The International Sustainability Standards Board (ISSB), established by the IFRS Foundation at COP26 to develop a global baseline of sustainability financial disclosures for capital markets, launched its first proposed sustainability standards for consultation on 31 March 2022.
The standards build upon the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD) and incorporate industry-based disclosure requirements derived from Sustainability Accounting Standards Board (SASB) Standards (discussed here).
The ISSB released two exposure drafts – one relating to disclosure of sustainability-related financial information and the other concerned with climate-related disclosures. The proposed standards have the potential to create uniformity in the disclosure of financial information about sustainability and climate-related risks and opportunities. Entities that prepare financial statements in accordance with IFRS Accounting Standards or other GAAP may use these standards. The consultation period for the two exposure drafts closes on 29 July 2022.
The objective of the proposed standards is to assist organisations making an assessment of an entity’s enterprise value in relation to sustainability and climate-related risks and opportunities. Disclosures made in accordance with these proposed standards are intended to supplement and complement the information contained in the entity’s financial statements.
Scope and purpose of disclosures
The General Requirements for Disclosure of Sustainability-related Financial Information exposure draft applies to the disclosure of material information about significant sustainability-related risks and opportunities. Materiality is assessed according to what information is necessary for users of general purpose financial reporting such as investors, financiers and creditors.
The type of sustainability-related information that will need to be disclosed encompasses risks and opportunities arising from an entity’s dependency and impact on resources and business relationships. For example, if an entity’s operations were dependent on a resource such as water, then potential scarcity of water supply for the entity’s operations, or a potential adverse impact on availability of water to a local community from the entity’s operations may be a material sustainability risk for that organisation. This risk could, in turn, expose the entity to greater government regulation of access to water or negative reputational effects associated with its impact on the local community, each of which may have a consequential impact on the enterprise value of the organisation.
The Climate-related Disclosures exposure draft applies to the disclosure of significant climate-related risks and opportunities arising from:
- physical risks from climate change; and
- risks associated with the transition to a lower-carbon economy.
Overview of standards
The standards require a company to identify the sustainability and climate-related risks and opportunities that entity faces.
The standards require reporting entities to properly examine their susceptibility to sustainability and climate-related risks and opportunities by setting out specific criteria for a company to conduct such an examination.
In addition, each standard asks an entity to disclose:
- Governance – governance processes, controls and procedures used to monitor and manage sustainability and climate-related risks and opportunities.
- Strategy – how sustainability and climate-related risks and opportunities may affect the entity’s strategy. In particular, the effects of these risks and opportunities on the business model and value chain, financial position, financial performance and cash flow over the short, medium and long-term.
- Risk management – the processes by which sustainability and climate-related risks and opportunities are identified, managed and assessed.
- Metrics and targets – how the entity measures, monitors and manages its significant sustainability and climate-related risks and its performance. For climate-related risks this includes disclosing its greenhouse gas emissions and information related to the disclosure of emissions.
The Climate-related Disclosures exposure draft also requires details about climate-related targets including:
- what the objective of the target is e.g. mitigation, adaption or conformance with sector or science based initiatives;
- the amount of the entity’s emission target to be achieved through emission reductions and how much of that entity’s emission reduction plan is to be achieved using carbon offsets; and
- how the target compares with the latest international agreement on climate change and whether the target has been validated by a third party.
This requires significant transparency in relation to emissions targets and commitments from a reporting entity.
In addition, reporting entities are required to examine resilience to climate-related risk by disclosing the results of climate scenario analysis.
Who might use these standards?
While disclosure of ESG financial risks in accordance with independent sustainability standards is not mandatory in Australia, it is encouraged (at least in relation to climate-related financial risks) by bodies such as ASIC, APRA, AASB / AUASB and ASX.
Given the standards seek to provide a global baseline for assessing sustainability risks and opportunities relevant to enterprise value and build upon the widely accepted TCFD framework, it seems likely that these standards will become the recommended standards for entities in Australia wishing to improve their ESG financial disclosures.
However, the ISSB has acknowledged that there are limits to the compliance requirements set by these standards. It has noted that other stakeholders are interested in the effects of sustainability risks and opportunities, beyond those focused on the impact on enterprise value; for example, the impacts of physical activities on the environment, which is often referred to as the double materiality concept. As noted by ISSB, such matters may be addressed separately through other forms of ESG-focused regulation.
Best practice in preparing financial statements and the company’s operating and financial review in relation to sustainability and climate-related risks, is evolving but it seems possible that in the near future, the expectations of those for whom such reports are written extend to biodiversity and nature related financial disclosures, given that the Taskforce for Nature Related Financial Disclosures is currently developing a disclosure and reporting framework in this area, which will be similar to the TCFD framework.
The ISSB standards illustrate the level of detail required to evaluate a company’s sustainability and climate-related risks and opportunities. In this respect, we expect the new standards (once finalised) will provide a roadmap for organisations considering these risks and opportunities, and particularly when they are undertaking their financial reporting.