Insights

How Far Does Our Company Extend? Organizational Boundaries in ESG Disclosure

ㅣTaehan Kim, COO of KoSIFㅣ

Nuclear family, extended family, immediate family, collateral relatives…

Many of us may remember learning at school about the different forms and boundaries of a family. But how far does a family actually extend? The answer may vary depending on the individual and the period in which they live. In the 1970s and 1980s, when large households were more common in Korea, many people would naturally have regarded grandparents as part of the family unit. Today, that perception may be less widespread.

Korea’s Civil Act provides a formal definition of family. Under Article 779, family members include: ① a spouse, lineal relatives, and siblings; and ② the spouses of lineal relatives, the lineal relatives of a spouse, and the siblings of a spouse, provided that they share the same household.

The word “family” is a collective noun: it brings multiple individuals together as a single unit. The members included within that unit can therefore differ across people and over time.

     How Far Does “Our Company” Extend? The Commercial Act Focuses on the Individual Legal Entity

“Company” and “business” are also collective nouns. The range of entities included in the idea of “our company” may therefore vary from person to person.

For example, an employee working at a holding company responsible for managing an entire corporate group may think of “our company” as including all affiliates within that group. By contrast, an employee working at a special-purpose company established to operate a particular project may define “our company” much more narrowly, limiting it to the entity that employs them.

As mandatory sustainability disclosure advances, discussion is growing over the scope of the reporting entity—in other words, where the organizational boundary of “our company” should be drawn.

Korea’s Commercial Act does not contain a separate provision explicitly defining the scope of a “company.” However, Article 169 defines a company as a legal entity established for the purpose of conducting commercial activities or other profit-making activities. This suggests that the Act treats each company as an individual legal entity.

With the exception of certain governance regulations applied by the Korea Fair Trade Commission to large business groups, most environmental and social regulations also apply at the level of an individual legal entity or business site. Korea’s emissions trading scheme, which designates regulated entities at the corporate level, is a representative example.

     Accounting and Disclosure Are Based on the Consolidated Group

Article 159 of the Financial Investment Services and Capital Markets Act, which establishes business-report disclosure requirements, likewise applies to listed corporations—that is, to individual legal entities.

However, the Act also requires business reports to include financial information. Under the Act on External Audit of Stock Companies, listed companies are generally required to prepare their accounts in accordance with Korean International Financial Reporting Standards, or K-IFRS, based on consolidated financial statements.

Consolidated financial statements treat two or more companies under a parent–subsidiary relationship as a single reporting group.

Under the Enforcement Decree of the External Audit Act, a parent–subsidiary relationship exists when a company has the ability to determine another company’s financial and operating policies in order to obtain benefits from its economic activities.

In some respects, the concept of a “reporting entity” in accounting and disclosure resembles the definition of “family” under the Civil Act.

Accounting uses the concept of an economic entity to determine whether one company should consolidate another into its financial statements. This is similar to the Civil Act’s use of a shared household as a criterion for determining whether the spouses of lineal relatives or the lineal relatives of a spouse should be included within the family.

Just as the Civil Act may treat more distant relatives as family when they share a household, accounting treats separately registered legal entities as a single organization when they form one economic substance.

In general, a company is regarded as a subsidiary when the parent holds more than 50 percent of its voting rights. A company may also be treated as a subsidiary at a lower ownership level when the parent exercises substantive control.

     Defining the Reporting Entity for Sustainability Disclosure

Under the IFRS Sustainability Disclosure Standards, which Korea is highly likely to adopt, “the reporting entity for sustainability-related financial disclosures shall be the same as the reporting entity for the related financial statements.”

In other words, sustainability information must be disclosed on the same consolidated basis as financial statements, incorporating information from subsidiaries over which the parent company exercises substantive control.

For environmental or ESG teams responsible for sustainability matters, the concept of a subsidiary may not be familiar. Existing internal systems have also generally been designed to comply with environmental and labor regulations applied at the level of individual legal entities or business sites.

Restructuring these systems and securing cooperation from personnel at subsidiaries will therefore be a significant challenge.

The issues do not end there.

Many companies have used the operational control approach to set organizational boundaries for greenhouse gas accounting. They must now determine whether to shift to a financial control approach and how to address inconsistencies among IFRS Accounting Standards, the GHG Protocol, and Korea’s emissions trading scheme guidelines.

A wide range of practical questions therefore remains unresolved.

     An Unavoidable Path That Requires Earlier and More Thorough Preparation

It is now close to impossible for most companies to operate without external capital. At the same time, financial institutions in Korea and abroad are increasingly calling for companies to disclose sustainability information without delay.

Companies cannot avoid the issue simply because preparation is difficult.

At the same time, it must also be acknowledged that sustainability disclosure is too demanding a transition for companies to navigate entirely on their own.

The devil is in the details. Companies will face countless technical and operational issues as they prepare for sustainability disclosure.

The Ministry of Environment and the Korea Accounting Institute are reportedly developing guidance on corporate greenhouse gas accounting, including the setting of organizational boundaries. This is a welcome development.

Mandatory sustainability disclosure should be introduced sooner, while the policies and practical support needed for implementation should be strengthened at the same time.