In recent years, the global focus on transitioning towards a sustainable economy has prompted governments, international organizations, and NGOs to develop Environmental, Social, and Governance (ESG) regulations, frameworks, and standards to encourage companies and investors to operate more sustainably and responsibly.
However, the rapid growth of these ESG-related directives presents a complex landscape for companies and investors to navigate, highlighting an urgent need for harmonized guidelines, simplified compliance procedures, and interoperability, or the possibility to leverage the same baseline information across multiple ESG regulations, standards and frameworks.
The real test lies in how seamlessly these ESG frameworks communicate with each other globally, facilitating the adoption of non-financial reporting and creating the conditions for more impactful sustainable finance policies.
Challenges of diverse ESG frameworks
According to a report published by EY, there are over 600 ESG reporting frameworks worldwide, applying varied interpretations of sustainability.
Companies, investors and other stakeholders face multiple challenges in this multifaceted landscape:
Lack of standardization
There’s a lack of standardization and interoperability across different ESG frameworks and standards, which creates significant challenges for all market participants. Different interpretations and methodological approaches across regions creates a patchwork approach, which limits the overall effectiveness of regulatory regimes.
Reporting under multiple frameworks
Companies and investors might be required to report under multiple frameworks, depending on their jurisdiction. This will be true almost for all globally operating companies.
Having to report under multiple frameworks means that companies might have to collect the same data multiple times due to differing methodologies adopted by different frameworks.
Comparability of information
The information disclosed is often not comparable between companies due to non-standardized reporting frameworks. This lack of comparability challenges investors and other stakeholders in assessing and comparing ESG performances across different companies.
Interoperability Efforts in the EU
These challenges noted above are on the radar of various global regulatory bodies and standard setters, and there are indeed efforts underway to improve interoperability, with Europe taking recent steps to streamline its constellation of ESG regulatory regimes. As part of its regulatory efforts to build sustainable finance marketsThe EU has taken active measures by introducing regulations like the Sustainable Finance Disclosure Regulation (SFDR), the Corporate Sustainability Reporting Directive (CSRD), and the EU Taxonomy, all aimed at guiding financial markets towards a more sustainable and transparent allocation of capital.Given market feedback around a general lack of alignment between many of these regimes, the EU regulatory bodies have spent 2023 focused on creating linkages between the data collection and reporting exercises that are core to each regulation.
A key effort is the work to improve the interaction between the SFDR and the EU Taxonomy technical screening criteria, particularly regarding the Principle Adverse Impact (PAI) indicators. For instance, the European Supervisory Authorities (ESAs) have proposed adjustments to the PAI indicators to align them with other sustainable finance legislation, like the EU Taxonomy and Climate Benchmarks Regulation.
On a wider scale, the EU is moving towards global interoperability of ESG standards. The European Commission’s adoption of the European Sustainability Reporting Standards (ESRS) is a testament to this effort. The European Financial Reporting Advisory Group (EFRAG), responsible for delivering the ESRS, has worked closely with the Global Reporting Initiative (GRI) to ensure a high degree of interoperability between the ESRS and the GRI standards. The aim is to simplify reporting processes through a digital taxonomy and a multi-tagging system, reducing the burden of “double reporting” for companies.
Moreover, the UN Principles for Responsible Investment (UN PRIs) have also encouraged EFRAG to improve the alignment between the ESRS and the International Sustainability Standards Board (ISSB) standards to reflect their similarities in content, as well as suggesting a TCFD-aligned presentation option for sustainability reports. Lastly, the UN PRIs have asked EFRAG to adjust the ESRS to require compliance with the UN Guiding Principles on Business and Human Rights.
All of these efforts underscore the efforts toward harmonizing ESG regulations within the EU, and establishing interoperability with other globally recognized standards, such as the GRIs.
Global efforts towards ESG interoperability
Outside of the EU, global regulatory bodies are taking steps to align their ESG frameworks with international standards, promoting a favorable environment for adoption of these disclosure practices.. Among them, India, the UK, the US, and China are making significant progress, each working towards ESG interoperability in their own way.
India is making moves with the Securities and Exchange Board of India (SEBI) updating its Business Responsibility and Sustainability Report (BRSR) to match global standards. This change brings it in line with international sustainability reporting frameworks like the GRI, TCFD, and the Sustainable Development Goals (SDGs).
In the UK, there are various frameworks coming into play as part of their Green Finance Strategy, such as the Sustainability Disclosure Requirements (SDR), UK Green Taxonomy, and other transition plans. As part of their strategy, these frameworks will aim to align with international standards, such as the SDR alignment with the ISSB standards once published in 2024.
Across the Atlantic, the US, Mexico and Canada are also working on sustainable taxonomies, climate risk guidelines, and ESG disclosure regulations. For example, in the US the Securities and Exchange Commission (SEC) is poised to introduce a Climate Disclosure Rule, which is broadly aligned with internationally recognized standards, such as the TCFD.
The integration and interoperability of ESG frameworks are essential for helping companies, investors, and other stakeholders navigate the complex landscape of sustainability reporting. As more countries and international organizations work towards harmonizing ESG standards, the goal of achieving a sustainable economy will eventually become more attainable.
This being said, complete standardization and interoperability is unlikely to be achieved overnight.
In the meantime, different technology solutions have demonstrated their potential to bridge this gap. One significant avenue through which technology can expedite progress is through the AI-powered extraction of data and the pre-population of reports required under different frameworks, standards, and regulations.
This is an area where the potential contribution of generative AI powered by large language models can prove invaluable. AI systems can identify and categorize ESG-relevant information from ESG existing documents and reports, and use them to generate outputs that are tailored to your specific reporting standard or framework of interest.
The global push for a sustainable economy has led to the proliferation of Environmental, Social, and Governance (ESG) regulations and frameworks, creating a complex landscape for companies and investors. The main challenges include the lack of standardization and interoperability, multiple reporting requirements, data collection inefficiencies, limited comparability of information, and regulatory divergence between regions.
While significant efforts are being made in the European Union to improve interoperability among ESG frameworks through regulations like the Sustainable Finance Disclosure Regulation (SFDR) and the European Sustainability Reporting Standards (ESRS), on a global scale, countries like India, the UK, the US, and China are also working towards ESG interoperability by aligning their regulations with international standards.
In spite of these positive trends, achieving complete standardization and interoperability in this fragmented landscape will take time. Technology, particularly AI-powered data extraction, can play a crucial role in bridging the gap and facilitating the transition to a more sustainable economy.