ESG reporting needs a refresh. Here’s how to fix it

The opinions expressed here by Trellis expert contributors are their own, not those of Trellis.​

In North America and Europe, there’s a battle regarding sustainability reporting and compliance. Opponents say onerous regulations will reduce profitability, while proponents claim that, left to their own devices, companies will ignore important societal goals such as tackling global warming, water pollution or health and safety issues.  

According to our research, both sides are right and wrong. We’ve examined the Sustainability Accounting Standards Board (SASB) standards (part of the International Sustainability Standards Board) and the Corporate Sustainability Reporting Directive (CSRD) to understand whether these standards can drive better societal performance and drive better financial performance.  

In general, reporting and compliance regulations aim to ensure that everyone in the business ecosystem plays by the same set of rules and that there’s accountability for how those rules are followed. In the best of worlds, those standards help improve corporate performance on a wide range of issues, from providing credible data to investors to reducing harmful toxic emissions.  

Unfortunately, our research finds that most ESG reporting requirements focus on outputs rather than outcomes and eschew targets. 

Our SASB findings 

With SASB, our report identifies three main challenges as currently constructed:  

• Most reporting metrics are activities/outputs rather than outcomes
• Most metrics are neutral or risk-focused rather than opportunity-focused 
• ESG reporting metrics neither integrate financial performance nor provide guidance on how to understand and drive better financial performance

Many companies and investors treat these metrics as the full scope of their sustainability efforts, but their design makes real progress unlikely. Our assessment shows that roughly 95 percent of SASB metrics focus on processes or outputs rather than measurable outcomes. Such activity-based measures reveal little about whether actions create societal or financial impact. For example, chemical companies must disclose how they engage with communities, yet this requires no specific actions or tracking of health outcomes.

The coal industry, for example, is required to report its Scope 1 emissions and the percentage covered under emissions-limiting regulations. It’s also required to “discuss” a strategy to “manage” its emissions (note, it does not say reduce) as well as set targets and discuss performance (all of which comes under discussion, so targets and performance reporting is not required). The industry isn’t required to set a target for reducing emissions, nor is it required to provide a baseline or show a link between reduced GHG emissions and lower energy costs, lower carbon fees and other financial metrics. So what can companies and investors really learn from this reporting?  

Our CSRD findings

The CSRD aims to better inform stakeholders by mandating double materiality and scenario planning. Both steps require strategic review of which ESG topics might drive better or worse financial performance as well as societal performance, which is a plus. However, our analysis finds different challenges with CSRD’s methodology:

• Its 1,000-plus required data points threaten to overwhelm users with immaterial information
• It lacks sector-specific standards (although there are plans to create them)
• Just five metrics explicitly measure positive financial outcomes rather than risk mitigation 
• It doesn’t provide a methodology or definitions for impact/risk/opportunity
• It doesn’t require targets   

These shortcomings inadvertently foster a lack of performance-based KPIs which would then limit sustainability-linked impact and value creation for companies and undermine the intended objectives of CSRD and other European reporting standards. 

While the regulation aims to enhance transparency and accountability for a company’s material impacts, it doesn’t mandate that companies set outcome-oriented targets. Instead, it requires disclosure only for targets that companies have already established. For any targets set, the regulation imposes a set of minimum disclosure requirements, including the nature and scope of the target, baseline value, baseline year, milestones and interim targets. 

So if a transportation company sets a target of 15 percent emissions reduction in five years, they would need to specify where the reduction is expected to take place, disclose the baseline emission levels and set annual target reductions. This would be useful information, although still not tied to financials (an ongoing weakness). However, if no such emission reduction target is set, these additional disclosures aren’t required. Therefore, the standard may actually disincentivize target setting as companies aim to avoid additional disclosure that could expose them to risks.

What practitioners can do 

As a result of these ESG reporting shortcomings, companies may collect data that’s not useful for making decisions. In fact, a common refrain at companies today is, “We need to spend our money on reporting, so we cannot spend money on sustainability execution.” In what world does this happen? In a world where metrics don’t require demonstration of performance or execution.  

Our dual reports on the two standards provide specific recommendations for improvement to both standard-setting bodies. At a high level, we recommend:

• Performance-based targets should be mandated for the most material impacts, risks and opportunities. These should include a baseline.
• Financial performance KPIs — both opportunities and risks — should be required and aligned with the most material targets.  

Even if reporting standards don’t improve, practitioners can still shift sustainability reporting from an onerous compliance checkbox to a strategic business exercise, by following the above recommendations and then mapping their sustainability KPIs to ESG reporting metrics. The following is an example which illustrates the proposed financial upside of decarbonization through improved energy management practices.

In summary, to make ESG reporting meaningful, standards must require outcome-based targets and aligned financial KPIs that clearly link sustainability performance to business value.