ESG and assurance: the road less traveled
Zhu Xiaoyu
The logo of the World Economic Forum (WEF) on a window inside the Congress Center in Davos, Switzerland, January 16, 2023. /CFP
The logo of the World Economic Forum (WEF) on a window inside the Congress Center in Davos, Switzerland, January 16, 2023. /CFP

The logo of the World Economic Forum (WEF) on a window inside the Congress Center in Davos, Switzerland, January 16, 2023. /CFP

Editor's note: Zhu Xiaoyu is an assistant professor at Lingnan College, Sun Yat-sen University in China. His research focuses on ESG and corporate finance. The article reflects the author's opinions and not necessarily the views of CGTN.

ESG, the heated topic in our business world today, stands for the three pillars of corporate social responsibility ratings: E for environment, S for social and G for governance. The ESG standards include a range of criteria for companies to conduct their corporate activities in a reliable manner.

To the general public, ESG is commonly linked to its environmental components such as carbon emission, water consumption, recyclable energy, etc. This association generates other names in related industries such as "green finance" and "sustainable finance." As well as the "E" component, "S" and "G" are equally important in the ESG concept. The social section of ESG includes issues such as employee rights and diversity in the workplace. The governance part of ESG refers to, usually but not limited to, compliances, shareholder rights and so on.

The ongoing 2023 World Economic Forum (WEF) annual meeting places ESG topics at high priority, indicating the substantial impacts of such domain and the spotlight of the current trends.

As ESG grows into a more widely accepted idea, companies, especially publicly listed companies, start to implement such measures into their day-to-day operations, at least according to their own disclosures.

New tabs have been added to company websites dedicated to describing their ESG strategies, goals and activities. Previously, ESG ratings are based on information extracted from texts and footnotes from the firms' financial reporting. Now, more firms provide separate ESG report as part of their non-financial reporting. These disclosures are treated at the same importance level as firms' financial reporting. ESG awareness roots deep in the minds of investors and citizens, and even Mr. Vincent van Gogh was given a strike in his long sound sleep.

As promising as these reports sound, misconducts and disasters in company behaviors raise social alarms. Multiple severe incidents such as oil leaks and customer account frauds challenge stakeholders' faith in companies' truthfulness when revealing their ESG well-doings.

Greenwashing, an action from corporations to deceive investors into believing the companies' pro-ESG activities, becomes the villain in the game. Rating companies rely on firms' voluntary disclosures for ESG-related data, and it's almost impossible to distinguish true material information from fake ones in this fashion. Research shows that companies often talk the ESG talk, but do not walk the ESG walk.

Combating this conundrum, public regulations strike out to require assurances of the ESG disclosures. The European Union produced a quicker response on this issue. Early in 2014, the Non-Financial Reporting Directive (NFRD) proposed by the European Parliament and the Council mentioned the assurance steps on non-financial reporting including environmental, social and employee, human rights, and anti-bribery and corruption.

In recent public regulations, such as the Corporate Sustainability Reporting Directive (CSRD), third-party assurances of reporting information are required, and extended to all ESG metrics and large companies or publicly listed companies. The assurances should provide detailed information subject to the EU Sustainability Reporting Standards, the latest version of which were adopted by November 2022. Moreover, European rules are not only applicable to EU companies but all companies in Europe or subsidiaries of companies operating in Europe.

In the U.S., fewer regulation rules are adopted due to different ideologies in political divisions and more shareholder-focused corporate goals. The public regulations in the U.S. so far pushed the assurances to Scope 1 and 2 of carbon emissions. (Scope 1 emissions are direct greenhouse emissions that occur from sources that are controlled or owned by an organization, such as emissions associated with fuel combustion in boilers, furnaces, vehicles. Scope 2 emissions are indirect greenhouse emissions associated with the purchase of electricity, steam, heat, or cooling.)

A train carrying coal moves past the Miller coal Power Plant in Adamsville, Alabama, the U.S., April 11, 2021. /CFP
A train carrying coal moves past the Miller coal Power Plant in Adamsville, Alabama, the U.S., April 11, 2021. /CFP

A train carrying coal moves past the Miller coal Power Plant in Adamsville, Alabama, the U.S., April 11, 2021. /CFP

Apparently, the private sector also promotes assurances on non-financial reporting. The verification requirements come not only from the public sector but also from the private sector. While public regulations could remain conservative (such as in the U.S.), but the private sector responds promptly to the lack of assurances in real ESG conducts.

In a long-term view, requiring assurance could be an optimal solution, in the sense that information asymmetry could sabotage the values of firms that implement real ESG procedures. It also rings the bells to the regulators and market that public-private cooperation could tackle the challenge, which has been proposed by the WEF this year.

So, how should we structure this assurance of ESG targets? No one has a definitive answer. What we know is that non-financial reporting is as important as financial reporting regarding material information, and all parties involved agree to some extent that assurance is required. While financial reporting is verified by auditing firms, the solution currently to ESG assurances is still the same group of auditing firms.

Nonetheless, ESG involves in a wide range of dimensions that only knowing financial accounting knowledge is insufficient in providing the assurance of ESG targets. How to validate the carbon emission volume? How to calculate energy efficiency, and in different industries with various fuel resources? The assurance of ESG, inevitably, requires the integration of accounting and engineering, chemistry, biology and other certain fields. We are not well prepared for that as of yet.

Well, challenges and opportunities often go hand in hand. With new equilibria forming in a new battlefield of ESG assurance, there are numerous tasks to accomplish.

Regulators and market participants should update principles and standards for assurances. Researchers should conduct theoretical and empirical analyses to offer policy insights and directions for developments. Courses and degrees should be designed to fulfill the demand for new types of specified accountants trained for multiple aspects of ESG content. Accounting firms, auditing firms and other practitioners should co-create such training with colleges and universities.

New industry norms, facilitations and prospects are forming. We are in the driver's seat to determine how fast and far we want to go, on the road less travelled.

(If you want to contribute and have specific expertise, please contact us at Follow @thouse_opinions on Twitter to discover the latest commentaries in the CGTN Opinion Section.) 

Search Trends