The IFRS Foundation Trustees announced on 3 November 2021 at COP26 some important and highly-anticipated developments in their efforts to provide global financial markets with a streamlined, high-quality climate- and sustainability-related disclosure framework.
It is rather apt that the announcement was made on the same day that finance ministers and leading figures in the financial world gathered at COP26 to discuss ways to unlock the reallocation of private (and public) capital to more sustainable, net zero activities. The existing plethora of different climate and ESG reporting standards and frameworks (aka the ESG ‘alphabet soup’) is a serious obstacle to investors being able to access climate and other sustainability data that is relevant, reliable and comparable. The IFRS hopes to do for the sustainability reporting world what it did for financial reporting with the IFRS Accounting Standards. The speed at which the IFRS’ plans are developing on this is testament to the urgency behind the need to address the ESG data gap at a global level.
Formation of the International Sustainability Standards Board
The new International Sustainability Standards Board (ISSB) will be tasked with developing a “comprehensive global baseline of high-quality sustainability disclosure standards to meet investors’ information needs”. The new IFRS Foundation Constitution was published today, setting out the global structure, governance and responsibilities of the new ISSB, as well as the qualifications and criteria required to become a member of the ISSB. We understand the Trustees are in the advanced stages of appointing a Chair and Vice-Chair(s) to the ISSB. The Trustees will soon begin a search for the additional board positions, up to the full complement of 14 members. The ISSB’s work is expected to commence as soon as the Chair and Vice-Chair(s) have been appointed and to begin with public consultations to inform the ISSB’s work plan (and in particular the disclosure standards referred to below).
From a UK perspective, the formation of the ISSB is of particular relevance because the UK government noted in its Greening Finance Roadmap published last month and in the FCA Discussion Paper 21/04 published on 3 November, that it expects the ISSB standards to form a core component of the forthcoming Sustainability Disclosure Regulation (SDR) regime (in particular when it comes to disclosures by corporates). The UK government also intends to create a mechanism to adopt and endorse ISSB-issued standards for use in the UK.
The IFRS also noted that there has been a formal commitment by the Climate Disclosure Standards Board (CDSB) and the Value Reporting Foundation (VRF) – two leading investor-focused sustainability disclosure organisations – to amalgamate into the new ISSB by June 2022. The VRF was created earlier this year when the Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting Council (IIRC) (which is responsible for the Integrated Reporting Framework) merged together.
The IFRS has also published FAQs in relation to the work of the ISSB going forward. The FAQs explain (among other things) the ISSB’s approach to materiality. This is important as the ISSB intends to focus on meeting the information needs of investors and the impact of climate change and other sustainability issues on “enterprise value” – whilst the EU and others favour an approach based on “double materiality”. See “General Requirements Prototype” section below for more detail on what the ISSB considers to be material.
Publication of “Prototype” Sustainability Disclosure Standards Prototypes
The IFRS also published a set of Prototype IFRS Sustainability Disclosure Standards developed by the IFRS’ Technical Readiness Working Group (TWRG). These prototypes are the result of six months of joint work by representatives of the CDSB, the International Accounting Standards Board (“IASB”), the Task Force on Climate-related Financial Disclosures (TCFD), the VRF and the World Economic Forum (WEF), supported by the International Organization of Securities Commissions (IOSCO) and its Technical Expert Group of securities regulators.
The TWRG has published two distinct disclosure standard prototypes: one on climate-related disclosures and the other on general sustainability disclosure requirements.
The intention is that these standards will form a “comprehensive global baseline of sustainability disclosures” that can be used on a standalone basis or integrated into jurisdictional requirements to serve broader stakeholder or public policy needs.
We have set out a high-level summary the two disclosure standard “prototypes” below.
- General Requirements for Disclosure of Sustainability-related Financial Information Prototype (the “General Requirements Prototype”)
The General Requirements Prototype sets out the overall requirements for disclosing sustainability-related financial information relevant to the significant sustainability-related risks and opportunities of “an entity” (which is not defined or elaborated upon in the discussion papers).
The disclosure requirements for each sustainability matter focus on matters essential to the way an entity operates: governance, strategy, risk management, and metrics and targets. In particular, there will be a requirement to disclose all sustainability-related financial information that is “material” to an entity for its primary users (i.e. existing and potential investors, lenders and other creditors). “Material” in this context means information that, if omitted, misstated or obscured, could reasonably be expected to influence decisions that the primary users of that particular entity’s general purpose financial reports make on the basis of those reports (i.e. investment decisions).
The disclosures should form part of the entity’s general purpose financial reporting.
- Climate-related Disclosures Prototype (the “Climate Prototype”)
The Climate Prototype builds on the TCFD recommendations and requires an entity to provide information that enables uses of general purpose financial reporting to assess the following:
- Governance: the governance processes, controls and procedures the entity uses to monitor and manage climate-related risks and opportunities;
- Strategy: the climate-related risks and opportunities that could enhance, threaten or change the entity’s business model and strategy over the short, medium and long term, including:
- whether and how information about climate-related risks and opportunities inform management’s strategy and decision making;
- the current and the anticipated effects of climate-related risks and opportunities on its business model;
- the impact of climate-related risks and opportunities on the entity’s financial position, performance and cash flows, both at the end of the reporting period and the anticipated effects over the short, medium and long term; and
- the resilience of the entity’s strategy to climate-related risks;
- Risk management: how climate-related risks are identified, assessed, managed and mitigated by the entity; and
- Metrics and targets: the metrics and targets (both cross-industry and industry-specific) that are used to manage and monitor the entity’s performance in relation to climate-related risks and opportunities over time.
Once the ISSB has been fully formed, it will have to consider the TWRG’s prototypes and launch a public consultation as soon as possible in 2022. The initial focus will be on adoption of an international climate standard first, followed by standards on other sustainability issues later.
However, adoption by the ISSB of global climate and other sustainability standards is just the first step – these will be voluntary standards so it will be up to different jurisdictions to decide whether and how to incorporate them into national law. Which is why it is particularly important that the ISSB is planning to have a ‘multi-location presence’ (with the central HQ based in Frankfurt but also dedicated sites across all the regions (the Americas, Asia-Oceania and EMEA). The ISSB FAQs make it clear that engagement with developing and emerging economies will be an important priority. In terms of future adoption of these standards at national level, it helps that the G20 and IOSCO among others have expressed support for the IFRS’ plans.
In the meantime, until the IFRS Sustainability Disclosure Standards have been adopted by the ISSB, the ISSB FAQs recommend that companies continue to use the existing voluntary frameworks and guidance as appropriate, in particular the:
- TCFD Recommendations;
- CDSB Framework;
- Integrated Reporting Framework;
- SASB Standards; and
- WEF Stakeholder Capitalism Metrics.
It is unclear at this stage how the ISSB will interact with the work the European Financial Reporting Advisory Group (EFRAG) is doing in terms of developing EU-wide sustainability reporting standards for inclusion in the forthcoming Corporate Sustainability Reporting Directive (CSRD) (see here). It has been suggested by some, including Accountancy Europe, that EFRAG should be invited to participate in the ISSB’s working groups and vice versa.