ISSB publishes its inaugural sustainability standards - Ancoram’s deep dive into IFRS S1
Today the International Sustainability Standards Board (ISSB, part of the IFRS Foundation) published its inaugural IFRS sustainability standards. In this post we provide a detailed analysis of IFRS S1, and critical issues companies should be aware of.
The inaugural IFRS sustainability disclosure standards comprise:
IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information, which provides the principles governing specific sustainability-related disclosures established in IFRS S2 and future IFRS sustainability disclosure standards; and
IFRS S2 Climate-related Disclosures, which requires specific disclosures concerning greenhouse gas emissions and other climate-related data (see our other post on IFRS S2 here).
These standards are the first of many to be issued by the ISSB - they are currently consulting on what their next priorities should be. In this article we do a deep dive into the requirements of IFRS S1.
When is IFRS S1 effective?
The effective date for disclosure is for reporting periods starting on or after 1 January 2024. Companies can adopt S1 at an earlier date, but must also adopt IFRS S2 at the same date.
What is the scope of IFRS S1?
S1 applies to any company stating it prepares its sustainability-related financial disclosures under IFRS sustainability disclosure standards (no surprise there). What makes S1 stand out is that the IFRS sustainability disclosure standards can be applied regardless of the GAAP applied in its financial statements - which, while improving access to the IFRS sustainability standards, could be seen as diminishing the status of IFRS in financial reporting.
The expectation is that sustainability reporting is provided in the same document as the company’s financial statements and notes. In the UK and many European states this would mean the annual report provided to investors and other stakeholders.
S1 frequently refers to “sustainability-related risks and opportunities”, as these are what drive the disclosures. This term is not defined in S1 but is principally determined by the specific requirements of S2 and other standards to be issued by the ISSB, the industry or sector a business operates in, its geographies and investor expectations.
What are the key principles of IFRS S1?
S1 establishes four conceptual foundations of sustainability reporting: fair presentation, materiality, reporting entity, and connected information and consistency.
Fair presentation
Sustainability-related risks and opportunities that could “reasonably be expected to affect an entity’s prospects” should be represented faithfully, i.e. they need to provide a complete, neutral and accurate set of disclosures, free from bias. A sustainability report prepared under IFRS sustainability disclosure standards is no place to promote the positives without disclosing the negatives! Information disclosed needs to be comparable, verifiable, timely and understandable.
Companies should also disclose additional information if the requirements of a specific IFRS sustainability disclosure standard (such as S2) are insufficient for users of the financial statements to understand the effects of sustainability-related risks and opportunities on the company’s cash flow, access to finance and cost of capital over the short, medium and long term.
Materiality
S1 requires companies to disclose material information that could reasonably affect their prospects. The standard clarifies that information is material if “…omitting, misstating or obscuring that information could reasonably be expected to influence decisions that primary users of [financial statements] make on the basis of those reports…”. Unlike certain other regimes, such as the European Sustainability Reporting Standards (ESRS) required by the EU, the ISSB standards consider materiality from the perspective of investors, lenders and other creditors. This inevitably means that IFRS sustainability disclosures could be more limited than those prepared under other frameworks.
Reporting entity
IFRS sustainability disclosures must be for the same reporting entity/group as the financial statements. For example, if an entity prepares consolidated financial statements, the sustainability report attached to those financial statements should be for the same group of entities as the financial statements. There are no ‘get out’ clauses to exclude particular entities from the IFRS sustainability disclosures, which may pose problems in disclosing the sustainability impact of associates, joint ventures and equities in other companies held by the group for investment purposes.
Connected information and consistency
Information should connect the dots between financial disclosures in the financial statements and the company’s sustainability-related risks and opportunities. For example, a manufacturing business with environmental clean-up provisions on the balance sheet would be expected to link this information to its sustainability disclosures, and vice versa. Similarly, a hedge fund with investments across a diverse portfolio of companies would need to link the ESG risks of these investments to its risk management disclosures under IFRS 7 Financial Instruments: Disclosures. Data and assumptions used in preparing sustainability-related disclosures should be consistent, as much as possible, with those applied in preparing the financial statements.
Am I able to avoid providing some disclosures?
Yes - IFRS S1 only requires companies to report information concerning material sustainability-related risks and opportunities (see section above on materiality). There is also a very limited exemption for commercially-sensitive information; essentially, where that information is not already in the public domain and disclosure could seriously prejudice the company’s ability to pursue an opportunity. Where this exemption is applied, companies are still required to state the fact in general terms. Companies preparing similar disclosures under ESRS issued by EFRAG / the European Commission should be aware that no such exemption applies under ESRS.
It is important to note that the significant majority of businesses providing sustainability disclosures will not do so on regulatory grounds, but because their customers require the data for their own sustainability disclosures. Any business that forms part of the supply chain for a US-, UK- or EU-listed company can expect to be asked for its ESG data, and it is unlikely that the customer(s) would be willing to grant the supplier an exemption for commercially-sensitive information.
A final ‘get out clause’ applies where high uncertainty exists - this is considered in greater detail below.
What content does IFRS S1 require?
S1 has recycled the four pillars approach of the TCFD recommendations, being governance, strategy, risk management, and metrics and targets. We recommend taking the time to review and understand these four pillars because they will be used to structure the requirements of any future IFRS sustainability disclosure standards issued by the ISSB:
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Governance relates to the processes, controls and procedures used by the business to monitor and manage its sustainability-related risks and opportunities. Specifically, governance disclosures should provide detail on:
The board (or committee, individuals or equivalent body charged with governance) responsible for oversight of sustainability-related risks and opportunities, how these responsibilities are reflected in the terms of reference, mandates, role descriptions and other related policies;
How that body determines whether appropriate skills and competencies are in place (or will be developed) to oversee sustainability-related strategies;
How and how often that body is informed on sustainability-related risks and opportunities;
How that body considers sustainability-related risks and opportunities in overseeing the business’ strategy, decision-making processes, risk management processes and related policies, including where trade-offs might exist; and
How that body oversees target-setting and monitors progress towards those sustainability-related targets, including how related performance metrics are included in remuneration policies.
S1 also requires disclosure of management’s role in the governance processes, controls and procedures above, including:
Whether the sustainability oversight role is delegated to a specific individual or committee and how that individual or committee is overseen;
The extent to which management uses controls and procedures to oversee sustainability-related risks and opportunities, and the extent to which those controls and procedures are integrated with other internal functions.
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Strategy concerns the approach a company takes to manage its sustainability-related risks and opportunities. This includes:
A description of those risks and opportunities, including the time horizon (short, medium and long term) over which the effects could be expected to occur, how the company defines its time horizons and how these definitions are linked to the time horizons used in its strategic planning processes;
An analysis of the current and anticipated effects of those risks and opportunities on the entity’s business model and value chain (i.e. its supply chain and marketing/distribution channels), where these risks and opportunities are concentrated (for example, by geography, facility or type of asset);
How the business has responded to, or and plans to respond to those risks and opportunities in its strategic decision-making processes;
Progress made by plans previously disclosed by the company, including quantitative and qualitative information;
Any trade-offs considered by the company between its sustainability-related risks and opportunities, for example by considering the environmental impact of a new facility versus the employment opportunities created by that new facility;
The effects of those risks and opportunities on the financial statements both now and in the future, including whether there is a significant risk of material adjustment in the next year to the value of assets and liabilities.
How the company expects its financial position to change over the short, medium and long term, considering its investment and disposal plans (both committed and uncommitted), and its planned funding sources to implement its strategy; and
How the business expects its financial performance and cash flows to change over the short, medium and long term, given its strategy above.
IFRS sustainability standards allow businesses to provide a single amount or a range when disclosing quantitative information – this is familiar territory for a finance team assessing its provisions and contingent liabilities, or a range of fair values for a financial asset. S1 provides a ‘get out clause’ that permits companies to omit quantitative disclosures where:
the financial effects of a single sustainability-related risk or opportunity are not separately identifiable from other risks and opportunities;
the level of measurement uncertainty is high (see section on judgements and uncertainties below); or
the business does not have the skills, capabilities or resources to provide the quantitative information.
This get out clause may be appealing to many companies on first glance, however the significant majority of businesses that will need to provide sustainability data are not listed companies publishing a sustainability report to their investors, but suppliers and businesses forming part of a listed company’s value chain.
Importantly, the disclosures will need to report on the company’s resilience and the capacity of its business model to adapt to the sustainability-related risks and opportunities described – both qualitatively and quantitatively (if data is available). Specific IFRS sustainability disclosure standards, such as S2, will proscribe additional resilience disclosures, such as scenario analysis.
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Risk management refers to the business’ processes to identify, assess, prioritise and monitor its sustainability-related risks and opportunities, including the extent to which those processes are integrated into business-as-usual risk management processes. These disclosures include:
Risk management processes and policies over sustainability-related risks, including data sources and parameters, the extent to which scenario analysis is used;
How the nature, likelihood and magnitude of the effects of those risks are assessed;
The extent to which the company priorities sustainability-related risks relative to other types of risk, and how those risks are monitored; and
Whether sustainability-related risk management processes have changed compared to the previous reporting period, and the extent to which these are embedded into the company’s overall risk management processes.
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Metrics and targets help explain the business’ progress and performance in relation to its sustainability-related risks and opportunities, including any targets set by itself or its regulators. S1 requires companies to disclose:
Any metrics required by a specific IFRS sustainability disclosure standard, such as S2; and
Metrics used by the company to measure and monitor its sustainability risks and opportunities, its performance and progress towards any targets.
These disclosures should include any metrics associated with the company’s business model, activities, or sector. S1 requires businesses to consider the sector-specific disclosure topics in standards issued by the SASB (which also forms part of the IFRS Foundation). Businesses may also consider:
Application Guidance issued by the Climate Disclosure Standards Board (CDSB, which has since been consolidated into the IFRS Foundation) for Water-related Disclosures and Biodiversity-related Disclosures;
Most recent standards issued by other standard-setters whose requirements are designed to meet the information needs of financial statement users, for example TCFD and ESRS issued by EFRAG / the European Commission; and
Sustainability-related risks and opportunities considered by other businesses operating in the same sector or geography.
Where metrics are developed internally, companies need to disclose how the metric is defined, the type of metric (absolute value, relative value, or qualitative), whether the metric is validated (and if so, by whom), the calculation method and its inputs, including any limitations of that method and its significant assumptions.
For each target, S1 requires businesses to disclose:
The metric used to set, and monitor progress towards, the target;
The specific quantitative or qualitative target;
The period over which the target applies;
The base period from which progress is measured;
Milestones and interim targets;
Performance against each target and an analysis of trends/changes in the company’s performance; and
Any revisions to the target (and an explanation).
Metrics should be consistent over time; any redefinition or replacement of a metric needs to be defined.
Can I apply other frameworks as part of my IFRS sustainability disclosures?
Yes. IFRS S1 requires companies to consider the frameworks that they might be subject to, considering their business activities, sector(s) and geographical area(s). Where a company provides disclosures under specific standards or other sources of guidance, these should be disclosed together with the industries or sectors considered for the company’s own sustainability disclosures.
Where should IFRS sustainability disclosures be located in the annual report?
Typically the ISSB expects that sustainability-related financial disclosures are included in ‘general purpose financial reports’, i.e. statutory financial statements, which, in the UK, form part of an annual report. However, the ISSB recognises that many listed groups will provide additional information in their annual report such as management commentary, which may not provide information to a consistent standard as the financial and sustainability sections of the annual report, nor be subject to a similar level of audit scrutiny. As such, any information provided under the IFRS sustainability disclosure standards should be clearly identifiable and not obscured by that additional information, such as commentary, non-GAAP measures and alternative performance measures.
Can I incorporate a sustainability report ‘by reference’?
Yes - although it’s challenging to find a reason why you might want to do this. S1 permits companies to provide the information required by IFRS sustainability disclosure standards by cross-referencing to another report, but this report needs to be available on the same terms and at the same time as the sustainability-related financial disclosures.
How should I handle judgements and uncertainties?
Users of the financial statements and sustainability report need to understand the judgements made in preparing the company’s sustainability disclosures. Sometimes these judgements can give rise to measurement uncertainty, particularly in subjects where data standards have not yet evolved to be sufficiently verifiable, amounts are estimated, subject to a number of variables or assumptions, or the outcome of a future event.
S1 requires companies to disclose where amounts are subject to “a high level of measurement uncertainty”, the sources of this uncertainty, and the assumptions, approximations and judgements that have been applied to measuring the amount. A high level of measurement uncertainty does not necessarily mean that the disclosure does not provide useful information, and so should not be a routine reason for not providing the disclosure.
As sustainability reporting becomes more widespread, we naturally expect the number of errors in sustainability reporting to increase, particularly where a company reports on the impact(s) of its value chain and impacts outside its direct sphere of control, such as scope 3 greenhouse gas emissions. Material prior period errors must be disclosed by restating prior period comparatives. These errors are different from changes in estimates, which are approximations that a business might need to revise as additional information comes to light.
