Posted by Emilija Emma

Give me comfort: The importance of sustainability expertise in sustainability reporting and assurance 

Continuing our thoughts on sustainability assurance, Emilija Emma discusses the rapid evolution of sustainability reporting, with a focus on GHG accounting, and shows why technical expertise is indispensable when preparing – and assuring – ESG disclosures.

If you have been involved in sustainability reporting over the past decade or two, you will likely share the sense of how spectacular the rate of change has been.

ESG reporting has moved away from the nice-to-have feel-good stories published in dedicated sustainability reports or webpages of a decade ago, and is rapidly becoming established as an integral part of annual reporting, interrogated in a similar way to financial data and used in decision-making.

To give investors confidence in the data and narratives reported, companies are increasingly obtaining some level of assurance on their ESG disclosures. For an introduction to sustainability assurance and an overview of how it is variously encouraged or required by standards, benchmarking schemes and regulations, you can refer to our recently published article: The Introduction to the assurance of ESG data.

Introduction to the assurance of ESG data

We have also created a a handy one page download of how assurance is variously treated in a varity of benchmarks, standards and regulations

Download Assurance for benchmarks, standards and regulations

Sustainability assurance is delivered by a range of market players

Capitalising on this opportunity, an increasing number of companies are now offering verification and assurance services for sustainability information. Companies delivering sustainability assurance include engineering, sustainability and other specialist consultancies as well as financial audit firms.

According to a 2023 review by IFAC (International Federation of Accountants), in some countries, such as the UK, the US, and South Korea, consulting and engineering firms with specialist sustainability knowledge deliver the majority of non-financial assurance engagements. Elsewhere, including France, Mexico, and Australia, the picture is altogether reversed and assurance is done almost exclusively by audit firms.

This situation is reflective of the historical and legal context of each country, but also the skills required to interpret and assess the validity of sustainability claims and figures. There is a need for both the thorough and impartial process which is the bread and butter of the well-established field of financial auditing, and in-depth technical knowledge of sustainability and its reporting – a field which is young and evolving rapidly.

The complexities, and evolution, of GHG accounting

To illustrate the highly dynamic nature of the field of sustainability, and to show why it is crucial for assurers to be sustainability experts with in-depth knowledge of the field and its latest developments, I’d like to take a closer look at Greenhouse Gas (GHG) accounting. GHG accounting is arguably one of the most developed areas of sustainability reporting. Compared to social value, nature risk or biodiversity, GHG disclosures are more widespread, tend to be reasonably similar, follow more established processes for collecting data and conducting calculations, and the availability of data is generally greater.

However, GHG accounting is in fact only a couple of decades old, and while it can appear to be relatively straightforward, in fact there is more to it than meets the eye.

The GHG Protocol is evolving

The GHG Protocol is the most widely used methodology for carbon accounting worldwide, explaining how emissions should be calculated from underlying energy and materials use data, and how to divide emissions into scopes for standardised reporting. The GHG Protocol’s Corporate Standard was first published in 2001, with a Revised Edition released in 2004; the Scope 3 Standard was published in 2011, and the Scope 2 Guidance in 2015, with additional appendices released at various times.

Compared to financial reporting standards, which have taken centuries to develop, this is very recent history. At the time of writing, the GHG Protocol is going through a series of consultations and only just establishing proper governance for regular reviews and updates.

It's evolution has been so rapid that some parts of it can appear to be a convoluted tangle of addenda and appendices, containing some contradictions and numerous awkward areas, lacking clarity for application to specific fields.

These areas have historically been filled by other, usually sector-specific organisations. For real estate these are the Association of Real Estate Funds (AREF), the Global Real Estate Sustainability Benchmark (GRESB), the Carbon Risk Real Estate Monitor (CRREM), the Partnership for Carbon Accounting Financials (PCAF), and others.

Emission factors are not as fixed as they might seem

In GHG accounting, we apply emission factors to data on quantities of materials and units of energy, to convert it to carbon equivalents. The aim is to provide a common platform to allow us to interpret, trade-off and transact GHG emissions. These factors underpin all carbon reporting – yet despite being a crucial part of GHG accounting, they are not fixed in the way that e.g. currency conversion factors are.

For starters, there is a variety of published emission factor sources available, calculated using different methodologies and updated at varying intervals. For some data types, such as natural gas combustion, this is less of an issue, as there is little scope for interpretation in measuring how much greenhouse gas is released when a unit of natural gas is burnt (although even then there are some methodological decisions made around the distribution and leakage rates).

Some emission factors, for instance those applied to the weight of, or money spent on, purchased goods and services, rely on assumptions which have nothing to do with chemistry. These include how, when and where the goods are manufactured or transported, how money flows in a given economy or between economies. As a result, there are competing methodologies, and thus several legitimate emission factor choices of varying accuracy and geographical applicability.

Even if a calculation methodology is selected, there can be further questions about how to apply it. E.g., there is some argument over the most appropriate timescale over which the global warming potential (GWP) of various greenhouse gases should be calculated. The most commonly used time horizon is 100 years, but a 20-year GWP is sometimes applied. This method prioritises gases with shorter lifetimes, and therefore the decision on which GWP is used has an impact on the relative importance placed on various greenhouse gases in reporting. This thus affects carbon reduction strategies and net zero targets.

Even well-accepted and broadly used factors can contain outdated assumptions which many users may be unaware of. For instance, the 2021 update to the UK’s Department’s for Environment, Food & Rural Affairs (DEFRA) emission factors, which UK readers will be familiar with, showed a 57% year-on-year reduction in the water supply emission factor, and a 62% reduction in the water treatment factor. This was a result of new evidence and better calculations - namely, DEFRA began using a weighted average of water company data for 2020, where previously a value from a discontinued publication of UK industry-wide intensity for 2012 was used. The value remained static in the 2022 update, but underwent another refinement in 2023, when additional data on volumes of wastewater and drinking water was provided by the UK water suppliers and incorporated into the calculation.

Fundamentally, GHG accounting is based on chemistry and physics, and while the molecular reactions and calculations are well understood, the broader systems within which they sit are not as clear. The concept is very different to financial accounting, which is based on the agreed social construct of value, upon which we have built our economies.

GHG inventory boundaries are not always aligned with financial reporting

A company reporting on its GHG emissions needs to select an inventory boundary, to ensure that it reports information relevant to its users. This is less straightforward than it sounds; according to the GHG Protocol, it is important to select a “boundary which reflects the substance and economic reality of the company’s business relationships, not merely its legal form.”

The GHG Protocol allows the use of two distinct approaches: the equity share and the control approach. While the equity share approach is straightforward on paper, the control approach leaves more room for interpretation. This is especially true for the operational control approach, where the company reports emissions over which it, or one of its subsidiaries, has operational control, and excludes those in which it has a financial stake but no ability to implement operating policies.

The operational control boundary is a common choice in GHG reporting, as it allows organisations to report on, and take responsibility for, emissions which they can physically influence. However, selecting this boundary creates the unique challenge of GHG reporting divergence from financial reporting, making it difficult for investors to quickly compare reports.

Companies with leased assets have particular difficulty in determining where to assign responsibility. The guidance provided by the GHG Protocol is less than clear on how leased asset emissions should be classified. Appendix F, containing guidance on leased assets, has to first be transposed or mapped onto the specific lease types used by real estate companies to try and determine a fair, consistent and responsible approach for classifying landlord and occupier emissions into scopes.

GHG reporting contains a lot of estimation

Reliance on estimation in GHG reporting is significant. E.g., it is not uncommon for real estate owners with occupiers on full repair and insure (FRI) or triple Net (NNN) leases to have significant data gaps, which have to be filled using estimations, usually based on typical benchmark intensity values. Data related to emissions associated with the value chain also tends to be based on estimation.

This is a challenge that companies reporting on their GHG emissions are grappling with – but it’s not one that financial reporting has had to encounter for many years.

Other areas of sustainability contain even more uncertainty

While the above gives a glimpse of some the complexities of GHG accounting, it is worth remembering that other areas of sustainability can be even more complex and uncertain.

Nature, social, and biodiversity impact - these other high-urgency pillars of planetary and societal health are only now beginning to receive the same type of attention as climate change, with guidance emerging on structured reporting approaches.

The Taskforce for Nature-related Financial Disclosures (TNFD) published its Recommendations on nature-related risk management and disclosure in September 2023. The intention is to help organisations report and act on evolving nature-related dependencies, impacts, risks and opportunities, and the taskforce is modelling its approach on the equivalent Taskforce for Climate-related Financial Disclosures (TCFD), which preceded it by 6 years.

Meanwhile the International Sustainability Standards Board (ISSB), having published the standards IFRS S1 and S2, is now conducting a consultation on agenda priorities, where it is soliciting views on which projects to prioritise. Topics include biodiversity, ecosystems and ecosystem services; human capital; human rights, and a research project on integration between financial reporting and sustainability reporting.

While these developments are beginning to get underway, most areas of sustainability remain far less mature than climate mitigation and GHG accounting – and this will affect organisations’ ability to report, and to have their disclosures assured.

Significant skill is needed to calculate and assure ESG data

It is likely that all of the above – the complex methodological decisions, the need to meaningfully make the best of the available data, the use of estimated data to gap-fill where required, will remain an important part of sustainability reporting for a while yet. The field is constantly evolving, with a proliferation of new standards and reporting requirements.

As a result, sustainability reporting is an area which requires significant skill and understanding of the accepted methodologies, their grey areas, and the best way to implement them – ideally in a sector-specific way that is also sensitive to the jurisdictions or regions in which the reporting organisation operates.

For the teams preparing such disclosures, as well as for those assuring them, it is vital to stay abreast of the rapid and extensive developments in the market. The year of 2023 alone has seen the release of multiple reporting frameworks and regulations, best practice guidelines, consultations on existing frameworks, and indications of future developments.

Assurance is a different beast when it comes to sustainability

Financial accounting has had many decades to evolve and take on its current, highly standardised and formulaic form with restricted scope for interpretation and a single correct way of doing any given calculation. In contrast, the complexity involved in sustainability reporting, and the technical expertise that is needed to evaluate the appropriateness of methodological decisions made to navigate inconsistent reporting standards, have made sustainability data much more difficult to assure in any standardised, prescribed way. This is reflected in the current market in the widespread use of limited, as opposed to reasonable, assurance for sustainability data.

It is technically possible to conduct reasonable assurance on a set of GHG figures, which a change in the GHG Protocol some years down the line would render invalid – e.g. if the GHG Protocol releases more granular guidance on leased assets that results in a reclassification of reported emissions from your Scope 3 to Scope 1. Stakeholders, having received disclosures under a reasonable level of assurance, would expect them to be immutable, and there is a high risk that your company will be accused of greenwashing.

If this feels like a bit of a minefield, that’s because it is. Companies should tread carefully when tackling ESG assurance.

When selecting an assurance provider, ask whether they have the requisite knowledge of sustainability. Do they know the GHG accounting approach accepted in your sector, and the methodological decisions made by your peers? Do they have experience in the areas where your most material impacts and risks lie? Do they have a sufficient understanding of sustainability target-setting to be able to assess whether your reported numbers support your narrative?

Transparency will be your friend; if you make sure that your sustainability disclosures speak openly about the methodological decisions and assumptions made, the reason for making them, and explain in good faith how the numbers and conclusions were arrived at, this will serve as insurance for your reputation.

The right people for the job

Sustainability disclosures, at their heart, are there to enable investment decision-making. Assurance is done to increase confidence in these disclosures.

The complexity and quick evolution of the field mean that it is crucial for both sustainability reporting and sustainability assurance to be cognizant of the challenges unique to the field. Verco’s team remains at the cutting edge of sustainability accounting, reporting and assurance, engaging in industry consultations, working with the major standard frameworks and other stakeholders.

Please do get in touch if you would like to discuss any of the topics raised in this article or Verco’s services in greater detail.

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