In the second of two new recent exposure drafts (see also my commentary on IFRS S1, "The ISSB begins to find its feet") the International Sustainability Standards Board (ISSB) have understandably deemed that Climate issues are important enough to have their own specific proposed standard, IFRS S2.
IFRS S2 has the simple title of "Climate-related Disclosures". In many ways, its overall approach is a narrower version of IFRS S1, which looks at "General Requirements for Disclosure of Sustainability-related Financial Information". The overall aim of IFRS S2, is to disclose information that would enable investors to assess the effect of climate-related risks and opportunities on its enterprise value. Reporting should centre on disclosures around governance, strategy and risk management of the business along with the metrics and targets that it uses to measure, monitor and manage significant climate-related risks and opportunities. A particular area of focus concerns physical and transition risks and opportunities that may subsequently arise.
There is specific mention in the Exposure Draft for IFRS S2 of how a company would be required to include in disclosures an explanation of how significant risks and opportunities in this area have affected its most recently reported financial position, financial performance and cash flows. We have here, therefore, a very direct reference to the traditional qualities of financial reporting as developed within the IFRS framework. This explanation might include the effects of increased revenue from, or the costs of products and services linked to, a lower carbon economy. It might also include physical damage to assets from climate events, and any costs associated with climate adaptation or mitigation.
Climate resilience gets a very specific mention in the Exposure Draft. The entity is required to report how any climate-related scenarios might impact on its ability to use assets. It is also necessary to consider whether climate impacts might cause a company to relocate, decommission or upgrade assets. Underpinning this is consideration of global initiatives such as the Paris Agreement, which has the objective of limiting global temperature increases in the 21st century to 2 degrees Celsius, whilst at the same time exploring opportunities to lower this even further to 1.5 degrees.
The SEC gets in on the act
Given these significant developments within the IFRS framework, my attention was also drawn to steps taken by the US Securities and Exchange Commission (SEC) in the area of climate-related matters. The SEC sets the rules for all companies doing business on US Stock Exchanges and therefore carries considerable clout in the country. An article in the Financial Times on 31 March noted that up until now, in the absence of properly developed standards in the field of climate-related reporting, investors were largely left on their own as far as assessing corporate performance in this area.
In the US, many entities report using US GAAP and it will be interesting to see whether standard-setters for this particular framework will emulate the IFRS examples. In the absence of specific guidance, the SEC has just voted to require climate-risk reporting for public companies. Some might attempt to resist these developments but they may be fighting a losing battle. If investors are dissatisfied with the quality of reporting in this area, they may take their own decisions. In some cases, this might mean expecting a higher rate of return for what they consider to be a higher risk investment. In the worst case, it might mean taking their hard-earned funds elsewhere for investment.
It will take time for these changes to take full effect but the developments are perhaps something of a wake-up call for the profession. In the past, sustainability and climate issues might, for some, have fallen into the so-called "motherhood and apple pie" category. This view is going to be increasingly difficult to sustain, a state of affairs that we would do well to wake up to sooner rather than later.
As with IFRS S1, this is an Exposure Draft. Comments and responses are welcome up until the close date of 29th July. Don’t feel like your opinion is not welcome; they are always at pains to emphasise that they want feedback from all quarters. You can find the details here.