Enhancing disclosure: the road to improved ESG reporting

The issue of ESG (Environmental, Social and Governance) has grown from a niche concern for oil and gas companies to an increasingly central issue over the last few years.

ESG issues were first mentioned in the UN’s Principles for Responsible Investment (PRI) in 2006. 

The PRI aimed to provide a voluntary framework to allow investors to better align their portfolios with ESG issues such as climate change and human rights.

In 2009, following the financial crash, the G20 established the Financial Stability Board (FSB) – an international body tasked with preventing a repeat of the crisis. 

And in 2015, the FSB created the Task Force on Climate-related Financial Disclosures (TCFD) to improve the reporting of climate-related financial information. 

The formation of the body coincided with the signing of the Paris Agreement, the first time nations had agreed to try and limit the global temperature increase to 1.5°C above pre-industrial levels.

Promoted by then Bank of England Governor Mark Carney and former mayor of New York Mike Bloomberg, the TCFD warned repeatedly that lack of visibility on climate risk posed a serious risk to the global economy. In 2017 the body issued recommended disclosure guidelines for companies in an effort to mitigate this risk. 

Firms such as BlackRock endorsed the principles of the TCFD, signaling to regulators and listed oil and gas companies that investors were serious about the issue.

Subsequently European and US regulators began to require firms to report on ESG in annual sustainability reports and regulatory filings. 

“In recent years we have seen a welcome move away from voluntary commitments, initiatives and common frameworks towards increased regulation and scrutiny,” says Amir Sokolowski, Global Director of Climate at non-profit the Carbon Disclosure Project (CDP).

Regional disparity

In 2023 the EU’s Corporate Sustainability Reporting Directive (CSRD) entered into force. It requires listed companies to report in detail on emissions, pollution, water usage, workers, affected communities and business conduct from 2024.

Meanwhile, in the US, oil and gas firms are currently operating under a regime developed by the Department of Labor that requires them to consider climate alongside other business risks. 

“The basic rule is that if there’s a risk to your company, a factor that potentially impacts it in a material way, you have an obligation to disclose it to the public and to shareholders,” says Rachel Goldman, a partner with Bracewell LLP, a US law firm that specialises in ESG issues.

Over the past two years US financial regulator the Securities and Exchange Commission (SEC) has been developing a new set of rules for US firms, designed to align them with the more stringent disclosure requirements in the EU. 

The rules were published in draft form last year but were the subject of strong resistance from the oil and gas industry. Their publication has been delayed as a result, with the latest schedule suggesting they will be released some time in the first half of 2024.

“There probably will be a rule that comes from the SEC, but it will likely be modified with specific components left out, such as certain requirements for Scope 3 reporting,” says Goldman.

 Scope 3 reporting – the obligation for firms to report on the emissions of the products they sell – has been the most contentious issue in the SEC proposals.

Elsewhere in the world, corporate reporting is less developed. A recent study by the Institute for Energy Economics and Financial Analysis (IEEFA) found that only 11 of the top 20 oil and gas producing companies in the Asia-Pacific region had net zero targets. Setting such targets is the first step companies take before reporting their progress against them.

Firms in the Asia-Pacific region have been subject to much less societal and investor pressure to report on climate risk, partly because the economies in which they operate are more dependent on fossil fuels, partly because they are often state-run, and partly because they are less reliant on debt finance than those in the US and EU.

The Road Ahead

An increasing focus on energy security as a result of the war in Ukraine has led to some back-sliding on climate issues from EU and US firms. 

BP – one of just a handful of majors to have set a Scope 3 emissions reduction target – announced plans to scale back its 2025 target from a 20% reduction to a 10-15% reduction and the 2030 target from a 35-40% reduction to a 20-30% reduction. Shell also reversed its plan for oil and gas production cuts. 

Some majors have also been taking an increasingly aggressive stance towards activist investors. 

These investor groups have taken stakes in firms such as Shell, BP, Chevron, ExxonMobil and TotalEnergies, using shareholder resolutions to force votes on ESG issues.

In 2021 activist investor Engine No 1 managed to replace three ExxonMobil board members with its own directors in an effort to get the firm to reduce its carbon footprint. 

But ExxonMobil has recently gone on the offensive, filing a lawsuit against two activist investor groups – Follow This and Arjuna Capital – claiming their resolutions breach SEC rules. 

Threatening investor confidence

Meanwhile on the lender side, US ESG-oriented equity funds saw their first ever calendar year of outflows last year, as investors pulled more than $5bn in the fourth quarter, according to a report by ratings agency Morningstar.

“Continued political scrutiny of sustainable and ESG strategies contributed to a chilling effect on demand for these funds,” says the Morningstar analysis.

Republican politicians have made a series of proposals in Congress to overhaul the Department of Labor rules on ESG climate disclosure – one of which was subject to a presidential veto from Joe Biden.

If a Republican president were elected later this year, the existing US ESG disclosure regime would be unlikely to be protected by such vetoes. 

But whatever the political headwinds, the increasing awareness amongst asset managers of the risk that climate represents to the economic bottom line is unlikely to change, according to Goldman. 

“There can be backlash, but asset managers are not likely to invest significant amounts into a company that doesn’t adjust for the energy transition,” she says.

Sokolowski adds that the CDP’s data shows that investors are more engaged with the issue than ever. In 2023, more than 740 leading financial institutions, representing over $136 trillion in assets, requested companies disclose according to CDP guidelines.