The evolution of sustainability disclosure standards in 2023 reflects a global shift towards harmonized business reporting on climate-related risks and opportunities, writes Morgan Lewis, partner, William Yonge.
The summer of 2023 ushered in a new era of sustainability disclosure for businesses, whether Europe-based or active in Europe, replacing the current fragmented reporting landscape. In June, the International Sustainability Standards Board (“ISSB”) issued its first set of sustainability disclosure standards, IFRS S1 and S2, potentially creating a common language and globally consistent baseline for disclosing the effect of climate-related risks and opportunities on a company’s projects.
ISSB was launched by the International Financial Reporting Standards Foundation (“IFRS”) during COP26 in Glasgow in November 2021. On 31 July 2023, the European Commission announced its adoption of the European Sustainability Reporting Standards (“ESRS”) for companies subject to the EU Corporate Sustainability Reporting Directive (“CSRD”), with EU member countries having until July 2024 to implement the rules
Corporate Sustainability Reporting Directive
The genesis of the Corporate Sustainability Reporting Directive was a concern that the gap between the sustainability information companies report and its intended users left investors unable to take proper account of sustainability risks in their investment decisions and left companies subject to existing requirements, not knowing precisely what detailed data they should report.
CSRD widened the scope of existing reporting, potentially increasing its coverage from around 11,700 to 50,000 companies, including:
- All EU large companies, whether listed or not exceeding an average of 250 employees;
- All companies, whether EU or non=EU listed on an EU-regulated market;
- Covered non-EU parent companies.
Reporting is to be phased over 2025-2029, with first reporting in 2025 on 2024 data, with covered non-EU companies first required to report in 2029 on 2028 data at the end of the phasing. However, planning for future compliance starts now. CSRD introduces reporting requirements about a company’s impact on the environment, human rights, social standards and sustainability risks and how those areas affect the company’s development, performance and position. Furthermore, CSRD integrates “double materiality” into the regime, that is, disclosure of the information “necessary to understand the [company’s] impacts on sustainability matters and how sustainability matters affect its development, performance and position”.
The ESRS was developed by the European Financial Reporting Advisory Group (“EFRAG”), which submitted a final draft to the European Commission in November 2022. The Commission, mindful of proportionality and long-term competitiveness, made some key modifications which eased the rigour of the submission. Whilst the standards on general disclosures are mandatory for all companies, specific disclosure requirements will only apply if deemed material to a company’s business model and activity. The Commission extended the phasing-in provisions for companies with fewer than 750 employees, postponing compliance for up to two years in areas such as biodiversity and social and rendered voluntary some requirements, including reporting a biodiversity transition plan. The Commission has faced criticism for such easing, which may pose difficulties for FMPs disclosing under SFDR and prove a source of inconsistency with the EU Taxonomy.
International Sustainability Standards Board
Regarding the ISSB standards, IFRS S1 requires an entity to disclose information about all sustainability-related risks and opportunities that could reasonably be expected to affect its cash flows, access to finance or cost of capital. IFRS S2 focuses on the disclosure of material information about climate-related risks and opportunities that could affect the company’s prospects, enabling users to understand its governance, strategy, risk management and performance related to climate and broadly aligns with the work of the Task Force on Climate-related Financial Disclosures (“TCFD”) which is already an accepted and globally recognised standard for climate financial reporting.
Notably, a company is required to disclose “material” information about such risks and opportunities that could reasonably be expected to affect its prospects, i.e., single, not double, materiality. This contrasts with the EU double materiality approach under CSRD and ESRS and compares with the single materiality approach in the US.
The ISSB standards are effective for annual reporting periods beginning on or after 1 January 2024, so investors, lenders and other creditors will start to be able to use information in 2025. The standards can work alongside standard accounting obligations, not just IFRS ones (internationally used), for example, GAAP (widely used in the US).
In support of a global baseline, the standard setters appreciate that where different sets overlap, they must be interoperable. IFRS and the Global Reporting Initiative worked with EFRAG in developing ESRS. ISSB has agreed to reference ESRS “as a source of guidance companies may consider, in the absence of a specific standard, to identify metrics and disclosures if they meet the information needs of investors”.
The ISSB standards were endorsed by IOSCO on 25 July following an assessment co-led with the FCA. The UK wants to be the first country in the world to endorse and adopt the standards for UK use and is calling on other countries to prepare for adoption of them in their jurisdictions. In October 2021, the UK Government confirmed that the ISSB standards would form a central component of the UK’s economy-wide sustainability disclosure integrated framework and the backbone of its corporate reporting element.
In 2023, the UK reiterated that commitment is subject to a formal assessment and endorsement process, which it aims to complete by the Summer of 2024. The FCA has announced it will, once endorsed, integrate them into the financial entity and listed issuer reporting requirements. Given the IFRS Foundation is the international body that governs the setting of global accounting standards adopted by the UK and over 140 other countries, it is not unreasonable to expect the new ISSB standards to have a real opportunity to become globally accepted.
© 2023 funds europe
