After more than a year of consultations, last week, the International Sustainability Standards Board (ISSB) issued its first two International Financial Reporting Standards: ‘IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information’ (IFRS S1) and ‘IFRS S2 Climate-related Disclosures’ (IFRS S2) (together, the ISSB Standards).
IFRS S1 requires companies to disclose information about their sustainability-related risks and opportunities that is useful to investors when making decisions about providing resources to these companies. Meanwhile, IFRS S2 requires disclosure of information specifically linked to climate-related risks and opportunities, and is designed to be used in conjunction with IFRS S1.
Closer to home, the day after the ISSB Standards were launched, the Federal Government released its second round of consultation on the design of a framework for mandatory climate-related financial disclosures by Australian businesses. The Australian framework will be formally established by the Australian Accounting Standards Board (AASB), and is intended to align as much as practicable with the ISSB Standards and in particular, IFRS S2.
In this alert, we canvas key requirements of the ISSB Standards, what they mean for Australian businesses as the Government develops Australia’s climate-related financial disclosure framework, and what lies ahead as frameworks for nature-related disclosures emerge.
What are the ISSB Standards?
The ISSB is a standard-setting board established by the IFRS Foundation in November 2021 at the 26th Conference of the Parties to the UN Framework Convention on Climate Change (COP 26), with a mandate to develop a comprehensive set of high-quality sustainability disclosure standards to meet investors’ information needs.
Accordingly, the ISSB Standards launched last week are designed to build confidence in sustainability disclosures and inform investment decision-making, and respond to growing demand for a consistent understanding of how sustainability factors affect companies’ financial prospects.
The ISSB Standards are intended to provide a single global baseline for companies to report on their sustainability-related risks and opportunities, enabling jurisdictional requirements to then add to these baseline requirements. They build on pre-existing disclosure frameworks including the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), and are designed to be provided alongside financial statements as part of the same reporting package.
What is in the ISSB Standards?
IFRS S1 describes a set of requirements for entities to disclosing information about their sustainability-related risks and opportunities. It applies the same four-pillar approach as the TCFD, requiring entities to provide disclosures about:
- Governance – the governance processes, controls and procedures the entity uses to monitor, manage and oversee sustainability-related risks and opportunities;
- Strategy – the entity’s strategy for managing sustainability-related risks and opportunities;
- Risk management – the processes the entity uses to identify, assess, prioritise and monitor sustainability-related risks and opportunities; and
- Metrics and targets – the entity’s performance in relation to sustainability-related risks and opportunities, including progress towards any targets the entity has set or is required to meet by law or regulation.
In parallel, IFRS S2 requires entities to disclose information about climate-related risks (both transition and physical) and opportunities that could reasonably be expected to affect their cash flows, access to finance or cost of capital over the short, medium or long term. Like IFRS S1, it takes the same four-pillar approach to reporting as the TCFD.
The ISSB Standards are effective for annual reporting periods beginning on or after 1 January 2024. However, a transitional relief provision in IFRS S1 allows entities to disclose information on only climate-related risks and opportunities under IFRS S2 for the first reporting period (in other words, entities only need to apply IFRS S1 in so far as it applies to climate-related disclosures for the first year).
Below, we consider specific details on the reporting requirements of the ISSB Standards.
IFRS S1 sets out the overall requirements for providing users of general purpose financial reports with a complete set of sustainability-related financial disclosures. It applies to all sustainability-related risks and opportunities that could reasonably be expected to affect an entity’s cash flows, its access to finance or cost of capital over the short, medium or long term.
IFRS S1 requires entities to report sustainability-related financial information in a way that is relevant, meaning that information needs to be capable of making a difference in the decisions of existing and potential investors, lenders and other creditors (referred to as ‘Users’ of general purpose financial reports). In this regard, entities need to disclose ‘material’ information’: according to IFRS S1, information is material if ‘omitting, misstating or obscuring that information could reasonably be expected to influence decisions that Users make on the basis of general purpose financial reports, which include financial statements and sustainability-related financial disclosures and which provide information about a specific reporting entity’.
In addition to the requirement for relevance, IFRS S1 requires disclosures to be ‘faithful representations’. This means that sustainability-related risks and opportunities need to be disclosed in a way that is complete, neutral and accurate.
In addition to these requirements, IFRS S1 sets out a set of ‘enhancing qualitative characteristics’ that improve the usefulness of sustainability information:
- Comparability – IFRS S1 encourages entities to disclose information in a way that helps Users identify and understand similarities and differences between entities. Information is more useful when it can be compared with information provided by the entity in previous periods and information provided by other entities – particularly those with similar activities or operating in the same industry.
- Verifiability – IFRS S1 encourages disclosure of data in a way that ‘enhances its verifiability’. For example, verifiability can be enhanced by providing information about the inputs and methods of calculation used to produce any estimations.
- Timeliness – information should be made available in time to help Users with decision-making.
- Understandability – information should be clear and concise, avoiding generic information and unnecessary duplication.
The core content of IFRS S1 aligns with and builds on the four-pillar approach to reporting recommended by the TCFD. As the ISSB’s ‘basis for conclusions’ notes, this decision to align with the TCFD structure was based on consultation feedback. The core content of IFRS S1 requires entities to make disclosures about:
- governance— entities need to disclose the governance processes, controls and procedures they use to monitor and manage sustainability-related risks and opportunities. This includes providing information about the governance bodies responsible for oversight, and management’s roles in governance.
- strategy—entities need to disclose their approaches to managing sustainability related risks and opportunities. Among other things, IFRS S1 requires entities to disclose information that enables Users to understand the sustainability-related risks and opportunities that could reasonably be expected to affect their prospects, and how these factors affect their business models and value chains. Entities need to describe the short, medium and long term effects of these factors on their financial position, financial performance and cash flows. Interestingly, IRFS S1 enables entities to define ‘short, medium and long term’ for themselves, provided that they explain their reasoning. In addition, entities need to disclose the resilience of their strategies to identified sustainability-linked risks.
- risk management—under this pillar, entities need to describe how they identify, assess, prioritise and monitor sustainability-related risks and opportunities. Among other things, entities need to describe the extent to which any processes for identifying, assessing, prioritising and monitoring sustainability-related risks and opportunities are integrated into and inform their overall risk management processes.
- metrics and targets—the final core pillar centres around reporting on performance in relation to sustainability-related risks and opportunities, including progress towards any targets an entity has set or is required to meet by law or regulation. With respect to metrics, while there is a requirement to apply any relevant metrics under another IFRS standard, when entities define their own metrics, they need to provide information about (among other things) how the metric was calculated and whether it has been validated by a third party. With respect to any targets, entities need to provide information about the period over which it applies, any interim targets, and – where a target has been revised – an explanation for the revision (among other things).
In addition to the core content of disclosures, IFRS S1 sets out other general requirements, including requirements for disclosing information relating to measurement uncertainty and judgments made by entities when preparing their disclosures, as well as requirements to correct errors where possible.
Importantly, general requirements include the sources that entities need to consider when identifying the sustainability-linked risks and opportunities that could reasonably be expected to affect their prospects. In particular, in addition to applying any applicable IFRS sustainability standards (i.e., IFRS S2), entities also need to look to the disclosure topics listed in industry-specific standards published by the Sustainability Accounting Standards Board (SASB).
Helpfully, the ISSB has released guidance to help entities understand how to use the SASB standards for reporting purposes under IFRS S1. While the activities of some entities will closely align with a single SASB industry standard, others may need to refer to multiple SASB standards. Once the appropriate SASB standard (or standards) has been identified, entities will need to consider the ‘disclosure topics’ in the relevant SASB standards to help them identify the sustainability related risks and opportunities applicable to their activities.
For example, an airline company reporting under IFRS S1 would apply IFRS S2 to identify relevant climate-related risks or opportunities, and would refer to the SASB standard relevant to airlines to identify any further relevant sustainability-related risks and opportunities. The company would then apply the metrics in IFRS S2 to make disclosures about its greenhouse gas emissions, and the metrics associated with applicable disclosure topics in the airlines SASB standard to disclose about other sustainability-related risks (for example, the ‘accident and safety management’ disclosure topic and the metrics relating to aviation incidents under that topic, such as number of aviation incidents).
IFRS S2 requires reporting entities to make disclosure about their exposure to climate-related risks (both physical and transition risks) and opportunities, where these factors could reasonably be expected to affect the entity’s prospects.
Like IFRS S1, IFRS S2 also sets out ‘core content’ requiring entities to disclose information regarding governance, strategy, risk management and its metrics and targets. Key aspects that must be disclosed under each pillar complement the requirements of IFRS S1 and include:
- Governance – the entity’s processes, controls and procedures used to monitor and manage climate-related risks and opportunities. This includes governance bodies responsible for overseeing these risks and opportunities and the extent to which these bodies consider these factors when overseeing the entity’s strategy.
- Strategy – entities need to disclose climate-related risks and opportunities that could reasonably be expected to affect their prospects, whether identified risks are physical or transition risks and the applicable time horizon; and quantitative and qualitative information on the impacts of these risks and opportunities on the entity’s financial position and performance.
- Risk management – under this pillar, entities are required to disclose information regarding how the entity assesses the nature, likelihood and magnitude of the impacts of climate-related risks, and whether they use scenario analysis to inform the identification of these risks and opportunities.
- Metrics and targets – importantly, metrics that must be disclosed under IFRS S2 include not only an entity’s scope 1 and 2 greenhouse gas emissions, but also scope 3 emissions (including upstream and downstream value chain emission). Further key metrics include (among other things) the percentage of assets or business activities that are vulnerable to climate-related risks and aligned with climate-related opportunities; and whether and how the entity is applying an internal carbon price in decision-making. The percentage of executive management remuneration linked to climate-related considerations also needs to be reported. For entities with climate-related targets, IFRS S2 requires disclosure of metrics used to set their targets; any interim targets; and processes for reviewing the target and progress toward reaching their targets (among other things).
While the final IFRS S2 remains largely the same to the exposure draft IFRS S2 released in March 2022, there are some notable differences, including:
- While the draft IFRS S2 required entities to disclose information about ‘significant' climate-related risks and opportunities that it reasonably expects could affect its business model, strategy and cash flows, its access to finance and its cost of capital, over the short, medium, or long term’, the final IFRS S2 omits the term ‘significant’. Instead, it requires entities to disclose information to 'enable users of general purpose financial reports to understand the climate-related risks and opportunities that could reasonably be expected to affect the entity’s prospects’ (among other things).
- The final IFRS S2 clarifies that entities must use ‘all reasonable and supportable information that is available to the entity at the reporting date without undue cost or effort’ when identifying which climate-related risks and opportunities and the financial impacts of such risks and opportunities (among other things). In this way, the final IFRS S2 takes account of the varying resources that may be available to reporting entities. Similarly, all entities must use climate-related scenario analysis using an approach commensurate with their circumstances, whereas, under the draft IFRS S2, entities were required to use climate-related scenario analysis unless unable to do so.
- Entities are now required to disclose any targets they are required to meet by law or regulation (in addition to voluntary targets).
- With respect to transition plans, where an entity has a transition plan in place that lays out its overall strategy for transitioning to a low-carbon economy, it must now disclose information about the assumptions used in developing this plan as well as the dependencies that the plan relies upon.
- When disclosing information about climate-related targets, entities must now disclose additional information regarding their processes for reviewing these targets, the metrics used to monitor progress; any revisions to the target and an explanation for such revisions and an analysis of trends or changes in the entity’s performance against targets.
Entities preparing disclosures under IFRS S2 will need to have regard to the same conceptual foundations and general requirements in IFRS S1, including, for example, with respect to reporting on uncertainties and errors, and the approach to materiality.
What do the ISSB Standards mean for Australian businesses?
Emerging expectations and frameworks for sustainability-related risk reporting
For Australian companies, the ISSB Standards will remain voluntary until codified under Australian law. Although Australia does not currently have mandatory frameworks for reporting on sustainability or climate-related risks and opportunities, reporting on climate-related financial risks is well embedded in the reporting practices of the vast majority of the top 300 Australian Securities Exchange (ASX)-listed companies, and consultations on a mandatory climate-risk framework similar to IFRS S2 is underway (we discuss this in detail below).
With respect to climate disclosures, Australian regulators including the Australian Securities and Investments Commission (ASIC) and Australian Prudential Regulation Authority (APRA) have published guidance on disclosing climate-related risks, and the ASX Corporate Governance Principles and Recommendations call for ASX-listed entities to consider whether they have material exposures to climate change risks by reference to the TCFD. In June, the Federal Government released a new statement of expectations for APRA, explicitly requiring APRA to promote prudent practices and transparency in relation to climate‑related financial risks and the adoption of climate reporting standards by regulated entities. APRA’s statement in response confirmed that it will continue to promote prudent practices and transparency in relation to climate-related risks in the Australian financial system.
While frameworks and guidance on sustainability-related reporting frameworks are less progressed, there is undeniably a growing expectation among Australian regulators and investors for companies to disclose broader sustainability risks relevant to them beyond climate-specific considerations: For example, ASIC Chair Joe Longo made clear that firms should already be preparing for the ISSB’s more rigorous disclosure standards in a speech to the Committee for Economic Development of Australia (CEDA) State of the Nation conference last month. Meanwhile, groups including the Business Council for Sustainable Development Australia have welcomed the ISSB Standards, and have encouraged Australian businesses to use them for reporting, so as to better meet the growing expectations of investors, regulators, and broader public.
The Federal Government has been consulting on the introduction of a framework for mandatory climate-related financial risk disclosures for Australian businesses since December 2022.
Following an initial consultation round that closed in February and received almost 200 submissions (read more about this initial consultation in our article here), Treasury released a second consultation paper (Consultation Paper) last week. This paper outlines Treasury’s proposed position on the design and implementation of the framework in light of initial feedback. The first phase of reporting is proposed to commence in 2024-25.
Importantly, the Consultation Paper draws on the draft version of the IFRS S2 (i.e., not the final version released by the ISSB last week), and provides a high level indication of how IFRS S2 can apply in the Australian context.
Key proposals for feedback
Below, we highlight some of the Government’s key proposals in the Consultation Paper.
Entities meeting prescribed size thresholds and that are required to lodge financial reports under Chapter 2M of the Corporations Act 2001 (Cth) (Corporations Act) would be required to make climate-related financial disclosures. It is proposed that the disclosure framework will have a three-phased implementation approach, whereby covered entities will initially be limited to large entities that expands over time to progressively apply to smaller entities. The initial size thresholds proposed for 2024-25 onwards (‘group 1 entities’) are that the entity must meet two of the following criteria:
Obligations for smaller Corporations Act companies (‘group 2 entities’) will commence from 2026-27, with obligations for smaller scale businesses applying from 2027-28 onwards (‘group 3 entities’).
Entities required to report under Chapter 2M of the Corporations Act that are ‘controlling corporations’ under the National Greenhouse and Energy Reporting (NGER) Act and meet NGER publication thresholds will also be initially covered, with obligations for controlling corporations who do not meet publication thresholds to commence later.
The principles of financial materiality would apply. The Consultation Paper notes that “climate-related financial information would be material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general financial reports make on the basis of the reports.” We note that this approach to materiality largely aligns with the ISSB’s approach to materiality in the final ISSB Standards.
Companies would be required to disclose information about governance processes, and controls and procedures used to monitor and manage climate-related risks and opportunities. Disclosures will need to be informed by qualitative scenario analysis at first, moving to quantitative scenario analysis in due course. Entities will also need to assess and disclose their climate resilience against at least two possible future states, one of which must be consistent with the 1.5 and 2 degree temperature goals set out in the Climate Change Act 2022 (Cth).
Entities will need to disclose their transition plans, including information about, target setting and mitigation strategies. Importantly, where offsets are contributing to transition plans, entities will need to disclose information about whether these offsets are verified though a recognised standard (such as the standard for Australian Carbon Credit Units under the Carbon Credits (Carbon Farming Initiative) Act 2011 (Cth))
Scope 3 reporting
From commencement, scope 1 and 2 emissions for the reporting period would be required to be disclosed. Importantly, material scope 3 emissions would need to be reported for all reporting entities from their second reporting year onwards. This would help to align with IFRS S2 requirements which encompass scope 3 reporting.
A transitional period from 2024-25 to 2026-27 would impose ‘relatively less onerous’ disclosure requirements on reporting entities (which will be group 1 and group 2 entities during this period), to give them time to develop internal capabilities and internal capacity to meet disclosure requirements. This would be supported by proposed modified liability settings over the same timeframe (we discuss this below).
Approach to liability for scope 3 emissions reporting
One interesting aspect of the Consultation Paper is the Government’s proposed approach to a modified liability regime for reporting on scope 3 emissions. In its initial round of consultation, the Government had sought views on tests that could be considered to ensure liability is proportionate to inherent uncertainty within some required climate disclosures, noting the US Securities and Exchange Commission’s proposal for a specific safe harbour regime for scope 3 emissions. As we discussed in our February Boardroom Brief, a legal opinion by barristers Sebastian Hartford-Davis and Kellie Dyon released earlier this year concluded that a ‘safe harbour’ for scope 3 emissions reporting is neither required nor desirable, as it would remove the incentive to improve and avoid substandard disclosure practices.
According to the Consultation Paper, the Government now proposes that climate-related financial disclosure requirements be drafted as civil penalty provisions in the Corporations Act. 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, with the effect that companies will be protected from false or misleading representation claims from private litigants over this period.
According to the Consultation Paper, the AASB will be responsible for establishing final disclosure standards, and the Government intends that Australian framework will be aligned as far as practicable with the ISSB Standards. The AASB is expected to consult on these standards later this year.
Where new legislation is required to give effect to the mandatory disclosure requirements, this will be progressed expeditiously by the Government with a view to a start date of 1 July 2024 for the first tier of regulate entities.
Separately, the Minister for Finance is developing arrangements for comparable Commonwealth public sector entities and companies to also disclose their exposures to climate-related risk.
Next steps: how can your business align with the requirements of the ISSB Standards and prepare for mandatory climate reporting in Australia?
With IFRS S1 and S2 finalised, companies should take action to understand the sustainability and climate-related risks and opportunities relevant to their industries and value chains, and look to build sustainability and climate disclosures into their current reporting processes. Steps that may assist this process include:
- reviewing the requirements of IFRS S1 and IFRS S2 in detail, including accompanying guidance material and relevant SASB industry-specific standards. Determining which SASB standard or standards are most relevant to the entity’s business activities will be an important step toward helping an entity to identify applicable sustainability-related risks and opportunities;
- assessing approaches to gathering and storing data about risks and opportunities relevant to the business. Are these adequate for capturing data about a broad range of sustainability-linked topics such as scope 3 greenhouse gas emissions, human rights issues and safety incidents?;
- completing a stocktake of the risk assessment processes that are in place for identifying, assessing, prioritising and monitoring sustainability and climate-related risks and opportunities. To what extent are these integrated into the business’ overall risk management processes? Where can integration be improved?;
- evaluating the extent to which governance processes and bodies currently take account of sustainability-related and climate-related risks and opportunities. For example, is the board actively engaged in oversight of sustainability and climate risks? Is there a specific committee charged with setting sustainability or climate-related targets?;
- identifying sustainability and climate-related risks and opportunities and how these affect both the entity’s business model and value chain. As we explain above, IFRS S1 and IFRS S2 require disclosure of ‘material’ risks and opportunities and in this light, businesses should evaluate whether current approaches to defining materiality align with the definition in IFRS S1;
- for companies without an established strategy for managing sustainability and climate related risks over the short, medium and long term, now is an important time to be considering developing a clear approach to managing these factors, as well as any voluntary sustainability or climate targets (and interim targets) which can be put in place to improve performance; and
- monitoring for further updates from the ISSB, which has indicated that it will work with companies and jurisdictions to support adoption.
Specifically with respect to climate-related disclosures, it will be important for companies (particularly large Corporations Act companies and controlling corporations under the NGER Act who meet publication thresholds, who are expected to have reporting obligations commencing in 2024-25) to review the requirements of IFRS S2, on the assumption that the Australian framework for climate reporting when finalised will largely align with these requirements. For companies who already report in accordance with TCFD recommendations, undertaking an analysis of gaps between current reporting and the requirements of the IFRS S2 may help to enhance their climate-related disclosures and prepare for mandatory reporting requirements to commence.
In parallel, companies should keep track of the Government’s consultation process on the mandatory climate disclosure framework, with submissions on the Consultation Paper open until 21 July 2023, and the Government indicating that where legislation is required to give effect to the new requirements, exposure drafts will be released. Finally, the AASB is expected to undertake public consultation on formal standards later this year and companies should monitor for updates from the AASB for opportunities to engage in this process.
Looking ahead: frameworks for reporting nature and biodiversity-related risks
With IFRS S1 and IFRS S2 published, the ISSB is now consulting on its next disclosure priorities, including the potential to develop standards for biodiversity, ecosystems and ecosystem services (among others).
In parallel, the Taskforce on Nature-related Financial Disclosures (TNFD) is in the process of finalising a risk management and disclosure framework for nature-related risks and opportunities. The TNFD released the fourth version of its beta framework for market consultation in March this year, and is expected to launch the official framework in September. Like IFRS S1 and IFRS S2, the current draft TNFD framework builds on the TCFD’s four-pillar approach to disclosures, but with specific nature-related ‘core’ and ‘additional’ metrics. The draft TNFD framework also integrates an assessment process that companies can use to identify nature-related risks and opportunities and prepare to make disclosures (called the ‘Locate, Evaluate, Assess, Prepare’ approach or ‘LEAP’). The Federal Department of Climate Change, Energy, the Environment and Water supports the TNFD as a strategic funding partner, and has engaged consultants to design and implement piloting case studies across a number of sectors – including critical minerals mining and natural gas extraction – to test the draft TNFD framework.
We expect to see particular interest from Australian governments and industry alike in the development of these specific frameworks for reporting on biodiversity and nature-related risks, particularly given growing interest from investors in biodiversity impacts: a 2021 report commissioned by the Australian Council of Superannuation Investors noted that Australian investors are seeking to understand how to manage and address financial risks to the businesses they invest in associated with biodiversity loss.
Accordingly, Australian companies should monitor the ISSB’s consultations on its next disclosure priorities, and look out for the launch of the final TNFD framework later this year.