A critical development in the implementation of a global baseline for ESG reporting was achieved on June 26, 2023 with the release by the International Sustainability Standards Board (the "ISSB") of final standards on sustainability ("IFRS S1") and climate-related ("IFRS S2") financial disclosures (collectively, the "Standards"). This final release marks the culmination of nearly two years of consultations and development of the Standards by the ISSB, beginning with prototype standards at the 26th United Nations Climate Change Conference of Parties in November 2021. Our summaries of the drafts of the Standards and other developments can be found here, here, and here.
The Standards are intended to serve as the global baseline for sustainability-related financial disclosures, providing a framework for comprehensive, comparable, and consistent reporting. With the consideration, and consolidation of certain aspects, of prominent global voluntary and mandatory sustainability standards and frameworks into the Standards, IFRS S1 and IFRS S2 also provide a welcomed consensus for disclosing entities to work with, marking a departure from the "alphabet soup" of voluntary and mandatory reporting regimes. The Standards are intended to be used for annual reporting periods beginning on or after January 1, 2024.
The ISSB has clearly prioritized climate-related disclosure as the transition measures allow entities to begin complying with the Standards in their first reporting year by providing climate related financial disclosures only.
Although this is a significant milestone towards setting a global baseline, we are not there yet. The Standards will become regulatory requirements only in those jurisdictions that choose to adopt them. Certain jurisdictions, including the United Kingdom, have committed already to their adoption, while others, including Canada, are openly considering them. The Standards already enjoy significant international support, including from the International Organization of Securities Commissions ("IOSCO"), the World Economic Forum, the G7, the G20, and the World Business Council for Sustainable Development. Similar enthusiasm for the Standards has been expressed by several stakeholders in Canada, including CPA Canada and some of the country's largest pension funds.
Although it remains to be seen whether the Standards will be adopted in Canada, Montreal is home to the ISSB's second main office and several prominent Canadian stakeholders, including CPA Canada and some of the country's largest pension funds , have already expressed their enthusiasm for their adoption in Canada. The Canadian Securities Administrators ("CSA") and the Office of the Superintendent of Financial Institutions ("OSFI") also announced their support for the work of ISSB in developing a global baseline for climate-related financial disclosures and provided comments. The Canadian Sustainability Standards Board (the "CSSB"), which is tasked with facilitating the interoperability of the Standards in the Canadian context, has announced that it was operational as of the date of the Standards' release. In addition, the CSA has put a "pause" on implementation of Proposed National Instrument 51-107 – Disclosure of Climate Related Matters (the "Proposed National Instrument") its enhanced mandatory climate related disclosures framework, and it remains to be seen how the CSA will implement a disclosure rule that aligns with the ISSB standards. Importantly, the US has not adopted IFRS financial reporting standards and it remains to be seen whether and to what extent the SEC will adopt climate disclosure standards that align with the ISSB standards.
Purpose and Framework of the Standards
The disclosure of material sustainability and climate-related information enables market participants that use financial disclosures, such as investors and lenders, to determine the effects of related risks and opportunities on a company's performance and prospects. With the adoption of accepted common standards, investors will be better positioned to understand corporate response and strategy concerning sustainability and climate-related risks and opportunities and companies will be better positioned to understand the expectations of investors. The disclosures will also facilitate end users' understanding of sustainability and climate-related risks and opportunities throughout a company's entire value chain.
The Standards build on the recommendations of the Task Force on Climate-related Disclosures ("TCFD"), including providing disclosures around its four central pillars: (1) governance; (2) strategy; (3) risk management; and (4) metrics and targets. They also incorporate aspects of the voluntary frameworks of the Sustainability Accounting Standards Board ("SASB") and the Global Reporting Initiative ("GRI"), among others. In the context of the Standards, information will be material if "omitting, misstating or obscuring that information could reasonably be expected to influence decisions that primary users of general-purpose financial reports make on the basis of those reports."1
Key Changes to the Standards
The ISSB communicated a number of key changes integrated in the final Standards, including:
1.Financial Materiality
Information is material where its omission, misstatement, or obscuring could influence decision-making by the primary users of financial reports (eg. Investors, creditors, shareholders). The Standards instruct companies to use subjective and contextual assessments based on an entity's circumstances, as well as industry-specific standards.2 Entities should disclose material information about their sustainability-related risks and opportunities that could reasonably be expected to affect their prospects.3
The GRI adopts a double materiality approach which includes consideration of the entity's impact on the environment and community regardless of any impact on enterprise value. ISSB has sidestepped this materiality debate for now.
For purposes of clarity, the ISSB has expressly limited the scope of the Standards by stating that sustainability and climate-related risks that could not reasonably be expected to affect an entity's prospects are beyond their scope.4
2. Impracticability
The Standards have introduced "impracticable" as a defined term. Requirements under the Standards are impracticable where an entity cannot apply them after making every reasonable effort to do so. As one example of its use, entities shall correct material errors in prior reporting periods by restating comparative amounts for said periods unless it would be practicable to do so.5 The introduction of this concept may help alleviate reporting burdens for smaller entities where the associated costs and effort would be unduly onerous.
3. Value Chain Reporting and Scope 1, 2 & 3 GHG Emissions
The Standards require that reporting entities assess sustainability and climate-related risks and opportunities across their entire value chain. In particular, IFRS S2 will require the disclosure and verification of absolute gross greenhouse gas ("GHG") emissions in accordance with the Greenhouse Gas Protocol: A Corporate and Accounting Reporting Standard (2004) (GHG Protocol) classified as and including scope 1 emissions, scope 2 emissions, and – most notably – scope 3 emissions ("Scope 3"), to the extent the information is available without undue cost or effort.6 A reporting entity is required to consider all 15 categories of Scope 3 set out in the Greenhouse Gas Protocol Corporate Value Chain Accounting and Reporting Standard (2011).7Examples of GHG emissions captured by Scope 3 include purchased goods and services, business travel, waste generated in business operations, transportation of purchased products, investments, and the end-of-life treatment of sold products.
More broadly, the Standards require reporting entities to consider how risks and opportunities could reasonably be expected to affect an entity's value chain, which the ISSB defines as "the full range of interactions, resources and relationships related to a reporting entity's business model and the external environment in which it operates."8
Disclosure of Scope 3 GHG emissions remain contentious issue globally with conflicting voluntary and mandatory regimes (including current proposed regimes). For example, the CSA has proposed a "comply or explain" approach for the disclosure of Scope 3 GHG emissions (in effect disclose or explain why such disclosure is not included) in the Proposed National Instrument, whereas OSFI has implemented a regime with mandatory disclosure of Scope 3 GHG emissions and the SEC current draft proposed rule includes mandatory disclosure of Scope 3 GHG emissions.
4. Qualitative and Quantitative Financial Effect Information
The Standards require the disclosure of both quantitative and qualitative information when reporting on current or anticipated financial effects of a sustainability related risk or opportunity, except in select circumstances. For example, quantitative information about the anticipated financial effects of such risks and opportunities are not required if it is determined that:
- the effects are not separately identifiable; or
- the uncertainty involved in an estimation is so great that the resulting information would not be useful.9
IFRS S2 now requires, in respect of reporting of climate-related targets, that entities disclose details regarding their target-setting processes and methodologies, including their approach to setting and reviewing targets and the monitoring of same.10 In identifying and disclosing the metric used to set a climate-related target and measure progress, entities must consider cross-industry metrics and industry-based metrics.11The Standards also permit entities to disclose single figures or ranges when providing quantitative information12 and, consistent with the approach to gathering GHG-related information, expect that entities use all reasonable and supportable information available as of the reporting date without undue cost or effort.13
5. Mandatory Scenario Analysis Under IFRS S2
Scenario analysis, which tests the climate change resiliency of entities and has been the subject of much debate in the development of disclosure regimes in Canada and globally, is now mandatory under IFRS S2.14The Standards define scenario analysis as "a process for identifying and assessing a potential range of outcomes of future events under conditions of uncertainty."15 As tacit acknowledgment that scenario analysis is frequently criticized as a costly and time-intensive exercise, application guidance for IFRS S2 advises that entities should use an approach to scenario analysis "that is commensurate with its circumstances" and that does not require "undue cost or effort"16
In addition to IFRS S2, IFRS S1 requires entities to identify whether and how they use scenario analysis to inform their identification of sustainability-related risks.17
Scenario analysis is mandatory for federally regulated financial institutions in Canada for fiscal year 2024 but is not required in the CSA's current draft rule. The SEC's current draft rule requires scenario analyses to be disclosed if prepared by the entity.
6. Uncertainty
A new section entitled "Measurement uncertainty" has been added to IFRS 1. The ISSB communicates that an entity should now identify the disclosed amounts that are subject to a high level of measurement uncertainty.18 Uncertainties relate to estimates that require the entity's most difficult, subjective or complex judgments.19 Entities should disclose the sources of measurement uncertainty as well as the assumptions, approximations, and judgments the entity has made in measuring the amounts.20
Effective Date of the Standards
As stated above, the Standards are effective for annual reporting periods beginning on or after January 1, 2024. However, entities may apply the Standards for periods prior to January 1, 2024 provided they disclose that they are doing so and that they apply both IFRS S1 and IFRS S2 concurrently.21
Transition Period and Means of Relief
Disclosures pursuant to the Standards are not required for any period before January 1, 2024 and comparative information is not required in the first reporting period where they are applied.22During the first reporting period for disclosures in accordance with IFRS S1:
- entities should report their sustainability-related financial disclosures at the same time as their next second-quarter or half-year interim general purpose financial report;
- entities are permitted to disclose information on climate-related risks and opportunities only; and
- entities are not required to disclose comparative information about their climate-related risks and opportunities.23
Entities that make use of the transitory period relief described immediately above are not required during their second annual reporting period to disclose comparative information about their sustainability-related risks and opportunities, other than their climate-related risks and opportunities.24
IFRS S2 also provides disclosing entities with flexibility during their first year of reporting through two forms of relief. First, if an entity uses a method other than the GHG Protocol to measure its GHG emissions during the annual reporting period immediately before its application of IFRS S2, it may continue to use that method. Second, entities are not required to disclose their Scope 3 emissions during the first annual reporting period.
The Bottom Line
The release of the Standards marks a significant milestone in the development of sustainability and climate-related disclosures, ushering in the first comprehensive set of baseline standards for global use. The Standards will, if widely adopted, result in disclosures that are comprehensive, comparable, and consistent, benefitting end users. The adoption of the Standards will also benefit reporting companies by streamlining the exercise of preparing disclosures.
The Standards have been prepared for adoption at a jurisdiction-level and would become law wherever that occurs – including in Canada, where the CSSB has been tasked with considering their interoperability. With the CSSB becoming operational on the date of the Standards' release, it remains to be seen how Canada will be positioned in the global march to sustainability-related disclosures. Other pressing questions in the Canadian context that remains to be answered are how the CSA will align revisions of the Proposed National Instrument and OSFI updates to Guideline B-15 Climate Risk Management with the Standards, One thing is unequivocally clear, however: sustainability and climate-related disclosures have arrived. Canadian businesses would be well-advised to begin preparing to make such disclosures.
Footnotes
1. IFRS S1, at s. 18.
2. IFRS S1, Appendix B at B19-22.
3. IFRS S1, at s. 17.
4. IFRS S1, at s. 6; IFRS S2, at s. 4.
5. ISSB S1, at s. 83.
6. IFRS S2, at ss. 29(a)(i), 30.
7. IFRS S2 at Appendix B at B32
8. IFRS S1, Appendix A at p. 24.
9. IFRS S1, at s. 38.
10. IFRS S2, at s. 34.
11. IFRS S2, at Appendix B at B67
12. IFRS S1, at s. 36
13. IFRS S2, at s. 11.
14. IFRS S2, at s. 22.
15. IFRS S1, Appendix A at p. 24.
16. IFRS S2, Appendix B at B1.
17. IFRS S1, at s. 44(a)(ii).
18. IFRS S1, at s. 78(a)
19. IFRS S1, at s. 80.
20. IFRS S1, at ss. 78(b)(i) and (ii).
21. IFRS S1, Appendix E at E1.
22. IFRS S1, Appendix E at E3.
23. IFRS S1, Appendix E at E6.
24. IFRS S1, Appendix E at E6(b).
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