After attracting significant interest from stakeholders, the consultation period for the International Sustainability Standards Board’s (“ISSB”) draft standards closed on 29 July. The ISSB has indicated that it will aim to finalise the standards by the end of the year.
As a reminder, the ISSB released draft standards on sustainability-related disclosures (“IFRS S1”) and on climate-related disclosures (“IFRS S2”) in April 2022.
The responses provided by a group of chief financial officers and institutional investors, convened by Accounting for Sustainability (“A4S”), provide an insight into the business and finance communities’ concerns around the current drafts.
Below are the main points of the respective CFO response (“CFO Statement”) and the investor response (“Investor Statement”). In short, both call for greater global alignment of sustainability reporting and strengthening of the current proposals.
The CFO Statement focused on the following areas:
- Alignment: it underlined the urgent need to align existing and emerging sustainability reporting standards, recognising that the ISSB will need to accelerate its current ongoing work.
- Dynamic and industry-specific nature of materiality: the ISSB standards are investor-focused and centre materiality around the information investors require to assess ‘enterprise value’ (as opposed to targeting a broader range of stakeholders and also assessing businesses’ impact, as a ‘double materiality’ approach does – discussed further below). The CFO Statement suggests that the standards should clarify how such assessment will be carried out (i) given the dynamic nature of what might be considered ‘material’ over time, and (ii) as it recognises that investors may require disclosures on broader impacts to assess risk and inform investment decisions, suggesting that it supports a double materiality approach.
The wider A4S response to the ISSB standards elaborates on how, as sustainability-related risks and opportunities are industry-specific, the standards should reflect this. Whilst, for example, industry-based disclosure requirements are included in Appendix B of IFRS S2, these are based on mostly unchanged existing SASB standards, which were initially developed for the US market. The response underlines that it is important to ensure that these standards are updated as required so that they remain relevant and appropriate for international adoption.
- Need for clear definitions and guidelines: the CFO Statement notes that having clear definitions and guidelines that enable preparers to report in a transparent, consistent and comparable manner can help support assurance and limit the use of lengthy footnotes and supplemental disclosures. For example, entities are required to disclose ‘significant sustainability-related risks and opportunities’, but ‘sustainability’ is not defined and it is unclear if ‘significant’ has a different meaning or is used interchangeably with ‘material’.
- Recognising reporting as a means to an end, not an end in itself: the CFO Statement notes that the standards should acknowledge the current practical challenges around providing accurate and complete data and that it is essential that the standards provide adequate timing for companies to adopt the necessary processes, controls and technology - the wider A4S response suggests, for example, phasing in some of the most challenging requirements. If not, companies might dedicate a disproportionate amount of time to reporting instead of focusing on action.
- Connection to financial reporting standards: the wider A4S response elaborates on this point and notes that, whilst recognising the need to assess the connectivity between traditional financial reporting and sustainability-related financial reporting, the ISSB’s drafts do not set out when this would be required and how it would be achieved.
- Broadening of issues: finally, the CFO Statement finds that it is necessary to address the broad set of environmental, social and economic issues that materially impact decision making and to move quickly to other topics after climate to capture the interconnectedness of all sustainability topics.
The Investor Statement focuses on the need for decision-useful data – in their opinion, this embraces a double materiality approach, i.e. outlining not just how people, planet, environment and the economy impact businesses, but also how businesses impact people, planet, environment and the economy. At present, the IFRS S1 only requires disclosure of information about businesses’ impacts to the extent they affect enterprise value.
Reflecting on both statements and drawing from other responses, the following trends emerge:
- Alignment: the ISSB has already made significant progress through, for example, the consolidation of the Value Reporting Foundation, its Memorandum of Understanding with the Global Reporting Initiative, and the proposed creation of the Sustainability Standards Advisory Forum, a working group aimed at facilitating dialogue across jurisdictions. However, it remains to be seen how, in practice, consistency will be ensured and duplications avoided.
An example is its approach to offsets – The European Securities and Markets Authority (“ESMA”) noted that IFRS S2 permits companies to count carbon offsets towards the achievement of their GHG emission reduction targets. This is contrary to the position in the European draft counterpart, ESRS E1. This divergence could cause confusion and lead to investors taking an artificially positive impression of company targets reporting under IFRS S2 compared to those reporting under ESRS E1.
- The ISSB’s narrow interpretation of materiality is a concern that numerous commentators have raised, and it will be interesting to see if/to what extent the ISSB broadens the scope in the final standards – for example, HSBC Bank (UK) Pension Scheme stated that focusing on enterprise value is a ‘backward-looking, lagging indicator’ and a failure to recognise double materiality with respect to sustainability risks ‘is likely to result in too narrow a focus being applied on sustainability risks’.
- Other commentators such as the Financial Reporting Council (“FRC”) found the interpretation of materiality to be unclear. In their response, the FRC suggested that it might be preferable for IFRS’s S1 concept of materiality to focus on information that could reasonably be expected to influence the decisions of investors as opposed to their assessment of enterprise value.
- Terms and guidelines:
- ‘Enterprise value’, ‘sustainability-related’ and ‘short/medium/long term’ are other terms that other commentators found needed clarification in order to ensure consistency across reporting.
- The Net-Zero Asset Owner Alliance recommended additional disclosure requirements for transition plans, such as ‘agreed near-term actions to deliver on the underlying strategy, alignment of engagement activities, information on financing the transition, and details on individuals and governance structures responsible for implementation’.
- Industry-specific standards: One could query if the A4S’ suggestion to update the SASB standards is achievable or if it might be preferable, as the FRC suggests, to simply introduce Appendix B as non-mandatory guidance.
- Timing: the FRC suggests introducing a phased approach and/or ‘comply or explain’ approach for certain disclosure requirements (similar to the Listing Rules requirement for TCFD). It also underlines that the ISSB requirements should be proportionate and scalable and suggests, for example, that some of the disclosures only be required ‘where relevant in the circumstances of the entity’.
ISSB: What next for the UK?
The UK Government continues to signal its support for the ISSB regime and has reaffirmed its intention to adopt it as part of its Sustainability Disclosure Requirements regime. Whilst a lot of the detail is yet to be ironed out, it aims to consult on an adoption process in the coming months.