The demand for better information about sustainability-related matters which would enable investors to factor in sustainability-related risks and opportunities in their assessment of enterprise value is increasing globally. At the same time, there is no standard for the disclosure of non-financial information, which means that a number of metrics and measures used by companies are not comparable. The same is true for data vendors and Rating agencies.
As a reaction to this lack of transparency, the International Sustainability Standards Board (ISSB) was launched during the COP26 summit in Glasgow on November 3, 2021, to meet this demand. The idea of a global baseline is also supported by G20 leaders, the International Organization of Securities Commissions (IOSCO), and others. To achieve the goal to reach a global standard, the ISSB is working closely with other international organizations and jurisdictions to support the incorporation of the global baseline into jurisdictional requirements and ensuring it is compatible with requirements aimed at broader stakeholder groups.
After just five months, the ISSB has published on March 31, 2022, its first two IFRS Sustainability Disclosure Standards (IFRS S1 and IFRS S2) for consultation, which shall form a comprehensive global baseline of sustainability disclosures designed to meet the information needs of investors when assessing enterprise value.
IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information (General Requirements Exposure Draft)
The proposed IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information (General Requirements Exposure Draft) would require companies to disclose information about all of their significant sustainability-related risks and opportunities.
The aim of the General Requirements Exposure Draft is to establish a comprehensive baseline of sustainability-related financial information by setting out the core content for a complete set of sustainability-related financial disclosures.
At its core, the General Requirements Exposure Draft proposes the disclosure of information about significant sustainability-related risks and opportunities on company level. The sustainability-related financial information disclosed would be centered on a company’s consideration of its:
Governance
Information on governance shall enable investors to understand the governance processes, controls, and procedures used to monitor and manage significant sustainability-related risks and opportunities.
Strategy
This information shall enable investors to assess a company’s strategy for addressing significant sustainability-related risks and opportunities, whether these risks and opportunities are incorporated into its strategic planning—including financial planning—and whether they are core to its strategy.
Risk management
Information to enable investors to understand the process by which a company identifies, assesses, and manages current and anticipated sustainability-related risks and opportunities and whether that process is integrated into its overall risk management processes. This information helps an investor evaluate the company’s overall risk profile and risk management processes.
Metrics and targets
This information shall enable investors to understand how a company measures, monitors, and manages significant sustainability-related risks and opportunities and assesses its performance, including progress toward the targets it has set.
This approach is consistent with the recommendations of the Task Force on Climate-Related Financial Disclosure (TCFD), which was founded by the Financial Stability Board (FSB) to improve and increase the reporting of climate-related financial information, but extends them to sustainability-related risks and opportunities beyond those related to climate.
IFRS S2 Climate-related Disclosures (Climate Exposure Draft)
The proposed IFRS S2 Climate-related Disclosures (Climate Exposure Draft) focuses on climate-related risks and opportunities. It incorporates the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) and includes metrics tailored to industry classifications derived from the industry-based SASB Standards.
With regard to this, the Climate Exposure Draft proposes to require a company to disclose information that would enable an investor to assess the effect of climate-related risks and opportunities on its enterprise value.
To achieve this aim, the proposed standard includes a requirement for companies to disclose information about climate-related physical and transition risks and opportunities. These disclosures shall provide material information about the significant climate-related risks and opportunities of a company.
As consistency is key to achieve a broad acceptance of the standard it may be welcomed by all stakeholders that the Climate Exposure Draft uses the same approach as the General Requirements Exposure Draft, so it would require a company to center its disclosures on the consideration of the governance, strategy, and risk management of its business, and the metrics and targets it uses to measure, monitor and manage its significant climate-related risks and opportunities.
Governance
The proposed Standard would require disclosure of information about the governance processes, controls, and procedures the company uses to monitor and manage climate-related risks and opportunities. The company would be required to disclose a description of the governance body, such as a board or committee, with oversight of climate-related risks and opportunities.
Strategy
With regard to information on the corporate strategy, the proposed standard would require companies to disclose information about how climate change could reasonably be expected to affect their business model, strategy, and cash flows over the short, medium, or long term, their access to finance and their cost of capital. For example, continuing to operate a particular line of the company’s business which might be harmful to its reputation and could limit its ability to access financing.
This includes information on climate-related risks and opportunities. With regard to this, a company would be required to identify physical risks and transition risks. For physical risks, the company would be required to explain whether the risks are acute or chronic.
- Acute physical risks could include the increased severity of extreme weather events such as cyclones and floods, putting a company’s assets at risk or disrupting its supply chain (such as disruption to a just-in-time delivery process).
- Chronic physical risks include rising sea levels or rising mean temperatures. These changes in the climate could affect a company’s strategy, for example, it may need to consider moving its production facilities.
In addition, companies are required to provide information on risks associated with a company’s transition to a lower-carbon economy. Transition risk includes policy or legal, market, technology, and reputation. An example of a market risk is reduced demand for high-carbon-based products, a legal risk is regulatory action banning the sale of a company’s products—gas water heaters or diesel vehicles. A technology risk or opportunity could be lower-emission substitutes for diesel vehicles.
To explain the company strategy and decision-making, a company would be required to disclose a description of its plans for responding to climate-related transition risks and opportunities, such as:
- how it plans to achieve any climate-related targets, including how these plans will be resourced and how it will review targets.
- how it expects to adapt or mitigate climate-related risks (for example, through changes in production processes, workforce adjustments, changes in materials used, product specifications or through introduction of efficiency measures).
- how it expects to adapt or mitigate indirect climate-related risks in its value chain (for example, by working with customers and supply chains or use of procurement).
- whether carbon-offsetting is part of its plan. If it is, a company would be required to disclose specific information to enable an investor to assess the offset schemes.
Some companies use carbon prices to internalize the cost of emissions when they make capital expenditure decisions. The proposed Standard would require a company to explain how it applies carbon pricing and disclose the price it uses for each metric ton of GHG emissions.
Companies will also be required to include information on their financial position, financial performance, and cash flows in its disclosures. This shall include an explanation of how significant climate-related risks and opportunities have affected its most recently reported financial position, financial performance, and cash flows.
A company would also be required to explain how it expects its financial position to change over time given its strategy to address significant climate-related risks and opportunities.
When providing quantitative information, companies are permitted to disclose single amounts or ranges of amounts.
As climate-related risks and opportunities can test a company’s resilience, investors need to understand how resilient a company is to those risks and opportunities. Therefore, companies would be required to disclose information such as whether it can continue to use its assets and investments the way it has been doing or whether a climate-related risk, such as an increased flooding risk, is likely to cause the company to relocate, decommission, or upgrade assets.
The company would also be required to disclose whether it has sufficient finance available to withstand the climate-related risks and to take advantage of climate-related opportunities. The proposed standard would require a company to use climate-related scenario analysis to assess its risks and opportunities when it is able to, but it also addresses other quantitative methods. The Climate Exposure Draft proposes requiring the company to disclose how its climate-related analysis aligns with the latest international agreement on climate change—for example, the Paris Agreement, which sets a goal of limiting the global temperature increase in this century to two degrees Celsius while pursuing efforts to limit the increase even further to 1.5 degrees.
Risk Management
The risk management disclosures follow the structure of the General Requirements Exposure Draft. The Exposure Draft proposes requiring information about the processes a company is using to manage climate-related risks and opportunities. A company would be required to explain the extent to which and how processes to identify, assess, and manage climate-related risks and opportunities are integrated into the company’s overall risk management process. It would also be required to disclose how it priorities climate-related risks relative to other types of risk, including its use of risk assessment tools (such as science-based risk assessment tools).
Metrics and targets
A company would be required to disclose the metrics and targets it uses to manage its significant climate-related risks and opportunities.
With regard to Greenhouse Gas (GHG) emissions the proposed standard would require a company to disclose its absolute gross Scope 1, Scope 2, and Scope 3 GHG emissions, in metric tons of CO2 equivalent, and the intensity of those emissions.
The company would be required to calculate these emissions using the GHG Protocol. A consolidated group would be required to disclose GHG emissions by associates and joint ventures separately from those by the consolidated group. The requirement to disclose Scope 3 emissions reflects the importance of providing information related to a company’s value chain.
The disclosure of GHG emissions is not an easy task, as for example shown by the blog post “Companies May Not Be Ready for SEC Climate-Disclosure Rules” published by MSCI Research on March 28, 2022. As the report shows, only 28% of the 2,565 constituents of the MSCI USA Investable Market Index are disclosing Scope 1 and 2 emissions, while only 15% disclosed any portion of their Scope 3 emissions. From my point of view this article shows that there is a lack of data which needs to be closed before investors could expect to receive reliable information for the decision-making process.
The proposed standard includes industry-based disclosure requirements. A company would identify the requirements applicable to its business model and associated activities. Disclosure topics included in the requirements relate to climate-related risks or opportunities for each industry group and a set of metrics is associated with each disclosure topic. The disclosure topics represent the climate-related risks and opportunities most likely to be significant to companies in that industry, and the associated metrics that are most likely to result in the disclosure of information relevant to an assessment of enterprise value. Examples of disclosure topics include ingredient sourcing, design for resource efficiency, and environmental footprint of hardware.
Within the current proposal, the standard includes 77 industry classifications across 11 sectors, such as “Alcoholic Beverages,” “Appliance Manufacturing,” and “Medical Equipment & Supplies’. The related disclosure requirements are derived from SASB Standards. This information has been identified as relevant to an assessment of the enterprise value of companies in that industry. The industry classifications are intended to be useful for companies and investors by identifying relevant disclosures. A company can view all of the topics and metrics, or just those for a specific industry. There are 68 industry-based sets of disclosure requirements in separate volumes. The remaining nine industry classifications do not have climate-related disclosure topics.
Summary
Generally speaking, the efforts to build a global standard for data and information on sustainability-related matters is needed, as such a standardized baseline would align the standards to which companies have to comply for their corporate sustainability reporting. In addition, such a standard would enable investors to factor in sustainability-related risks and opportunities in their security selection process based on reliable standardized information.
But even as this initiative is backed by high-level decision makers and supranational organizations like the G20 Leaders or IOSCO, it is still unclear if the ISSB will be able to align the requirements from local regulations like the EU-Taxonomy or the proposed requirements for U.S.-listed companies to disclose certain climate-related risks.
Nevertheless, once defined and implemented I could imagine that these standards will drive the future development of local regulations and may lead to some chance within existing frameworks, since local regulations do only apply to local companies while the asset management industry acts globally and needs therefore a global standard to determine whether a company does fit to the respective investment objective of a portfolio or not.
The views expressed are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.
Refinitiv Lipper delivers data on more than 330,000 collective investments in 113 countries. Find out more.
Join a growing community of asset managers and stay up to date with the latest research from Refinitiv and partners to help you inform your investment decisions. Follow our Asset Management LinkedIn showcase page.
