The International Financial Reporting Standards Foundation (IFRS) announced on March 31 that the International Sustainability Standards Board (ISSB) released its first exposure drafts of proposed standards of company sustainability and climate-related disclosures. The new standards will become a comprehensive global baseline, assisting the capital market participants to conduct sustainability disclosures. Moreover, this overarching framework can effectively meet the market demand for more reliable and consistent information from companies’ reports. According to the proposals, reporters are encouraged to prepare the sustainability-related financial information alongside with company financial statement and to disclose the relevance of the sustainability-related financial information to the information in their financial statements.
The ISSB, established at COP26, is currently gathering feedback on the proposed standards during a 120-day consultation period that ended on 29 July 2022. After that, the ISSB will finalize the disclosure standards based on the consultation response by the end of this year.
IFRS S1: General Requirements for Disclosure of Sustainability-related Financial Information
IFRS S1 is the general reporting requirement on firms’ sustainability-related information. Under this principle, companies should disclose the information about their exposure to all significant sustainability-related risks and opportunities, which is material to influence their entity value. The information disclosed covers several topics such as impacts and dependencies on people, the planet and the economy, which enables investors to understand companies’ monitoring and management processes of their sustainability risks and opportunities. Besides the disclosure made at a standalone entity level, companies should report on sustainability-related information across their value chain, including activities, interactions, and relationships along the supply chain, and their assets and investments.
IFRS S2: Climate-related Disclosures
IFRS S2 is a specific requirement on climate-related issues. It requires companies to disclose material information to help investors assess the influence of significant climate-related risks and opportunities on enterprise value. The proposal requires information on the governance process, controls, and procedures used to monitor and manage climate-related risks and opportunities. It also emphasizes the influence of climate change on the company’s business models, strategy, and cash flows, as well as the identification of physical climate change risks and transition risks related to the shift toward a low-carbon economy.
Apart from the strategic information, IFRS S2 also requires companies to disclose absolute Scope 1, 2, and 3 information, applying the calculation methods in GHG protocol. The ISSB regards the Scope 3 emissions as an important component in the investment-risk analysis because they represent the largest portion of an entity’s carbon footprint by far.
ISSB Aligns with the US Regulator’s New Rules
The US Securities and Exchange Commission (SEC) announced on March 21 the release of its proposal for climate disclosures for US public companies. This is the first time that the SEC has enforced US-listed companies to provide information on climate risks that they are facing and plans to address those risks. If companies have adopted a transition plan, they should explain the plan, including the metrics and targets used to identify and manage physical and transition risks. If companies have used scenario analysis to assess resilience toward climate change, they should report on the parameters, assumptions and analytical choices they used, and project the impacts on their financial performance. For large companies, Scope 1 and 2 emissions will be required for FY 2023, and FY 2024 for smaller companies.
Both the SEC and the ISSB have integrated the TCFD recommendations into the proposed requirement on climate-related disclosure, indicating an increasing emphasis on climate information and a promising future of forming a global baseline on it. In terms of Scope 3 emission, the SEC calls for relevant information only if they are material or if the company has an emission reduction goal that includes Scope 3. However, ISSB takes a step further compared to the SEC’s new rules. The ISSB requires companies to disclose absolute scope 3 information calculated using the GHG protocol, which attaches more importance to the Scope 3 information.
Key Takeaway: Companies Should Get Prepared and Take Action Now
It is an inevitable trend for companies to disclose their ESG performance and, in particular, their targets and effort to fight against climate change. However, according to a KPMG survey in 2020, around 40% of companies acknowledge the financial risks of climate change in their reporting, while only 20% report climate risks in line with the TCFD recommendations. Therefore, more companies worldwide should get involved and set their targets for reducing carbon emissions.
There is absolutely a need for a global framework, which can further enhance the consistency and comparability of corporate reports. Companies in different regions can have more clarity about the regulatory expectations on them and save more costs to publish high-quality information. While standards may evolve, it’s better for companies to design a feasible action plan and pay attention to non-financial information actively. An effective strategy is to show leadership from the top level of management, also embed awareness in operations, and involve stakeholders across the organization. All in all, make tweaks rather than wait and start from scratch.
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