ISSB publishes first-ever global sustainability reporting standards

A sophisticated investor likes to clearly see the financial implication of an entity’s sustainability initiatives 

Background 

The long-awaited global sustainability disclosure standards were released on 26 June 2023. Better late than never is what can be said as there is a plethora of frameworks and standards that can be used to measure and report on sustainability and other non-financial information that causes confusion and uncertainty in the market. 

It is estimated that more than 300 mandatory reporting schemes and more than 200 voluntary reporting schemes are used globally. Organisations can cherry pick the framework or standard that it thinks suitable and disclose its non-financial information to its stakeholders. This could also lead to greenwashing financial and non-financial information disclosed in the integrated annual reports. There is no common agreement on what should be measured and whether that information should be subject to external assurance. 

The IFRS Foundation formally announced the establishment of the International Sustainability Standards Board (ISSB) at the 2021 United Nations Climate Change Conference (COP26) in Glasgow. The ISSB was entrusted in developing a global baseline of sustainability disclosure standards and helps consolidate what has long been described as an “alphabet soup” of standard-setters. 

On 26 June 2023, ISSB issued its first two IFRS Sustainability Disclosure Standards, ushering in a new era in international corporate reporting: IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2 Climate-related Disclosures. IFRS S1 and IFRS S2 are built on and consolidate the Task Force on Climate-Related Financial Disclosures (TCFD) recommendations, Sustainability Accounting Standards Board (SASB) Standards, Climate Disclosure Standards Board (CDSB) Framework, Integrated Reporting (IR) Framework and World Economic Forum metrics to streamline sustainability disclosures.

Objective

The objective of this article is to comment on the practical application of IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information, and key challenges from global and local perspective. The author wishes to cover IFRS S2 Climate-related Disclosures on the same note via a separate article. 

IFRS S1

The objective of IFRS S1 is to require an entity to disclose information about its sustainability-related risks and opportunities that is useful to primary users of general-purpose financial reports in making decisions relating to providing resources to the entity. 

In overall the terminology used in the IFRS S1 is primarily based on the accounting terminology like materiality, primary users, and general-purpose financial reports. The language in the standard is an “Accounting Language”, or in other words its sustainability translated into an accounting language. This is a deviation from the other existing sustainability frameworks/standards where IFRS S1’s primary focus is on the investor. This would help organisations to break the barrier between the Accounting and Sustainability worlds and have a common understanding within the teams. In my view this is a positive move from a point of view of an investor, as a sophisticated investor likes to clearly see the financial implication of an entity’s sustainability initiatives. 

Both IFRS S1 and IFRS S2 refer to meeting the needs of primary users of general purpose financial statements. In other words, this refers to investors or the shareholder of the entity. However, the other widely used sustainability frameworks such as Global Reporting Initiative (GRI) meets the needs of broader stakeholders in preparing sustainability related information. Therefore, I am of the view that entities may continue to use broader sustainability frameworks such as GRI to meet the information needs of wider stakeholders, together with ISSB standards which forms the baseline of disclosing information for investor needs. However, entities need to ensure to avoid duplication of information when adhering to both. Further, in my view, this is a positive move by the standard setter to facilitate a broader stakeholder requirement by the usage of a standard such as GRI, whist complying with the IFRS S1 and IFRS S2.

In the world of sustainability there are various definitions to the term materiality such as dual materiality, impact materiality and dynamic materiality. However, IFRS S1 defines materiality based on the needs of the investor by stating “the information is material if omitting, misstating, or obscuring it could reasonably be expected to influence investor decision”. This definition of materiality is borrowed from the IFRS Accounting Standards. It aligns the financial and non-financial information presented in the integrated annual report. This convergence of the materiality definition goes in par with the original thinking where the primary uses of financial statements are the investors. I am of the view that this definition of materiality will curtail the greenwashing.   

IFRS S1 specifically mentioned to disclose information relating to sustainability related risks and opportunities. The term “sustainability” has a broader definition which covers not only the environmental or climate factors but also the social, governance and economic factors. 

Sustainability-related risks and opportunities may arise from, for example, climate change, water use, land use, workplace health and safety, labour conditions in the value chain, and data security. Although the standard provides transitional relief in the first annual reporting period by disclosing information only on the climate related risk and opportunities, eventually, to make sure it is aligned with IFRS S1. From the second year of application, entities need to identify a complete and valid set of sustainability-related risks and opportunities. This would directly impact how entities define what the risk management activities could be as well as how the metrics and targets could be identified and used. I am of the view that disclosing sustainability related risks and opportunities stems from the principle of relevance. Relevant to whom? Relevant primarily to an investor. 

Relevance coupled with materiality pins the report writers to avoid greenwashing. 

IFRS S1 encourages entities to disclose matters other than climate-related disclosures by referring to other globally accepted standards and frameworks such as SASB Standards, CDSB Framework, Industry Practices, GRI Standards and European Sustainability Reporting Standards (ESRS). ISSB is currently in the process of developing other topic based standards such as bio-diversity, eco systems, human rights, labour, and anti-corruption. It is encouraging to observe that ISSB is going beyond climate-related disclosures, to have a more holistic view on sustainability related issues. Further, as stated earlier, entities may continue to use the other globally accepted sustainability frameworks such as GRI, till ISSB publishes its future topic standards. It is worth noting that the standard setter is moving towards developing subject-related standards. 

Under IFRS S1, entities are required to disclose material information about sustainability risks and opportunities that could impact the business. Specifically, entities must provide details about how these risks and opportunities could influence the entity’s business model, strategic plans, and consequently, cash flows, ability to raise funding, or cost of capital over the short, medium, and long term. The goal is to give users a clear understanding of how environmental and social factors may affect the entity financially, both now and in the future. This emphasises how sustainability issues can directly impact an entity’s financial performance which is a critical investor information. The emerging trend for entities to report on both financial and non-financial information reflects the growing need for integrated business reporting. It may be beneficial for an entity to look at its competitors in the same industry or region to take note of the risks and opportunities they identified, to make its own identification process more comprehensive.

IFRS S1 requires entities to prepare and disclose sustainability related risks and opportunities for the same reporting entity as the related financial statements. If the reporting entity is a group, the consolidated financial statements and the sustainability-related financial disclosures will be for the parent and its subsidiaries. The definition of a reporting entity is consistent with that in IFRS Accounting Standards and excludes Associates and Joint Ventures as the investor does not control these investees. However, IFRS S1 would also require an entity to disclose material information about all the significant sustainability-related risks and opportunities to which it is exposed. These risks and opportunities relate to activities, interactions, and relationships and to the use of resources along its value chain, such as any material investments it controls, including investments in associates and joint ventures, for example, financing a greenhouse gas-emitting activity through a joint venture. Therefore, I am of the view that the reporting entity concept in IFRS S1 is bound by the principle of materiality and relevance. Sustainability-related financial information is not always monitored at entity level within the group and requiring sustainability-related financial information at every level of a group could become challenging and costly for preparers, at least initially.

IFRS S1 states that sustainability related disclosures need to be provided at the same time as at the financial statements and as a part of general-purpose financial reports. If the entity is a listed entity, quarterly financial statements are published as per the listing rules other than the annual financial statements. In order to comply with IFRS S1 requirement, sustainability related risks and opportunities also need to be provided on quarterly basis (or at the same time as at the financial statements and as a part of general-purpose financial reports). IFRS S1 has given transitional relief for the first year of reporting, but eventually, to make sure it is aligned with IFRS S1 from the second year of application. Entities need to develop procedures and processes to report sustainability related risk and opportunities at the same time as at the financial statements from subsequent years. This would be challenging for entities who have been used to report sustainability related information on an annual basis. 

IFRS S1 also specifically requires that an entity to provide information about the current and anticipated financial effects of sustainability-related risks and opportunities. An entity is required to disclose the anticipated financial effects of sustainability-related risks and opportunities on the entity’s financial position, financial performance, and cash flows over the short, medium and long term, taking into consideration how these risks and opportunities are included in the entity’s financial planning. This would be challenging for entities who have used to provide historical information about entity’s sustainability disclosure using other frameworks/standards. 

In financial reporting, entities usually use the historical cost and fair value to measure the items in financial statements. Accounting standards generally provide detailed requirements on how these items are measured initially and subsequently. IFRS S1, however, doesn’t provide direct measurement guidance. Instead, entities are required to apply judgement and to consider metrics associated with the industry based SASB standards and other frameworks. Metrics and targets cannot be established in isolation and an entity must take into account the business models, activities and other common features that characterise participation in an industry together with stakeholders in other relevant business units. Further, sustainability-related financial disclosures are set to become more forward-looking than historical financial information, given that metrics will show an entity’s progress towards targets it has set, or is required to meet by law or regulation.

Both IFRS S1 and IFRS S2 are effective for annual reporting periods beginning on or after 1 January 2024. Mandatory application of IFRS Sustainability Disclosure Standards depends on each jurisdiction’s endorsement or regulatory processes. The application of IFRS Sustainability Disclosure Standards is not linked to the application of IFRS Accounting Standards. Therefore, an entity applying IFRS Accounting Standards for financial reporting purposes is currently not required to also apply IFRS Sustainability Disclosure Standards, and vice versa. 

The Institute of Chartered Accountants of Sri Lanka is the national body for issuing Accounting and Auditing Standards in Sri Lanka and is currently in the process of introducing these two standards to the corporate sector and other stakeholders. Further, the International Organization of Securities Commissions (IOSCO) has announced its endorsement of the ISSB Standards following its comprehensive review of the Standards. IOSCO is now calling on its 130 member jurisdictions—capital markets authorities that regulate more than 95% of the world’s securities markets—to consider how they can incorporate the ISSB Standards into their respective regulatory frameworks to deliver consistency and comparability of sustainability-related disclosures worldwide. In Sri Lankan context, Securities and Exchange Commission of Sri Lanka (as a member body of IOCSO) needs to consider how listed companies in Sri Lanka can incorporate ISSB Standards and issue directions accordingly. 

Conclusion 

To reap the full potential of IFRS S1, entities need to strengthen their governance, redesign controls, and rethink their processes and procedures. To capture and monitor sustainability-related financial disclosures required by the standard, entities will need to go far beyond updating the organisation chart, ticking boxes and will have to match their commitments with the necessary expertise and experience of leadership teams as well as sustainability professionals.

(The writer serves as the Senior Director – Climate Change and Sustainability Services of Ernst & Young Sri Lanka. He is an Associate Member of Institute of Chartered Accountants of Sri Lanka (ACA), an Associate Member of Institute of Certified Management Accountants of Sri Lanka (ACMA), an Associate Member of the Chartered Institute of Management Accountants of United Kingdom (ACMA-UK), a Chartered Global Management Accountant (CGMA) and Master of Business Administration (MBA) degree holder of Postgraduate Institute of Management of University of Sri Jayewardenepura.)

(Disclaimer: Opinions expressed here are solely my own and do not express the views or opinions of my employer. It should not be relied upon as an advice.)