A global baseline for sustainability reporting, IFRS S1 and S2, were launched in 2023 by the International Sustainability Standards Board (ISSB).
The standards have been developed to meet the needs of investors and to enable companies to provide comprehensive sustainability information to global capital markets. Sustainability reporting continues to gain momentum to cover details on organisations’ Environmental, Social and Governance (ESG) considerations.
In a recent ICAEW webinar, Getting started with climate reporting, 92% of attendees admitted to having less than limited experience of sustainability reporting, or none at all. The time to get started with sustainability reporting is now. Organisations can start to report on IFRS S1 and S2 voluntarily before mandatory reporting requirements.
IFRS S1 and S2
IFRS S1 and S2 bridge the information gap, facilitate greater consistency, and provide quality information to the investor community. This will enable the community to make more informed decisions on an organisation’s sustainability performance and its prospects.
Effective from January 2024, IFRS S1 and S2 were developed based on two widely adopted frameworks, Taskforce on Climate-Related Financial Disclosures (TCFD) and SASB Standards. The standards focus on integrating sustainability-related information and its impact on the financial statement.
A firm supporter of the ISSB since its launch, the UK government indicated it will explore adopting ISSB’s standards to create UK Sustainability Reporting Standards (UK SRS), aiming to make endorsement decisions by early 2025.
IFRS S1 and S2 as the bridge between companies and stakeholders on ESG matters
Companies are under scrutiny from regulators, investors and the government, to better manage their own sustainability-related risks and their impact on the environment and the society. Further, a growing number of investors are embracing the Principles for Responsible Investment (PRI) and becoming active owners in the investment process. Sustainability information and ESG data are at the centre of investment analysis and decision making under PRI.
Following concerns raised by investors and surmounting industry pressure to adequately address sustainability-related matters in financial reports, IFRS S1 and S2 mark a significant step in the right direction. We explore these standards in detail below.
IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information
IFRS S1 sets out the general requirements for the disclosure of material sustainability-related risks and opportunities in general purpose financial reports. These risks and opportunities are those that could reasonably be expected to affect a business’s cash flow, access to finance or cost of capital over the short, medium, or long-term.
In the UK, this is likely to be the Strategic Report or the Operating and Financial Review, with an expectation that the assumptions used for sustainability reporting purposes will align with the data used for financial reporting purposes, and other commentary elsewhere in the annual report which will require thought and possibly change in the wider financial statements.
IFRS S1 is expected to apply to any entity, irrespective of which financial reporting standards are being adopted (eg UK GAAP or UK-adopted IFRS), thereby extending the reach of the standard beyond the largest listed companies and may support businesses to adopt on a voluntary basis. The core content of the standard is based upon the four pillars of the TCFD framework:
- Governance – the governance processes, controls and procedures the entity used to monitor and manage sustainability-related risks and opportunities.
- Strategy – the entity’s strategy to manage sustainability-related risks and opportunities.
- Risk management – the processes the entity uses to identify, assess, prioritise and monitor sustainability-related risks and opportunities.
- Metrics and targets – the measurement of 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.
These pillars should be familiar in the UK as certain listed entities have been required to apply the full TCFD recommendations. Other Public Interest Entities, AIM companies and large private companies and LLPs, have also been required to include TCFD-aligned disclosures since 2022. However, compliance with the current UK regulations would not ensure compliance with IFRS S1 and S2.
IFRS S2 Climate-related Disclosure
IFRS S2 focuses specifically on climate-related disclosures, requiring businesses to disclose information about material climate-related risks and opportunities which may be physical (eg wildfires, floods or long-term shifts in the climate) or transitional (eg a response to policies and regulations that stimulate the transition towards a lower-carbon economy). S2 is also structured around the same four pillars as IFRS S1: governance, strategy, risk management and metrics and targets. Similar to IFRS S1, disclosures are required for material climate-related risks and opportunities. Â It has been clarified that entities should avoid unnecessary duplication in IFRS S2 with disclosures already addressed by IFRS S1, as overlaps in the management process are expected for overall sustainability matters and for climate specific matters.
Within IFRS S2, a climate scenario analysis is required to assess the entity’s overall resilience against climate change. The entity’s capacity to adjust or adapt its strategy and business model to climate change over short, medium and long terms should be assessed and disclosed through scenario modelling. Scenario analysis is an important step to enable decision making that mitigate risks and aim for long term value creation.
The implications of IFRS S1 and S2 on UK small and medium sized enterprises (SMEs)
The information required for disclosure under IFRS S1 and S2 is extensive. It requires a rigorous design of processes, procedures, and systems throughout the year. These disclosures cannot be easily compiled at year-end solely for the reporting purpose.
IFRS S1 and S2 will undoubtedly present more difficulties for UK SMEs as they represent a significant step-change from the current reporting practices in the UK. SMEs are encouraged to adopt the standards even if they may fall outside of the scope for mandatory reporting. Sustainability conscious businesses are reporting on sustainability information voluntarily for various reasons, including:
- Create a competitive advantage that enhance brand reputation.
- Demonstrate active management of sustainability risks and opportunities.
- Avoid greenwashing by embedding sustainability activities within business procedures.
- Meet growing expectations from stakeholders on sustainability disclosures.
- Improve transparency of governance around sustainability.
- Attract sustainability-linked capital.
- Inform, attract and retain talents who are placing increased emphasis on an organisation’s approach to sustainability.
One of the challenges facing UK SMEs is the need to consider the climate resilience of their strategy and business model. As mentioned before, businesses will need to use climate-related scenario analysis, such as assessing the impact of several hypothetical climate trajectories using a set of assumptions and inputs. Scenario analysis differs from traditional accounting approach as it is forward-looking and it intends to explore uncertainties faced by the reporting entity across different future climate pathways. To conduct a scenario analysis fit for purpose, companies could consider the extent of the exposure to climate-related risks and opportunities as well as the skills, capabilities, and resources available. Entities must consider all reasonable and supportable information that is available without unnecessary cost or effort.
A statement of compliance with the IFRS Sustainability Disclosure Standards is, at this time, only permitted if all requirements are complied with.
Interoperability with the Corporate Sustainability Reporting Directive
IFRS S1 and S2 had been formed with close ties to the Corporate Sustainability Reporting Directive (CSRD) in the European Union (EU). Under the CSRD, organisations across the EU are required to provide more extensive sustainability disclosures. The CSRD does not only affect EU companies, it is anticipated that CSRD will impact around 50,000 UK businesses that either have significant operations within the EU or are part of the value chain of EU companies.
The IFRS Foundation and the European Financial Reporting Advisory Group (EFRAG) have published interoperability guidance to illustrate the high level alignment achieved between IFRS Sustainability Disclosure Standards and the European Sustainability Reporting Standards (ESRS) for CSRD.
How we can help with Sustainability Reporting
At Saffery, we support the ISSB’s efforts in creating a more streamlined framework for sustainability reporting. We recognise the importance of sustainability and ESG disclosure for our clients and also support the industry as a whole in improving transparency around climate-related matters.
If you’d like to discuss any of the topics mentioned above, or you’re ready to get started with sustainability reporting for your business, please get in touch with Richard Collis and Yi Zheng.
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