Finding A Common Reporting Language On Climate And Sustainability
The IFRS Foundation’s announcement of the establishment of the International Sustainability Standards Board on Nov. 3, 2021, at the 26th United Nations Climate Change Conference of the Parties in Glasgow is an important milestone. The issue of sustainability reporting and disclosures has been gaining momentum.
Currently, with innumerable reporting frameworks, metrics, and standards, this area is still fragmented. For example, some of our Indian companies that voluntarily report on sustainability use any one of many available frameworks, namely the Integrated Reporting (IR) Framework from the Value Reporting Foundation (VRF), the Global Reporting Initiative (GRI) standards, the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) or the Common Metrics proposed by the World Economic Forum’s International Business Council to measure long-term value creation. This can be a maze for investors to navigate through.
Path For One Common Sustainability Reporting Language
The birth of the ISSB and consolidation of the VRF (which houses the IR Framework and the U.S. Sustainability Accounting Standards Boards’ Standards) and the Climate Disclosure Standards Board (CDSB) into the ISSB is a welcome development. Such strategic convergence will enable the ISSB to leverage existing standards, thereby facilitating the creation of globally consistent, comparable, and trusted standards for corporate environmental, social, and governance reporting.
PwC in its 2021 Global Investor ESG Survey noted that “investors in their decision making would be better informed if companies applied a single set of ESG reporting standards (74% agreed). They also said (73%) want companies to use a recognised framework when preparing their ESG reporting”.
History repeats itself with what we saw when countries across the globe, including India, adopted IFRS or converged IFRS for purposes of financial reporting—one common financial reporting language.
Climate Risk Is Critical, But Equally Important Are Other Broader ESG Matters
ISSB has published two prototypes: one on climate-related disclosures and the other on general sustainability disclosure requirements. Basis the work of the Technical Readiness Working Group (comprising the CDSB, TCFD, IASB, VRF, and WEF) on these prototypes, the ISSB is on track to publish the first climate standard in the second half of 2022. Business response to climate change is perhaps the most pressing issue facing society and so focusing initially on climate risk seems reasonable.
For instance “just over a third of investors in PwC’s ESG Survey thought that the quality of the information they get on environmental issues is good enough and for 65% of them, reducing Scope 1 emissions (direct emissions from a company’s operations) and Scope 2 emissions (indirect emissions from purchased or acquired electricity, steam, heat, and cooling) was the top issue for companies to priortise”. “Nearly 80% of the respondents also said that ESG was an important factor in their investment decision making”.
Consequently, it is becoming increasingly important for investors to understand both ESG risks and opportunities of a company and their linkage to financial performance, to make effective comparisons across entities and over time. While investor needs are crucial, so are the needs of other stakeholders—the long-term goal being the wider societal impact reporting on ESG to serve broader stakeholder needs.
A Sneak Peek Into The Two Prototypes For Sustainability Disclosures
The General Requirements Prototype
The General Requirements Prototype aims to set out the overall direction for disclosing sustainability-related financial information (SRFI) relevant to the significant sustainability-related risks and opportunities of an entity. These ESG topics could relate to climate change, labour practices, human rights, community relations, water, biodiversity, etc.
Additionally, disclosures are required to be made through the four pillars of governance, strategy, risk management, supported by metrics and targets related to material sustainability topics. A concept of hierarchy—similar to IFRS—of using other sustainability standards in the absence of an ISSB Standard that applies to a specific sustainability matter has also been introduced.
Finally, in terms of the reporting channel, it does not specify a single required location. Instead, disclosures would be made as part of an entity’s general purpose financial reporting, including within an entity’s management commentary, management’s discussion and analysis, operating and financial review, integrated report, or strategic report. Sustainability disclosures would be made for the same reporting period and at the same time as the entity’s financial statements. Accordingly, the above disclosures attempt to create strong linkages and connectivity with financial reporting.
The Climate-Related Disclosures Prototype
The Climate-Related Disclosures Prototype recommends disclosures of both quantitative information and qualitative narratives of how climate-related matters and the associated risks and opportunities affect the entity’s financial position, performance, and enterprise value. This again requires disclosures through the four pillars discussed above with respect to the climate change topic. Specific disclosures include:
The governance body (a board or another committee) having oversight of the above matters, including management’s role;
Reasonably expected positive or negative effects (including financial effect) to the entity’s business model, strategy and cash flows over the short, medium, or long term;
Description of any physical risks or transition risks e.g. increased severity of extreme weather events such as cyclones and floods, and chronic risks such as rising sea levels or rising mean temperatures. Transition risks could include regulatory, technological, market, legal or reputational risks;
How does the entity plan to achieve its climate-related targets? Any advancing research and development, adoption of new technologies, reliance on offsetting strategies (e.g. afforestation), Whether targets are science-based, and if so, whether it has been validated by a third party? the timeframe, metrics used to assess progress and any milestones; and
Disclosure of cross-industry and specific industry-based metrics to understand management’s performance in mitigating or adapting to climate-related risks or maximising related opportunities. Some of these metrics include (a) Scope 1, 2, and 3 greenhouse gas emissions and intensity; (b) the proportion of assets or business activities vulnerable to transition and physical risks; (c) the proportion of revenue, assets or other business activities aligned with climate-related opportunities, (d) related capital expenditure, financing or investment deployed; (e) internal carbon price mechanisms used in decision-making (e.g. investment decisions, transfer pricing, or scenario analysis);(f) the proportion of executive management remuneration affected by climate-related considerations. Interestingly, “nearly 70% of the respondents in PwC’s ESG Survey thought that ESG performance measures and targets should be included in determination of executive compensation targets and pay.”
As it can be seen, the above will result in the presentation of more consistent, complete, comparable, and verifiable climate-related sustainability information.
ESG Disclosure Landscape In India
Back home, the Securities and Exchange Board of India now requires the top 1,000 listed companies by market capitalisation to prepare a Business Responsibility and Sustainability Report from the financial year 2022–23 and is voluntary for FY2021–22. It also allows companies already preparing sustainability reports based on internationally accepted reporting frameworks (such as the GRI, SASB, TCFD, or IR) to cross-refer those disclosures.
In addition to disclosures around management’s ESG processes and governance policies, specific non-financial data is also required on topics such as training programmes, energy emissions, water and waste, social impact generated, supply chain, etc.
Companies are already enthusiastically preparing for this by reviewing their existing systems, policies, processes, and controls to be able to reliably produce and report their ESG narrative. There is also a desire to report on various ESG initiatives, plans, targets, and progress to stakeholders.
Call To Action
In my view, expectations from sustainability reporting should be as high as they are for financial reporting. The introduction of globally adopted sustainability standards with comparable metrics, disclosures, and connected with financial reporting will not only achieve this objective but also be capable of being robustly and independently assured. This will aid investors and other capital market participants to have a better understanding of a company’s performance and value creation prospects. The time is now – our policymakers and corporates should continue to participate in this global change and engage with the ISSB to build upon and align as appropriate with the global sustainability standards.
Sumit Seth is a chartered accountant. Views expressed are personal.
The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.