Today — 31st March 2022 — the International Sustainability Standards Board (ISSB) launched a consultation on its first two proposed standards for global sustainability reporting. In case you don’t follow these developments as avidly as we do, a brief reminder that the ISSB was the new body established at COP26 in November last year, charged with creating a global standard for sustainability disclosures. The ISSB is part of the IFRS Foundation and the younger sister of the International Accounting Standards Board (IASB) that sets the principles for globally accepted accounting disclosure standards.
The consultation is open until 29th July 2022. There’s quite a lot to take in across the two proposals which are: IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2 Climate-related Disclosures. So, we thought it might be helpful to share our initial take on the content with a bit of reading between the lines about what, as things stand pre-consultation results, the implications might be for businesses.
Starting with the basics — what are these proposals actually about?
Both proposals have, at their hearts, an objective to support the disclosure of material information about sustainability- (IFRS S1) and climate- (IFRS S2) related risks and opportunities such that the primary users of a company’s financial statements can assess enterprise value.
The climate proposal goes further and leans towards what I would think of as ‘double materiality’. In other words, not just the ability of climate-related issues to have an impact on future business performance but also the scale of the business’s impact on the planet through its use of inputs, activities and outputs (we’re talking about the full value chain here) as justification for its response to and strategy for managing climate risks and opportunities. And it looks to evaluate a company’s adaptability to climate change.
The effective date has not been set yet for either of the proposed standards — the consultation seeks feedback on how long companies will require to implement once the standards have been finalised, which the ISSB is aiming to do by the end of this year.
And now for the implications…
Businesses won’t have to tear up progress to date and start again
There’s been a genuine attempt to align existing frameworks — hurrah!
Both the General Requirements and Climate-related Disclosures drafts propose to adopt the Task Force for Climate-related Financial Disclosures (TCFD) framework of governance, strategy, risk management, and metrics & targets. This provides a natural evolution for those already following or working towards TCFD-aligned reporting for climate-related risks and opportunities and is welcome structure for the wild west of ‘other’ sustainability issues like social impact and human capital.
Sustainability data capture and analysis will have to get MUCH more efficient
This could be a biggie — the proposals as they stand look to align the reporting period for sustainability and climate information with that of the financial statements. And for everything to be published at the same time.
In our experience, there is no way that the current processes for analysing and reporting sustainability data could keep up with the finely honed year-end finance process. And, for that reason, the reporting period for sustainability data included in annual reporting tends to lag the financial year by anything from 3 months to a year.
This may finally bring some teeth to the business case for meaningful sustainability data investment. Which would be a fantastic leapfrog forward and answer the prayers of many Chief Sustainability Officers who have been trying to pivot the approach in large organisations.
Or something else may have to give in the short term!
CFOs will need to seriously get involved if they aren’t already
One element that quite excites me is the ambition of both proposals to start connecting the information in sustainability and climate disclosures with information within the financial statements. This means that any businesses whose sustainability reporting sits outside of the CFO’s direct jurisdiction will need to reconsider their operating model.
Standards are being (further) raised for climate-related disclosures
The climate-related disclosure proposal goes further and deeper than TCFD in a few areas. The first is in relation to climate governance. TCFD recommends a description of the Board’s oversight of and Management’s role in assessing and managing climate-related risks and opportunities. The ISSB proposal would require further disclosure on how climate-related risks and opportunities are reflected in the committee terms of reference, board mandates and policies.
Secondly, there are enhanced disclosure requirements proposed around the use of and quality of carbon offsets.
Thirdly, any climate targets would need to explain how they compare with the ‘latest international agreement on climate change’. This is defined as the norms and targets set by the UNFCCC which, at this point in time, means the Paris Agreement to limit global warming to well below 2 degrees Celcius and pursue efforts to limit it to 1.5 degrees.
There’s also a strong recommendation for companies to use scenario analysis (i.e. looking at different temperature rise scenarios and transition pathways) when assessing climate-related risks and opportunities. Which requires a lot of robust data gathering and analysis. And the proposals look for the impact of this risks and opportunities analysis to be disclosed as a financial point estimate or range.
Finally — if that’s not enough to get your teeth into — there are seven cross-industry metrics being proposed in the climate-related standard. GHG emissions on an absolute and intensity basis (adhering to the GHG Protocol), transition risks, physical risks, climate-related opportunities, capital being deployed to climate-related risks and opportunities, internal carbon prices and the % of executive remuneration linked to climate-related considerations.
There’s no avoiding scope 3 and the value chain
The upstream and downstream impacts of many businesses dwarf their direct operational impacts. This is particularly true in financial services where lending to and investments in other companies fall within their scope 3 impacts. However, scope 3 has always been the trickiest to define and measure so disclosure is usually patchy at best and very definitely inconsistent across different companies.
The new proposed standards recognise the challenges in scope 3 but also take a ‘comply or explain’ approach to the inclusion of material sustainability impacts up and down the value chain. Particularly in the climate-related disclosure proposal where the ambition to account for full upstream and downstream carbon emissions clearly comes through.
It’s how change will really be driven but it implies a huge shift in how companies engage with their suppliers, intermediaries and customers. And massively expands the ‘sustainability data investment case’ discussed earlier. Then trying to get all of that data gathered, analysed, checked and disclosed on the same frantic timeline as the year-end financial reporting process…that’s a big challenge! You can see why Ernst and Young are looking to recruit 1,300 people into their new sustainability service offering…
The upshot, we believe, is that the proposed standards unveiled today will drive meaningful progress in sustainability and climate disclosures. It won’t get us to the full answer — more work is required on taxonomy, quantitative methodologies and cutting through the ‘noise’ and PR that currently dominates many sustainability reports. However, none of us should underestimate the company-wide effort, change and investment that will be required to step up and meet these new standards, assuming (and hoping) that they avoid being diluted in the consultation process.