The new dawn in climate change disclosures

The new dawn in climate change disclosures

The environmental, social and governance (ESG) movement is experiencing historically high stakeholder interest. Recognizing public concerns over climate change, numerous companies and governments committed to ambitious net zero pledges. In tandem, investors identified the huge potential associated with funding the transition to a low-carbon economy. The ESG movement faces difficult questions associated with a lack of standardization, regulation, and common purpose and values.

In India, broader legislative intent in the ESG space has been ahead of the curve, especially under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. For example, from FY 2022 to 2023 top 1,000 listed companies are required to provide Business Responsibility and Sustainability Report against nine principles covering both environmental and social aspects such as climate action. This report has evolved from the National Guidelines on Responsible Business Conduct principles issued by the MCA, which itself emanates from the UN Sustainable Development Goals. Further, top 500 listed companies can voluntarily adopt Integrated Reporting. However, absence of a common framework continues to hinder comparability of ESG information.2 A snapshot of ESG disclosures of 100 Indian companies with the largest market capitalization as of March 2021 is as follows:

ESG reporting framework/standard

Global Reporting Initiative (GRI); Sustainability Accounting Standards Board (SASB); UN Sustainable Development Goals (SDG); Task Force on Climate-related Financial Disclosures (TCFD); UN Global Compact (UNGC)

The IFRS Foundation Trustees announced the creation of the International Sustainability Standards Board (ISSB), a new standard-setting board to issue standards on sustainability- related financial disclosures. The ISSB has now published its first two proposed IFRS Sustainability Disclosure Standards, which—once finalized—will form a comprehensive global baseline of sustainability disclosures designed to meet the information needs of investors when assessing enterprise value. Similar proposals on sustainability information have also been made by other standard setters—e.g.,3Securities and Exchange Commission (‘SEC’) and 4the European Financial Reporting Advisory Group.

This article is intended to provide an overview of the proposals made by ISSB, certain differences in the proposals of SEC and European Union and contribute to the dialogue within the ESG information ecosystem.

Method of ESG disclosure

of sustainability-related financial information. This Exposure Draft proposes the disclosure of information about significant sustainability-related risks and opportunities. The General Requirements Exposure Draft proposes companies to present fairly a complete set of sustainability-related financial disclosures. Fair presentation is the faithful representation of information about sustainability-related risks and opportunities, applying the principles set out in the General Requirements Exposure Draft. A company would be required to disclose sustainability-related financial information as a part of its general purpose financial reporting. The proposed Standard would require the sustainability-related financial information to be reported at the same time as the financial statements are reported.

The proposed Standard requires disclosure of material information about sustainability-related risks and opportunities across a company’s value chain. The proposed Standard sets out requirements related to prescribed matters including comparative information, use of financial data and assumptions, sources of estimation and outcome uncertainty and statement of compliance which were adapted from the relevant IFRS.

General Requirements for Disclosure of Sustainability-Related Financial Information-(Proposed IFRS S1)

The General Requirements Exposure Draft sets out the core content for a complete set of sustainability-related financial disclosures, establishing a comprehensive baseline

The proposals define materiality differently and would apply a materiality threshold differently to various disclosures. The SEC proposal would primarily apply a disclosure threshold based on its definition of materiality, although the threshold is not applied consistently throughout the proposal. That definition is based on the US Supreme Court precedent.

The proposed ESRS uses the concept of “double materiality,” which means a disclosure is material if it is material from what is called an “impact” perspective, a financial perspective or a combination of both. Materiality would be the threshold for all disclosures, except for the prescribed disclosures, which would be required regardless of materiality.

The ISSB’s definition of materiality would align with the definition of materiality in IFRS standards for financial statements. This threshold would be applied to all disclosure requirements in the proposed standards.

Climate Related Disclosures (Proposed IFRS S2)

The proposed standard on Climate-related Disclosures propose a company to disclose information that would enable an investor to assess the effect of climate-related risks and opportunities on its enterprise value. The Exposure Draft would require a company to center its disclosures on the consideration of:

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 an oversight of climate- related risks and opportunities.

• What are the terms of reference for the company’s climate- monitoring governance body?
• What is management’s role in assessing and managing climate-related risks and opportunities?
• How does the company ensure that it has people with the right skills and competencies available to oversee its strategies?

The General Requirements Exposure Draft emphasizes that companies are required to provide information that enables investors to assess the connections between various sustainability-related risks and opportunities, including the specific risks and opportunities set out in the Climate Exposure Draft. When a company integrates its oversight of sustainability-related risks and opportunities, the company should also integrate its disclosures on governance rather than providing separate governance disclosures for each significant sustainability-related risk and opportunity.

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 might be harmful to its reputation and could limit its ability to access financing.

Climate-related risks and opportunities

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.

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).
• 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.

Financial position, financial performance, and cash flows A company would be required to include in its disclosures an explanation of how significant climate-related risks and opportunities have affected its most recently reported financial position, financial performance, and cash flows. For example, the company might disclose a material asset impairment as a consequence of the company’s strategy for managing a transition risk. Equally, it could be the investment in new technologies to take advantage of a climate-related opportunity.

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. Examples include the financial accounting consequences of increased revenue from, or costs of, products and services aligned with a lower-carbon economy, physical damage to assets from climate events, and the costs of climate adaptation or mitigation. When providing quantitative information, companies are permitted to disclose single amounts or ranges of amounts.

Proposals by ISSB, SEC and the European Commission would require disclosures of climate-related impacts on the financial statements, but the nature and location of the disclosures would differ:

• SEC proposal would require registrants to disclose prescribed matters in an audited note to the financial statements e.g., impacts (positive and negative) of severe weather events and other natural conditions and transition activities on each financial statement line item, unless the aggregate impact on an absolute value basis is less than 1% of the total for the line item.
• He proposed ESRS would require an entity to disclose in its management report how material climate-related risks and opportunities have affected its financial performance, financial position and cash flows and how the entity expects financial performance, financial position and cash flows to change over the short, medium and long term (which is defined as up to 5 years, more than 5 to 10 years and more than 10 years, respectively) under the effects of material climate-related risks and opportunities.
• He ISSB proposal would require an entity to disclose, as part of its general purpose financial reporting (e.g., management’s commentary in an entity’s annual report), the effects of significant climate-related risks and opportunities on its financial position, financial performance and cash flows for the reporting period, and the anticipated effects over the short-, medium- and long-term (which are undefined in the proposal), including quantitative information unless it is unable to do so.

Climate resilience

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 2 degrees Celsius while pursuing efforts to limit the increase even further to 1.5 degrees.

The SEC proposal would not require a registrant to use a scenario analysis to assess its resilience to climate- related risk. The proposed ESRS would require an entity to use a climate-related scenario analysis, with at least one scenario in line with the Paris Agreement. The ISSB proposal would require an entity to use a climate- related scenario analysis or, if it is unable to perform such an analysis, alternative methods or techniques (e.g., quantitative analysis, stress tests), to assess the resilience of its business strategy.

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.

Green House Gas (GHG) emissions

The proposed Standard would require a company to disclose its absolute gross 5Scope 1, 6Scope 2 and 7Scope 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.

All three proposals would require disclosure of Scope 1 and Scope 2 GHG emissions, but the proposed ESRS and ISSB standards would subject these disclosures to the general materiality thresholds while the SEC would require them in all cases. The nature of the required disclosures would also differ.

The SEC proposal would require an entity to disclose its Scope 3 emissions if they are material or if the entity has set an emissions target that includes Scope 3 emissions. Smaller reporting companies (as defined by the SEC) would not be required to disclose Scope 3 emissions. The ISSB and ESRS proposal would require entities to disclose Scope 3 emissions, subject to the general materiality threshold included in the proposal.

Industry-based disclosures

The proposed Standard includes industry-based disclosure requirements. A company would identify the requirements applicable to its business model and associated activities. The proposed Standard includes 77 industry classifications across 11 sectors, such as alcoholic beverages, appliance manufacturing and ‘medical equipment and supplies.’

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.

The SEC proposal does not preclude the use of industry- specific standards. The proposed ESRS is expected to eventually include sector-specific requirements. The ISSB proposal would require that entities comply with sector- and industry-specific requirements.

Assurance

Assurance is a key facet in increasing trust in the quality and accuracy of ESG information. Though building trust is the responsibility of all stakeholders, the role of assurance cannot be underestimated. Assurance increases the confidence of decision- makers in the accuracy and reliability of the reported information and ensures robust enforcement, required to build trust and address issues such as greenwashing. 8A snapshot of assurance on ESG disclosures of 100 Indian companies with the largest market capitalization as of March 2021 is as follows:

SEC proposes that disclosures in the annual report about Scope 1 and Scope 2 emissions would initially be subject to limited assurance and later reasonable assurance for both accelerated and large accelerated filers with phased-in effective dates. The CSRD would require an independent assurance provider to provide limited assurance (with a transition to reasonable assurance after 6 years) over all the sustainability disclosures included in management’s report, not just the disclosures about Scope 1 and Scope 2 emissions. The ISSB proposal does not address assurance.

As evident above, there is a lack of a common language for sustainability reporting. The risk of fragmentation exists for assurance standards too. As demand for assurance on “sustainability branded” assurance standard reporting grows, there is an urgent need for globally accepted sustainability / ESG assurance standards that can be used by all assurance professionals.

International Auditing and Assurance Standards Board has supported developing a standard(s) for assurance on sustainability reporting and agreed that specific guidance would be provided on the most critical challenges as part of the initial standard-setting effort including guidance on fraud risk andmanagement bias, forward-looking information, and assurance reporting. The Board on balance supported, as a first step, developing the standard(s) for assurance on sustainability reporting standard consistent with ISAE 3000 (Revised). In India, the Institute of Chartered Accountants of India has issued a draft of Standard on Assurance Engagements (SSAE 3000) — as an umbrella standard applicable to all assurance engagements on sustainability information and draws reference from ISAE 3000.

How we look at it

Proposed climate-related disclosures

• This Exposure Draft of ISSB is expected to enable users of general purpose financial reporting to assess the effects of climate-related risks and opportunities for enterprise value, to understand an entity’s use of resources and strategy for managing risks and opportunities, as well as to evaluate an entity’s ability to adapt its planning, business model and operations to climate-related risks and opportunities.
• To ensure that the overall objectives of the Exposoure Draft are realized and to help promote the further integration and alignment of climate-related reporting, we believe that modifications are required, such as greater clarity on the definitions of terms used (such as ‘significant’, ‘material’, ‘relevant’, ‘vulnerable’, climate related) and additional illustrative guidance and examples to assist entities in interpreting and implementing the requirements.
• Many of the terms used in the Exposoure Draft, whilst perhaps familiar in the context of sustainability reporting, may be interpreted and applied differently in the context of financial reporting. Most notably, the concept of materiality from a sustainability perspective which encompasses the concepts of double and dynamic materiality. ISSB should provide additional clarification on the topic of materiality and how to reconcile the application of materiality in various approaches.

Independent assurance

• Assurance is a key feature in increasing trust in the quality and accuracy of sustainability information. The rise of independent assurance — coupled with enhanced standards and increased automation and reporting rigor — has the potential to further build trust in sustainability information and among ecosystem stakeholders.
• As sustainability reporting standards evolve a new, globally consistent assurance standard for sustainability reporting is needed to prevent standards fragmentation and consistency, which will be expected, and assumed, by users of the reporting.