The International Sustainability Standards Board (ISSB) issued IFRS S1 and IFRS S2 being its first global sustainability disclosure standards (the Standards) on 26 June 2023. IFRS S1 sets out disclosure requirements aiming to provide investors with information about the short, medium and long term sustainability related risks and opportunities that a company faces. IFRS S2 sets out specific disclosures that are climate related. But what does this mean for UK private limited companies?
The current position – ESG reporting in the UK
The ESG reporting standards and frameworks currently existing in the UK (being voluntary for many companies) each have a different focus, methodology and emphasis. There is therefore a lack of uniformity in ESG reporting in the UK. Examples of these standards / frameworks are:
- Task Force on Climate-related Financial Disclosures (TCFD)
- Sustainability Accounting Standards Board Standards (SASB Standards)
- Carbon Disclosure Project
- Global Reporting Initiative Standards
- European Union Corporate Sustainability Reporting Directive
The Standards seek to create a global "common language" for disclosing the effect of sustainability-related risks and opportunities on a company's financial prospects. It is hoped that the Standards will harmonise ESG reporting requirements and provide consistency and comparability between entities that will benefit stakeholders.
Adoption of Standards in the UK
Individual jurisdictions are to decide whether companies in their respective jurisdiction will be required to comply with the Standards. In October 2021, the UK announced that UK adopted Standards will form the central component of the UK's sustainability disclosure requirements. The UK Government has stated that it will consult on a framework to adopt and endorse the Standards for the UK (which come into effect for annual reporting periods beginning on or after 1 January 2024 (with early application permissible)).
The Department for Business and Trade, working with the Financial Reporting Council is (as of July 2023) conducting a review of the non-financial reporting requirements that UK companies need to comply with to produce their annual report and a call for evidence has been issued (closing on 16 August 2023). This seems to be the beginning of the journey to adopt the Standards in the UK. We await further developments and understand that the Government will develop proposals for public consultation in 2024 and, subject to stakeholder views, look to adopt legislation making the Standards part of UK company law.
The Financial Conduct Authority has also stated that it intends to update its reporting requirements for listed companies in line with the Standards once they are endorsed for use in the UK.
It seems likely that the Standards will, at least initially, only apply to listed and large companies (most likely those of over 500 employees with an annual turnover of over £500 million being the threshold currently required for compliance with TCFD) but undoubtedly the effects will be felt by other entities where stakeholders push for sustainability related information to be disclosed as they themselves will be under huge pressure to provide this information.
What do the Standards say?
IFRS S1
IFRS S1 states that "the usefulness of sustainability-related financial information is enhanced if the information is comparable, verifiable, timely and understandable." To that end, IFRS S1 requires an entity to disclose information about all sustainability-related risks and opportunities that could reasonably be expected to affect the entity's cash flows, its access to finance or cost of capital over the short, medium or long term. IFRS S1 also prescribes how an entity prepares and reports its sustainability-related financial disclosures, setting out general requirements for content and presentation of disclosures so that the information is useful to investors.
IFRS S2
IFRS S2 requires an entity to disclose climate-related risks (both physical and transition risks) to which the entity is exposed and climate -related opportunities available to the entity that could reasonably be expected to affect the entity's cash flows, its access to finance or cost of capital over the short, medium or long term.
Both Standards
For both IFRS S1 and IFRS S2, disclosures would need to be published as part of an entity's general purpose financial statements and would be against four central pillars:
- Governance – companies will have to disclose the governance processes, controls and procedures they use to monitor, manage and oversee sustainability-related risks and opportunities (IFRS S1) and climate-related risks and opportunities (IFRS S2). This will require providing detailed information about governance bodies / individuals responsible for sustainability issues and controls and the procedures in place to support the oversight of such sustainability issues.
- Strategy – requires an entity to make sustainability related financial disclosures to enable stakeholders to understand an entity's strategy for managing sustainability related risks and opportunities (IFRS 1) and climate-related risks and opportunities (IFRS S2) that could reasonably be expected to affect the entity’s prospects. For climate-related risks, the entity must disclose whether the risk is a climate-related physical risk or a climate-related transition risk and must include information about its climate-related transition plan. There is a focus here on the resilience of a company's sustainability strategy. This limb requires companies to disclose quantitative (where possible) and qualitative information about how sustainability-related risks/climate-related risks and opportunities (both for the relevant reporting period and anticipated) affect or may affect the financial performance and cash flows of the company.
- Risk Management – requires a company to disclose the processes and policies a company uses to identify, prioritise and monitor sustainability-related/climate-related risks and opportunities, including information about data sources and how the company assesses the nature, likelihood and magnitude of sustainability/climate-related risks and opportunities (including, in relation to climate issues, whether and how scenario analysis is used).
- Metrics – IFRS S1 requires an entity to disclose (for each sustainability risk/opportunity): the metrics the entity uses to measure and monitor that sustainability-related risk or opportunity; its performance in relation to that sustainability-related risk or opportunity, and any targets that the entity has set or is required to meet by law or regulation and its progress against these. Example metrics are not included for IFRS S1 (although they are for IFRS S2) but the standard guides people to the SASB Standards, the CDSB Framework Application Guidance, the Global Reporting Initiative Standards and the European Sustainability Reporting Standards.
Preparation is key
Complying with the Standards (when adopted in the UK) is unlikely to be mandatory for all companies, there will no doubt be a knock on effect. Companies should start preparing for these changes, putting in place systems to equip them for the inevitable increased scrutiny on ESG from stakeholders, regulators and Government. All companies will be at different places on their sustainability journey and we set out below some recommendations that companies should consider putting in place or strengthening now as part of their environmental, social and governance agenda in readiness for adoption of the Standards:
People:
Put ESG and sustainability reporting on the board agenda – Each board meeting should have ESG and sustainability as an agenda item to monitor and consider how the sustainability policy and practices are progressing across the business. This should be a priority at the top level of the company.
Appoint a governance body and / or senior person within the business to focus on sustainability – This governance body or senior person should have appropriate skills and competencies and be responsible for the oversight of sustainability related risks and opportunities, reporting to the board. Controls and procedures should be considered and put in place to support oversight of sustainability matters across the business.
Form a cross-functional sustainability team across the business – The cross-functional team should work together to action sustainability related tasks so that there is not a "sustainability silo" and the oversight of sustainability related risks and opportunities can be integrated across the business.
Consider whether external agents or consultants should be appointed or new hires made – Depending on the stage of the business in the sustainability journey, it may be helpful to appoint external agents or consultants or recruit to assist in establishing or developing sustainability practices. External consultants will likely be required when it comes to setting science based targets.
Consider ESG training and awareness raising – Investigate and budget the education of the workforce through training and awareness raising.
Diligence:
Identify what the business already does (data is key) – Identify and collate:
- what data the business already collects;
- what policies are in place;
- internal systems and processes in place for collecting, aggregating and
- validating sustainability-related information across the business and its value chain;and
- disclosures currently made in relation to ESG issues including climate change.
Discuss ESG expectations with stakeholders – Reach out to and discuss with investors, bankers, insurers and other stakeholders what their expectations and requirements are and the timeframe that they are working towards.
Evaluate existing processes – Consider whether the existing systems and processes are adequate and perform a gap analysis, using ESG reporting recommendations as a guide. Refer to:
- IFRS S2 metrics (in relation to climate-related risks and opportunities) – both cross-industry metric categories (set out in the standard) and also industry-based metrics (associated with disclosure topics defined in the Industry-based Guidance on Implementing IFRS S2);
- disclosure topics in the SASB Standards relevant to the business;
- any relevant CDSB Framework guidance;
- any published sustainability risks and opportunities identified by other entities operating in the same industry / geography;
- the Global Reporting Initiative Standards (to the extent applicable);
- the European Sustainability Reporting Standards (to the extent applicable); and
- the guidance of any other standard setting bodies.
Review the value chain – Review the value chain (upstream and downstream) and consider how these activities can be monitored and measured.
Actions
Conduct a risk assessment – Conduct a risk assessment to consider the sustainability related risks and opportunities that affect or could reasonably be expected to affect (in the short, medium or long term) the business (business model, value chain and finances). Consider where risks and opportunities are concentrated (e.g. geographical areas, facilities, types of assets).
Introduce / update ESG and sustainability policies – There may be a number of stand-alone policies that fall under an overarching sustainability policy (including anti-bribery; modern slavery; conflicts of interest; diversity, equity and inclusion; health and safety, and the environment) that interact with a business' code of conduct and ethics.
These policies could be benchmarked against those of similar businesses.
Responsibility for each policy should be assigned. Statements should be accurate and evidence-based to not be categorised as greenwashing.
Identify what changes can be made to the business model – Consider what changes could be made to the business model to address sustainability related issues (from a climate perspective, IFRS S2 suggests that changes could include plans to manage or decommission carbon, energy or water intensive operations or resource allocations from demand / supply chains).
Identify reporting metrics and targets – Having already performed a gap analysis, identify the key metrics for the business to report on for sustainability and set science based targets. Determine how the magnitude of risks will be measured.
Collect data – Start gathering information to be able to report against metrics, including quantitative and qualitative information about the effect of sustainability related risks and opportunities (current and anticipated effects in the short, medium and long term). Measure against targets and track the business' responses to sustainability risks and opportunities.
Conduct scenario analysis – Conduct (at first simple) scenario analyses to assess the business' exposure to policy outcomes and / or physical risks in its key strategic locations. In time, develop more sophisticated scenario analyses.
Continuous development
Ongoing review of strategy, metrics and targets – Keep the ESG and sustainability strategy as a top priority and under continual review looking to best practice and be prepared to adjust to changes in regulation and stakeholder requirements.
This article is not intended to provide comprehensive legal advice – please refer to the Standards and relevant guidance for further details and obtain formal advice from your legal advisors