desire for complementarity at all levels, and a commitment to mutually self-supporting actions.

In conclusion, never forget that the benefit of standard processes comes only in that they are used. It is the acceptance of a standard, which is necessary for its existence.

You can learn more about sustainability standards in corporate reporting here.

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