Standards on sustainability and climate-related disclosures being developed by International Sustainability Standards Board

General requirements exposure draft

Draft IFRS S1 targets existing and potential investors, lenders and other creditors, on the basis that these users will use general purpose financial reporting when reviewing investment opportunities.¹

For this target audience, Draft IFRS S1 attempts to standardise the target audience’s materiality assessment of an entity’s financial statement. The manner in which it does this is by ensuring a specific answer to the question: what sort of sustainability-related information is likely to influence an investment decision based on an entity’s financial statement?

In essence, Draft IFRS S1 aims to provide the target audience with the following:

1. information specific to the practices and circumstances of the entity, rather than a generic disclosure; and
2. material information necessary for an assessment of how the entity contributes to and is affected by sustainability-related risks and opportunities.²

We note that a degree of scepticism is warranted in the context of Draft IFRS S1’s second aim. As noted by the exposure draft, given ‘the very nature of the sustainability-related disclosures, the information required by IFRS Sustainability Disclosure Standards is likely to be deemed immediately material.’³ For example, there is a high chance that all entities exposed to a significant climate-related risk would assess information about the governance of that risk to be material.

Further to the above, participants should be aware that sustainability-related financial information encompasses a wide spectrum of activities and considerations. For example, financial statements could include information about:

• an entity’s governance of sustainability-related risks and opportunities, and its strategy for addressing them;
• decisions made by the entity that could result in future inflows and outflows that have not yet met the criteria for recognition in the related financial statements;
• the entity’s reputation, performance and prospects as a consequence of the actions it has undertaken, such as its relationships with people, the planet and the economy, and its impacts and dependencies on them; and
• the entity’s development of knowledge-based assets.⁴

As a baseline, an entity is required to identify the significant sustainability-related risks and opportunities which could reasonably be expected to affect its business model, strategy or cash flows.⁵ Further, Scope 3 emissions (i.e. emissions originating in a company’s value chain and beyond its direct control) are also required to be disclosed.⁶ In identifying the sustainability-related risks and opportunities, metrics used as a point of comparison will also need to be disclosed, even in circumstances where there is an absence of an applicable IFRS Sustainability Disclosure Standard.⁷

Climate exposure draft

The Draft IFRS S2 builds on the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD) and incorporates industry-based disclosure requirements derived from SASB Standards, which can be found here.

The objective of Draft IFRS S2 is to require an entity to disclose information about its exposure to significant climate-related risks and opportunities, enabling users of an entity’s general purpose financial reporting to:

• assess the effects of significant climate-related risks and opportunities on the entity’s enterprise value;
• understand how the entity’s use of resources, and corresponding inputs, activities, outputs and outcomes support the entity’s response to and strategy for managing its significant climate-related risks and opportunities; and
• evaluate the entity’s ability to adapt its planning, business model and operations to significant climate-related risks and opportunities.

To measure the risks (consisting of both physical risks and risks associated with transitioning to differing energy sources), and climate-related opportunities, Draft IFRS S2 focusses on an entity’s disclosure information as it is relevant to ‘cross-industry metric categories’.’⁸ The metrics considered in Draft IFRS S2 are:

• greenhouse gas emissions;
• transition risks;
• physical risks;
• climate-relate opportunities;
• capital deployment;
• internal carbon prices; and
• remuneration.

Helpfully, Draft IFRS S2 appreciates the ambiguity associated with the term ‘cross-industry metric categories’. The guidance material accompanying Draft IFRS S2 clarifies the metrics and provides examples relating to TCFD. The material provided in the guidance materials has been replicated below for convenience:⁹

A recent development in light of the above has been the proposed inclusion of Scope 3 emissions. The inclusion of Scope 3 emissions has been met with controversy for two reasons. Firstly, this inclusion poses great difficulty and cost associated with the calculation and monitoring of emissions. Secondly, the emissions arise from a company’s indirect actions (e.g. customer’s consumption of the company’s product, associated supply chains etc.). Although these emissions are a major component of a company’s carbon emissions, some regulators have shown a greater reluctance to readily accept its inclusion into the standards (see the SEC below). However, given the late inclusion of Scope 3 disclosures, the IFRS continues to develop “safe harbor” provisions, to give companies protection or reduced liability on disclosed Scope 3 information.¹⁰

What sustainable and climate-related measures have countries adopted globally?

The current commercial landscape suggests that some companies believe publically available information is enough to provide material information about all of its sustainability-related risks and opportunities.¹¹ Both draft standards disagree. To some extent, this divergence of opinion between financial statement users and producers is the rationale underpinning the creation of the draft standards.

As it currently stands, countries have started to advocate for more transparency in relation to an entity’s climate and sustainability disclosures. However, at present, there is minimal uniformity between the approaches adopted by different countries.

Australia

Australia’s Financial Services Council (FSC) published FSC Guidance Note No 44 Climate Risk Disclosure in Investment Management.¹² The intent is to provide practical steps, based on leading practice, to guide investment managers on how to communicate with investors regarding the relevant green or sustainable attributes of relevant products and services.

Like other international jurisdictions, application of the Guidance Note is voluntary.

China

China Enterprise Reform and Development Society (CERDS), alongside a number of major Chinese companies, issued The Guidance for Enterprise ESG Disclosure (the Guidance) with intention for this guidance to become effective on 1 June 2022.¹³ On its face value, the Guidance seeks to adopt global sustainability disclosures and align them with unique Chinese business considerations such as social welfare system contributions and the housing provident fund.

The Guidance is applicable to voluntary or mandatory disclosure requirements that may apply to Chinese companies. Each Chinese company can choose the applicable time cycle for making its disclosures. Subject to disclosure being made in accordance with the Guidance, an official ESG report will be generated and made available on a platform designated by the regulatory authority or chosen by the Chinese company.

US

On March 21, 2022, the U.S. Securities and Exchange Commission (SEC) proposed rules that are prescriptive and intended to provide investors with consistent and comparable data.¹⁴ Notably, the proposed rules required entities to disclose:

1. direct greenhouse gas (GHG) emissions (Scope 1);
2. indirect GHG emissions from purchased electricity and other forms of energy (Scope 2); and
3. indirect emissions from upstream and downstream activities in a company’s value chain (Scope 3).¹⁵

A unique feature of the SEC’s proposed rules is in relation to carbon offsets or renewable energy credits or certificates (RECs). If these schemes are a part of an entity’s net emissions reduction strategy, the entity will be required to disclose the role that carbon offsets or RECs play in its climate-related business strategy. Similarly, if a company uses an estimated cost of carbon emissions internally within an organisation, the company would be required to provide specified disclosures relating to its internal carbon price.¹⁶

As noted above, the SEC received significant pushback on its proposals for Scope 3 reporting. For example, global investment manager BlackRock called for a more flexible ‘comply-or-explain’ approach (similar to New Zealand’s framework below) from the SEC on Scope 3. This is despite the SEC already having less prescriptive standards relative to say, China. Again, the rationale for this outcry from BlackRock was ‘the methodological complexity involved in tracking the emissions and the lack of direct company control impact the usefulness of Scope 3 disclosure.’¹⁷

New Zealand

New Zealand’s Exchange (NZX) has released an exposure draft of the changes it proposes for the NZX Corporate Governance Code (the Code).¹⁸ For context, the Code was established pursuant to NZX rule 3.8.1 that outlines a set of principles and recommendations governing entity corporate governance and disclosure standards. The overarching intention of the Code is to ensure listed companies report against the Code when making public disclosures in a standardised matter.¹⁹ In the context of new revisions to the code (i.e. honing the principles and recommendations relating to sustainability and climate-related disclosures), the NZX has proven its intention to actively monitor developments relating to these standards. To better oversee the implementation of the Standards, NZX revealed its plans to create a new corporate governance body, the NZX Corporate Governance Institute, at the end of 2022.²⁰

Recommendations relating to ESG considerations and Climate-related disclosures were put forth as they related to Principle 4 (Reporting & Disclosure) of the Code. Practically, these recommendations propose a distinction between financial (Recommendation 4.3) and non-financial reporting (Recommendation 4.4).

For the purposes of non-financial reporting, the recommendation suggests measures such as:²¹

• requiring issuers of financial statements to provide ESG reporting on their website alongside an annual report that includes a clear statement as to where that information is available;
• issuers will report the process by which their non-financial reporting disclosures have been prepared where it has not been subject to formal review or audit by an external auditor; or
• alerting issuers to the new climate reporting requirements under the Financial Sector (Climate-related Disclosures and Other Matters) Amendment Act, and directing issuers to NZX’s ESG Guidance Note.

What happens now?

As outlined above, countries will continue to proactively implement measures aimed at minimising their compliance costs while they wait for the proposed standards to be published. In the meantime, the ISSB is now reviewing the feedback it has received on the Climate Exposure Draft and General Requirements Exposure Draft. The intention of the ISSB is to publish the standards at the end of the 2022 calendar year.

If you have any questions or are seeking advice relating to either the Draft IFRS S1 and/or Draft IFRS S2, please contact a member of our team.