This article was co-authored with Jayne Kelly.
Introduction
In June 2023, the International Sustainability Standards Board (ISSB) launched the inaugural standards, International Financial Reporting Standards S1 and S2. As we have previously reported here, these standards require entities to disclose information about their sustainability-related financial information (IFRS S1) and climate-related risks and opportunities (IFRS S2).
The Iaunch of the IFRS S1 and S2 is expected to have a significant impact on the reporting obligations of an entity, and its board of directors and senior management that will be responsible for such reporting. Entities that are already reporting voluntarily under the Taskforce for Climate-related Financial Disclosures (TCFD) framework will now be able to rely on clear guidance in order to properly prepare and meet their disclosure obligations.
The new IFRS S1 and S2 standards complement the international trend of mandating TCFD reporting as we have previously explained here. More significantly, the IFRS standards support the ongoing consultation by the Australian Government on the proposal to mandate climate-risk disclosures in Australia.
Deep Dive on IFRS S1: Sustainability-related financial disclosure
The IFRS S1 is a general standard that requires an entity to disclose information about all material sustainability-related risks and opportunities that could reasonably be expected to affect the entity’s future operations and compliance with future regulations. This information includes an entity’s strategy and objectives in relation to sustainability. IFRS S1 also requires an entity to disclose information about its greenhouse gas emissions. An entity’s disclosure under IFRS S1 could include matters that arise out of its relationship with its stakeholders, new regulations, the economy, emerging technology and the natural environment throughout the entity’s value chain.
The standard provides four pillars for disclosure and the information expected to be disclosed for each:
Governance
- how an entity’s board of directors and senior management will oversee, manage and address sustainability-related risks and opportunities;
- how the board of directors and/or senior management’s responsibilities are reflected in the terms of reference, mandates, role descriptions and other related policies applicable to these positions;
Strategy
- current and anticipated effects of sustainability-related risks and opportunities on an entity’s business model and value chain as wells as an entity’s strategy and decision-making;
- effects of sustainability-related risks and opportunities on the entity’s financial position, financial performance and cash flow;
- the time horizons (e.g., short, medium and long-term) over which the effects of those sustainability-related risks and opportunities could reasonably be expected to occur;
- an explanation of how an entity defines these time horizons, and how they link to the planning horizons used by the entity for strategic decision-making;
Risk Management
- the processes and related policies the entity uses to identify, assess, prioritise and monitor sustainability-related risks and opportunities, including the use of scenario-analysis to inform these risks and opportunities;
- whether and how an entity prioritises sustainability-related risks relative to other types of risks;
Metrics and Targets
- applicable metrics associated with particular business models and activities as well as the metric used to set the target, with reference to supporting materials and guidelines to the IFRS Sustainability Disclosure Standards such as the sector-specific standards from the Sustainability Accounting Standards Board or the Climate Disclosure Standards Board Framework for water and biodiversity-related disclosures;
- any quantitative and qualitative target the entity has set or is required to meet by law as well the period for which the target applies, including any milestones and interim targets;
- whether the metric is validated by a third party as well as the method used to calculate the metric, including the limitations of the method used and any significant assumptions made; and
- any revisions to the target and an explanation for those revisions.
In addition to the sustainability-related risks and opportunities that must be disclosed, IFRS S1 also provides general rules that disclosures must meet to be relevant and useful. Disclosures must:
- be made with fair representation that provide a complete, neutral, and accurate description of the risks and opportunities;
- report on material information that stakeholders would expect to know apart from commercially sensitive information in order to make an informed decision on what sustainability-related impacts would impact their investments in relation to the entity;
- be made in a manner that enables users to understand the connections between an entity’s financial reports and disclosures made under IFRS S1;
- include the timing of reporting and any comparative information in respect of the preceding period for all amounts disclosed in order to provide any information on progress;
- include any assumptions, potential for uncertainty and any correction to errors in order to allow the users to manage their expectations on the veracity of disclosures; and
- provide an explicit and unreserved statement of compliance with the requirements of the IFRS S1.
Deep Dive on IFRS 2: Climate-related disclosure
IFRS S2 is a more detailed standard that focusses on an entity’s climate-related physical and transition risks and opportunities. This standard requires an entity to disclose information about its Scope 1, 2 and 3 greenhouse gas emissions, its adaptation plans and mitigation strategies, its physical and transition risks and opportunities, governance and management of such risks and opportunities, and the metrics and targets it used to measure and monitor its risks and opportunities.
Disclosures under IFRS S2 must provide:
Governance
- information about the governance body(s) and management’s role in the governance processes, controls and procedures used to monitor any action to manage climate-related risks and opportunities;
- information about how the body(s) responsible determines whether the appropriate skills and competencies are available or will be developed to oversee the strategies designed in the disclosure;
- in the event that responsibility is delegated to a specific management-level position or committee, how oversight will be exercised, how support will be provided, and how controls and procedures are integrated within an entity’s internal functions.
Strategy
- the current and anticipated effects of climate-related risks and opportunities on the entity’s business model and value chain;
- the effects of risks and opportunities on the entity’s financial position, cash flows, and the resulting strategy and decision making that have been factored into an entity’s financial planning, including a climate-related transition plan;
- all reasonable and supportable information available to an entity at the time of reporting that enables users to understand climate-related risks and opportunities, which may include how emerging policy and technology may impact the entity’s business model and value chain;
- any description about an entity’s business model and value chain such as geography, facilities and types of assets, and any anticipated impacts on those factors;
- any information that details how an entity will be resourcing or plans to resource the activities disclosed as part of their strategy to mitigate or manage risks and opportunities;
- any climate-related risks and opportunities for which there is a significant risk of a material adjustment on an entity’s assets and liabilities within the next annual reporting period;
- any plans on how an entity expects its financial position to change over the short, medium and long term, given its strategy to manage climate-related risks and opportunities;
Risk Management
- any information about the processes and related policies for identifying, assessing, prioritising and monitoring climate-related risks and opportunities, and the extent to which such processes are integrated into the entity’s overall risk management process;
- information about the use of climate-related scenario analysis to inform the identification of risks;
- how the entity assesses the nature, likelihood and magnitude of the effects of those risks using qualitative and quantitative criteria;
Metrics and Targets
- any information relevant to the cross-industry metrics to enable users to readily compare disclosures across industries;
- any industry-based metrics associated with business models and activities that the entity uses to identify risks and opportunities such as absolute Scope 1, 2 and 3 greenhouse gas emissions generated during the reporting period in accordance with the Greenhouse Gas Protocol: A Corporate Accounting and Reporting Standard (2004);
- any targets set by the entity, and any targets it is required to meet by law or regulation, to mitigate or adapt to climate-related risks to allow an entity to measure progress towards these targets.
Why does this matter?
The IFRS S1 and S2 are designed to provide investors with the information they need to make informed decisions about an entity’s sustainability performance and how prepared they are to adapt to the material impacts of climate change. The standards are also designed to help an entity better manage its risks and opportunities such that this will lead to a more consistent and comparable approach in reporting on progress.
Overall, the trend towards more consistent and comparable reporting via the use of the IFRS S1 and S2 is a positive development towards climate resilience. By requiring entities to disclose information about their sustainability and climate-related risks and opportunities, entities are encouraged to take steps to mitigate risks and improve accountability. It also allows investors to make informed decisions that unlock the potential for accelerating climate solutions by investing in entities that genuinely progress their activities towards meeting their climate targets.
The Treasury’s Consultation for Mandatory TCFD reporting
Amid the growing pressure from investors to understand the material risks that climate change presents to the global financial system, the Australian Treasury (Treasury) released a consultation paper to seek initial views on mandatory climate-related financial risk disclosure in December 2022.
In response to this consultation paper, Treasury received 194 submissions from peak bodies, businesses, individuals, academics, research institutes and public sector entities. These submissions were almost universally supportive of the Government mandating climate-related risk disclosures. However, feedback in relation to the governance and oversight arrangements in the financial reporting system was mixed and is still ongoing.
In June 2023, Treasury released its second consultation paper on the proposal to make the TCFD framework mandatory for Australian entities (Second Consultation). Under the proposed phased approach, all entities will be required to lodge climate-related risk disclosures by 2027-2028.
The phasing is intended to work as follows:
| Phases |
Timing |
Reporting Entities |
| 1 |
2024-25 onwards |
Entities that meet two of the three thresholds:
- Has over 500 employees;
- Has $1 billion in consolidated gross assets in the end of the financial year of the company and any entities it controls;
- Has control of $500 million or more in consolidated revenue for the financial year of the company and any entities it controls; and
Entities that are required under Chapter 2M of the Corporations Act that are a ‘controlling corporation’ under the NGER Act and meet the NGER publication threshold.
|
| 2 |
2026-27 onwards |
Entities that meet two of the three thresholds:
- Has over 250 employees;
- Has $500 million in consolidated gross assets in the end of the financial year of the company and any entities it controls;
- Has control of $200 million or more in consolidated revenue for the financial year of the company and any entities it controls; and
Entities that are required under Chapter 2M of the Corporations Act that are a ‘controlling corporation’ under the NGER Act and meet the NGER publication threshold.
|
| 3 |
2027-28 onwards |
Entities that meet two of the three thresholds:
- Has over 100 employees;
- Has $25 million in consolidated gross assets in the end of the financial year of the company and any entities it controls;
- Has control of $50 million or more in consolidated revenue for the financial year of the company and any entities it controls; and
Entities that are required under Chapter 2M of the Corporations Act that are a ‘controlling corporation’ under the NGER Act.
|
| |
|
|
Source: Climate-related financial disclosure – Consultation paper
The biggest priority is for standards to be developed quickly in order to ensure that investors are able to make informed decisions and that entities are disclosing consistent and comparable information. The Treasury Laws Amendment (Measures for Consultation) Bill 2022 which seeks to amend the Australian Securities and Investment Commission Act 2001 is currently before Parliament to give the Australian Accounting Standards Board (AASB) the ability to develop climate-related standards, with reference to the IFRS S1 and S2.
The Second Consultation seeks feedback on the following proposals which would apply to reporting requirements:
- principles of financial materiality would apply;
- from commencement, companies would be required to disclose information about governance processes, controls and procedures used to monitor and manage climate-related financial risks and opportunities;
- from commencement, reporting entities would be required to use qualitative scenario analysis to inform their disclosures, moving to quantitative scenario analysis by the 2027/28 reporting year;
- from commencement, reporting entities would be required to disclose climate resilience assessments against at least two possible future states, one of which must be consistent with the global temperature goal set out in the Climate Change Act 2022;
- from commencement, transition plans would need to be disclosed, including information about offsets, target setting and mitigation strategies;
- from commencement, all entities would be required to disclose information about any climate-related targets (if they have them) and progress towards these targets;
- from commencement, entities would be required to disclose information about material climate-related risks and opportunities to their business, as well as how the entity identifies, assesses and manages risks and opportunities;
- from commencement, Scopes 1 and 2 emissions for the reporting period would be required to be disclosed;
- disclosure of material Scope 3 emissions would be required for all reporting entities form their second reporting year onwards. Scope 3 emissions disclosures made could be in relation to any one-year period that ended up to 12 months prior to the current reporting period; and
- by the 2027/28 reporting year, reporting entities would be required to have regard to disclosing industry-based metrics, where there are well-established and understood metrics available for the reporting entity.
Of note, a modified liability approach is proposed given concerns raised in relation to the requirement to report on scope 3 emissions and the fact that there may not be sufficient data available to allow confident and accurate reporting. The proposal is that climate-related financial disclosure requirements would be drafted as civil penalty provisions in the Corporations Act. However, the application of misleading and deceptive conduct provisions to Scope 3 emissions and forward-looking statements would be limited to regulator-only actions for a fixed period of three years after the reporting regime commences.
Next steps
The launch of the IFRS S1 and S2 provide entities with more clarity, consistency and comparability in relation to how entities identify, assess and plan for sustainability and climate-related risks and opportunities. Other countries such as the UK, Canada, EU Member States, New Zealand and Singapore have either already made TCFD reporting mandatory or have announced that they plan to mandate such reporting.
In line with international support for mandating TCFD reporting and the growing societal expectation for corporate climate action, Australian entities would be wise to start preparing for mandatory TCFD disclosures, particularly having regard to the forthcoming mandatory reporting requirements.
To find out more about how sustainability and climate reporting will impact your organisation, and the resulting duties and responsibilities placed on directors and senior management, please contact a member of our climate and sustainability team.
