Antonia comes to JLK Rosenberger on secondment as part of the PKF Global Opportunity (PKF GO) program. Her education and specialization at her firm in Dusseldorf, Germany, focus on corporate sustainability and reporting, ESG research, and consulting. Her background provides a unique EU perspective on ESG.
Corporate reporting on environmental, social, and governance (ESG) topics is gaining more attention across industries and the world as regulators, and different stakeholders demand more transparency from companies to disclose their current and future impact on the environment and society. According to the 2021 AM Best Report entitled US Insurers’ Perceptions of ESG, between 40% and 50% of insurers in the United States actively engage with ESG. Additionally, it was found that approximately 60% of the US reinsurance industry seeks greater clarity from regulators, particularly with respect to identifying, measuring, and reporting ESG factors.
However, opponents question the value of ESG reporting and criticize that it contributes to greenwashing. One recent example is the Utah, Texas, Louisiana, and West Virginia against the Securities and Exchange Commission (SEC) regarding the ESG proxy disclosure rule for investment companies.
Initiatives such as the Net-Zero Insurance Alliance (NZIA) state that insurance companies play an important role in transitioning to a net-zero global economy through underwriting practices and products. Its initial 29 members committed to transitioning their insurance and reinsurance underwriting portfolios to net-zero greenhouse gas emissions by 2050. Facing political pressure and antitrust risks, nine members, nearly 1/3 of the total membership, have exited the alliance since March. This includes the world’s largest reinsurer, Munich Re, as well as Zurich Insurance, Hanover Re, French insurer AXA, reinsurer Scor, German insurer Allianz, and Japanese insurer Sompo Holdings. This long list highlights the difficulty of dealing with the controversial discussions around ESG in the insurance industry.
Regulations in Europe, also affecting the insurance industry, are ahead of the US, and stricter rules will be implemented as of 2024. Since 2017, ESG reporting has become mandatory for large stock-listed companies. As a next step, all large private and insurance companies must comply with the reporting requirements. As insurance companies can have a significant impact via their investment and underwriting activities, they are foreseen to play a critical role in the transition towards a fully sustainable and inclusive economic and financial system in line with the EU’s Green Deal.
Update on federal and state regulations on ESG
In March 2022, the SEC voted to advance a set of proposed rules for climate-related disclosure statements:
- description of the governance of climate-related risks and relevant risk management processes,
- information about climate-related risks that are reasonably likely to have a material impact on their business, results of operations, or financial condition,
- impact of climate-related events (severe weather events and other natural conditions) and transition activities on consolidated financial statements, as well as on the financial estimates and assumptions used in the financial statements,
- certain climate-related financial statement metrics in a note to their audited financial statements: Scope 1 (direct emissions) and Scope 2 (indirect emissions from purchased electricity or other forms of energy) greenhouse gas emissions. Scope 3 emissions (upstream and downstream activities in the company’s value chain) only need to be disclosed if they are material or if the company has set reduction goals that include scope 3 emissions.
By the close of the comment period on the proposal in June 2022, the SEC received more than 11,000 comments (a significantly higher volume than usual) from a wide range of stakeholders, both in favor of and opposed to various aspects of the proposal. The SEC is expected to issue the final regulation this year. Unless the SEC cuts back on many of the controversial requirements, the commission will likely face lawsuits, with several powerful industry groups and business associations already signaling intentions to do so. Some voices challenge the legality of the SEC’s authority in this area. One of the most controversial issues in the SEC’s proposal is the disclosure of greenhouse gas emissions, particularly the inclusion of Scope 3 emissions.
The proposed SEC rules would be phased in for all companies, with the timing of compliance depending on the company’s status (e.g., large accelerated filer) and the content of the disclosure requirement. As originally proposed, the impact of the new rules would not be noticeable until 2023/2024 at the earliest. However, the compliance timeline could also be extended as the final rulemaking will be delayed by several months.
In addition to these rules at the federal level, there are also proposals at the state level, e.g., the Climate Corporate Data Accountability Act in California. This Act would apply to U.S.-organized entities that do business in California and have total annual revenues over $1 billion. According to Politico, approximately 5,400 companies doing business in California would be required to submit disclosures under the proposed Act. For the prior calendar year, annual reporting on the Scope 1, 2, and 3 greenhouse gas emissions would commence in 2026. This Act passed the California Senate and now heads to the Judiciary Committee. Obviously, the Act would only affect very large companies, but it shows what regulators will demand regarding ESG reporting and which direction ESG reporting may take. The Climate Corporate Data Accountability Act would go beyond the climate disclosure rules proposed by the SEC as it requires to disclose all three scopes of greenhouse gas emissions.
Comparison with developments in the European Union
Currently, EU law exclusively requires large and listed companies (11,700 companies in the EU) to publish an ESG report. Companies qualify as large when two of the following three criteria are fulfilled: more than 250 employees, EUR 40 million in revenue (for insurance companies gross premium written), and a balance sheet total of EUR 20 million. With the EU’s Corporate Sustainability Reporting Directive (CSRD) entering into force on January 5, 2023, the requirements are getting stricter, and the scope of application enlarges to approx. 50,000 companies. EU member states will have 18 months from this date to transpose the CSRD provisions into their respective national laws. The CSRD was first proposed in April 2021 as part of the European Green Deal and the Sustainable Finance Agenda to ensure that the goals of the Paris Agreement are implemented. The first set of companies under the scope will have to apply the standards in fiscal year 2024, with reports published in 2025.
Companies subject to the CSRD will have to report in accordance with the European Sustainability Reporting Standards (ESRS), which are being developed by the European Financial Reporting Advisory Group (EFRAG). The twelve sector-agnostic standards covering ESG topics are publicly available as drafts. Compared to the Task Force on Climate-Related Financial Disclosures (TCFD), the ESRS is more comprehensive, detailed and requires more information. The EFRAG indicates that all information required by TCFD is covered by the ESRS. The European Commission expects the first set of ESRS to be adopted by mid-2023.
In Europe, ESG reports and all information included will be subject to third-party assurance. Ultimately, it should be the same level of assurance as for financial data. ESG information must be disclosed in the management report to enhance the interconnection between financial and non-financial information.