On 29 July 2022, the International Sustainability Standards Board’s (ISSB) 120-day consultation on ‘exposure drafts’ of the first two proposed “IFRS Sustainability Disclosure Standards” will close. The ISSB will then consider the feedback and look to finalise the standards in 2023.
The objective of these standards is to ensure that investors have access to high quality, consistent and verifiable ESG information regarding investee businesses (and their supply chains), irrespective of jurisdiction.
The Financial Reporting Council (FRC) has reviewed the exposure drafts and, in its response to the ISSB, describes the publication of these exposure drafts as a “momentous achievement” and notes that “climate and wider sustainability and ESG data is increasingly being used for capital allocation decisions, and therefore, needs to be as reliable and comparable as financial reporting”.
What is the ISSB and what is it trying to achieve?
The ISSB was established by the IFRS Foundation at COP26 in 2021 to develop a comprehensive global baseline of sustainability disclosures for capital markets, which are compatible with jurisdiction-specific reporting requirements. The objective is for primary users (investors, creditors, lenders and other creditors) to be able to use such information, in conjunction with traditional financial statements, to assess an entity’s enterprise value.
In this context, the range of information that could be relevant for the purposes of determining enterprise value is broader than just the information contained in financial statements. Reporting entities will need also to disclose societal and environmental impacts, to the extent that they influence a primary user's assessment of that entity’s enterprise value (and so affect the returns to providers of financial capital).
This approach can be distinguished from (a) broad-based corporate disclosure obligations regarding sustainability matters which aim to meet the needs of multiple stakeholders (often based on jurisdiction-specific requirements) and (b) traditional financial reporting which requires a user to base their assessment of enterprise value on historical monetary data.
ISSB Standards Architecture
The ISSB’s stated intention is to consolidate and build on existing reporting frameworks and this can be seen in the proposed architecture of the standards. Emmanuel Faber, Chair of the ISSB, says that the draft standards are “fully building upon the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), and they also incorporate industry-specific requirements based on the SASB Standards.”
The final suite of reporting standards will comprise an overarching general requirements standard and a number of thematic and industry-specific standards. Under each standard, disclosures will be made using the same “four pillar” structure that is set out in the TCFD Recommendations: (i) governance, (ii) strategy, (iii) risk management and (iv) metrics and targets. This will provide a common conceptual disclosure framework across all of the standards.
The intention is for each standard to be complementary to the others in order to minimise duplicate disclosure. The FRC has expressed some reservations on this point and has suggested that the general requirements standard should deal “only with holistic and common disclosure requirements, removing duplication and leaving topic-specific requirements to the specific disclosure topic standards.”
General Requirements Exposure Draft (IFRS S1)
The general requirements standard will require an entity to disclose material information about all of the significant sustainability-related risks and opportunities which could affect its enterprise value.
When assessing the significance of such risks and opportunities, reporting entities should refer to the various disclosure topics set out in the IFRS Sustainability Disclosure Standards, the SASB Standards, the ISSB’s non-mandatory guidance, industry practice and other standard-setters’ materials to assist with this process.
In its response to this exposure draft, the FRC expressed a particular concern regarding the additional reporting burden for companies (notwithstanding the UK adoption of the TCFD Recommendations).
Climate Exposure Draft (IFRS S2)
The first thematic standard will cover climate-related risks and opportunities. As with the TCFD Recommendations, reporting entities must consider physical and transitional risks and, in addition, a number of industry-specific disclosure requirements, based on the SASB Standards, will be required.
In its response to this exposure draft, the FRC welcomes the formalisation of the TCFD Recommendations into IFRS S2, but notes that some of the disclosure obligations are “identical to the requirements in IFRS S1, which is somewhat unnecessary”. On that basis, the FRC suggests that this standard should “focus only on topic-specific elements in relation to climate change”.
SASB Standards
Both proposed standards require consideration of the SASB Standards, which identify the sustainability disclosure topics most relevant to enterprise value for a typical business in each of 77 different industries.
The ISSB is seeking to embed SASB’s industry-based approach into its process and, notably, in an upcoming organisational change, the Value Reporting Foundation (which hosts the SASB Standards) will be consolidated into the IFRS Foundation, following formal approval by the respective governing boards in June.
However one current drawback of the SASB Standards is that they are notably US-centric. The ISSB acknowledges that this is a potential issue, so it is taking on the leadership of a project to improve the international applicability of the SASB Standards.
Indeed the FRC points out that the SASB Standards are based largely on research into the US market and contain multiple references to US-specific regulations. Accordingly, it strongly recommends that, until the ISSB’s work on international applicability is complete, the SASB Standards should only constitute non-mandatory guidance where an IFRS Sustainability Disclosure Standard for a specific topic does not yet exist.
Next Steps
The publication of these exposure drafts was a significant milestone. UK businesses, especially larger companies which operate in industries with significant sustainability risks and opportunities, will need to monitor the work of the ISSB (and the FRC) closely, as these new standards take shape.
"Rarely do governments, policymakers and the private sector align behind a common cause. However, all agree on the importance of high-quality, globally comparable sustainability information for the capital markets. These proposals define what information to disclose, and where and how to disclose it." Emmanuel Faber, Chair of the ISSB.