On 26 June 2023, the International Sustainability Standards Board (“ISSB”) issued its first two sustainability standards, IFRS S1 and IFRS S2. These standards, which incorporate the recommendations of the Task Force on Climate-related Financial Disclosures (“TCFD”), address disclosure requirements related to a company’s governance, strategy, risk management, and sustainability-related metrics and targets. IFRS S1 and IFRS S2 are intended to complement each other and catalyse convergence of global ESG standards, making it easier for investors to distinguish between companies’ ESG credentials as well as standardising (and therefore, in theory, reducing) reporting burdens of companies.
The creation of the ISSB by the Trustees of International Financial Reporting Standards (“IFRS”) Foundation was announced in November 2021 at COP26, with wide supranational support giving it a mandate to, among other things, develop global sustainability reporting standards. Its creation is viewed as a consequential step towards the development of a global baseline of corporate reporting standards under the IFRS framework. The previously fragmented system of ESG reporting (spread across several competing frameworks) was confusing and ultimately unhelpful for the investment community and consolidation under the IFRS framework is likely to be welcomed by both companies and investors alike.
IFRS S1 and IFRS S2 represent the first step in the ISSB’s goal to harmonise ESG reporting standards and the ISSB is currently consulting on whether other standards may be needed (initial proposals include biodiversity, ecosystems and ecosystem services, human capital, and human rights). The consultation closed on 1 September 2023.
Key Points to Note
IFRS S1 (General Requirements for Disclosure of Sustainability-related Financial Information) requires a company to disclose information about all sustainability-related risks and opportunities that could reasonably be expected to affect the company’s cash flows, its access to finance or cost of capital over the short, medium, or long term. In addition, IFRS S1 sets out general requirements for the content and presentation of required disclosures so that the information disclosed is useful to primary users in making decisions relating to providing resources to the company.
IFRS S2 (Climate-related Disclosures) requires a company to disclose information about climate-related risks and opportunities that could reasonably be expected to affect the company’s cash flows, its access to finance or cost of capital over the short, medium, or long term.
In terms of the core content, under both standards, for both sustainability and climate-related risks and opportunities, companies will be required to make disclosures about:
- the governance processes, controls, and procedures the company uses to monitor, manage and oversee those risks and opportunities;
- the company’s strategy for managing those risks and opportunities;
- the processes the company uses to identify, assess, prioritise, and monitor those risks and opportunities; and
- the company’s performance in relation to those risks and opportunities, including progress towards any targets it has set, and any targets it is required to meet by law or regulation.
The disclosures required by IFRS S1 and IFRS S2 are to be made as a part of a company's general financial reporting package.
The requirements in IFRS S2 integrate, and are consistent with, the four core recommendations and 11 recommended disclosures published by the TCFD and a comparison between the two standards has been published by the IFRS Foundation. Following the publication of IFRS S1 and IFRS S2, the ISSB will take over the monitoring of the progress on companies’ climate-related disclosures from 2024.
The UK has been a leader in mandating climate and sustainability disclosures, with requirements to disclose certain climate-related disclosures applying to large UK incorporated (private and public) companies and limited liability partnerships. In addition, the UK Listing Rules require listed companies to include a statement in their annual report that sets out whether they have made disclosures consistent with TCFD recommendations or provide an explanation for the lack of such disclosures. Following the analysis of the 2022 annual reports of 20 UK listed companies across four sectors: materials and buildings, energy, banks and asset managers, the Financial Reporting Council reported that notwithstanding an incremental improvement in the quality of companies’ disclosure of net zero commitments and interim emissions targets, disclosures of concrete actions and milestones to meet targets were sometimes unclear, and comparability of metrics between companies remains challenging. It is our expectation that the implementation of IFRS S2 will help improve non-financial reporting among listed companies.
The ISSB has specified annual reporting periods beginning on or after 1 January 2024 as the period for which the new ISSB standards should be adopted, with certain transition reliefs for the first annual reporting period. Consequently, the first financial reports to use them will be published in 2025. Companies may choose to apply the standards ahead of this time, provided that both IFRS S1 and IFRS S2 are being applied and the company discloses that it is using them.
As a next step, the ISSB will work with jurisdictions and companies to support adoption of the new standards and work with jurisdictions wishing to require incremental disclosures beyond the global baseline.
In the UK as part of its recent Primary Market Bulletin 45, the Financial Conduct Authority (the “FCA”) was quick to welcome the launch of the standards, noting that it remains committed to playing an active role in supporting implementation of the ISSB standards and helping to build capacity to adopt these around the world. In the first half of 2024, the FCA intends to consult on proposals to implement disclosure rules for listed companies that reference UK-endorsed IFRS S1 and IFRS S2. Assuming the UK Government’s endorsement process is completed by the middle of 2024, the FCA aims to finalise its policy position by the end of that year, with the new requirements applying to financial years beginning on or after 1 January 2025.
Separately, the EU Corporate Sustainability Reporting Directive (“CSRD”) has now entered into force, extending existing sustainability disclosures obligations for nearly 50,000 in-scope EU, and some non-EU-based, companies from 1 January 2024. As the standards underpinning the CSRD and IFRS S2 are both built on the recommendations of TCFD, they are expected to be largely compatible. It remains to be seen whether reporting in accordance with the CSRD will be expected or required of UK-listed companies. In addition, the European Securities and Markets Authority’s public statement on sustainability disclosure reiterates the importance of sustainability-related disclosure in EU prospectuses.
HM Treasury’s recently closed consultation on the future regulatory regime for ESG ratings providers should also portend additional benefits for companies and investors and lead to further harmonisation of the fractured ESG ratings space.
The release of the ISSB standards is an indication of the importance of clear and consistent ESG reporting standards to companies, investors and governments around the world and marks the beginning of ISSB’s role as an international standard-setter for ESG disclosures.
Given increasing investor attention to ESG matters as well as the proliferation of disclosure requirements in the space, it is important that companies ensure that they are fully up to date and in compliance with ESG disclosure requirements. Recent cases in the UK demonstrate that investors may even use non-compliance with ESG policies as a cause of action for litigation (as was the case in the recent Client Earth v Shell case in the UK High Court). For growth companies (and privately held, venture-backed companies, in particular) in the Tech and Life Sciences space, these recent developments represent the first sea change in an investment environment which looks set to become increasingly focused on accountability on ESG matters.