Developments in sustainability reporting have moved at an unprecedented pace in recent months and years. The demand for sustainability disclosures to be made by entities in a globally consistent manner has become a priority for the investor community as well as various levels of government worldwide.
Historically, sustainability reporting standards have gone by many names — including non-financial reporting, ESG (environmental, social and governance) reporting, CSR (corporate and social responsibility) reporting, integrated reporting, and sustainability reporting — and encompass different topics, including climate, emissions, pollution, social responsibility, and governance. The various types of sustainability frameworks have been governed by numerous different standard setters and have typically been non-mandatory and inconsistent in their requirements, resulting in greenwashing, with entities often cherry-picking and disclosing only information that casts their activities in a positive light. This fragmentation has led to calls for the formation of a standard setter that can begin issuing a single set of globally consistent sustainability standards as a global baseline. These rapid developments have increased the need for Boards of Directors (or equivalent governing bodies) and Those Charged with Governance (TCWG), such as audit committees, to educate themselves and remain current on the status of sustainability reporting requirements worldwide.
What is sustainability reporting and how does it differ from traditional financial reporting?
disclosure is quickly evolving from being optional to mandatory
Traditionally, corporate reporting has focused on reporting an entity’s financial position, performance, cash flows, and changes in equity. While accounting requirements still differ worldwide (e.g. IFRS, US GAAP), there is a great deal of consistency in the fundamental requirements. This type of reporting has traditionally been used as a means of measuring an entity’s enterprise value. However, other factors also impact enterprise value, which may not be entirely captured in traditional financial reporting, and link to the sustainability of an entity’s business model in a wider sense.
Why are investors and stakeholders demanding this type of information?
Investors are increasingly requesting information that affects an entity’s enterprise value but is not captured in traditional financial reporting. For example, entities emitting significant quantities of greenhouse gases (e.g. carbon dioxide and methane) may eventually suffer financial consequences as a result of government intervention (e.g. carbon pricing schemes), decreased demand for its goods and services compared to greener alternatives, and/or assets that become stranded because they must be replaced with alternatives, resulting in inefficient capital allocation. These demands from investors and commitments made by governments necessitate the participation of entities worldwide. Many jurisdictions are enacting laws and regulations that will require the disclosure of sustainability information, and disclosure is quickly evolving from being optional to mandatory.
Will we be impacted by sustainability reporting developments?
Many regulators worldwide have expressed various levels of commitment to requiring disclosure of sustainability information. Some jurisdictions, such as the European Union, have taken a broad approach where requirements will capture a much greater number of entities based on measures of sales, total assets and employees regardless of whether the entities’ shares are publicly traded.
What standards exist and are currently under development?
Currently, there is a wide variety of reporting frameworks and standards available to entities, usually on an optional basis; over 500 formal and informal frameworks currently exist. In November 2021, the International Financial Reporting Standards (IFRS) Foundation announced the formation of the International Sustainability Standards Board (ISSB), which will issue IFRS Sustainability Disclosure Standards.
Which entities will have to apply IFRS Sustainability Disclosure Standards? Will all countries adopt them?
While the IFRS Foundation cannot require any entities to apply IFRS Sustainability Accounting Standards, many jurisdictions will require their use or develop their own requirements that use IFRS Sustainability Disclosure Standards as a baseline and add jurisdictional specific requirements. Jurisdictions will make their own decisions about which sustainability frameworks to require and to which entities they will apply. However, consistent with the widespread adoption and acceptance of IFRS Accounting Standards which are now permitted or required in over 140 jurisdictions worldwide, it is expected that IFRS Sustainability Disclosure Standards will be applied extensively worldwide.
What are IFRS Sustainability Disclosure Standards and how are they being developed?
IFRS Sustainability Disclosure Standards will be issued by the ISSB. A Τechnical Readiness Working Group (TRWG) was formed in 2021 which built on the well-established work of other standard setters, culminating in the release of four documents in 2021: (1) General Requirements for Disclosure of Sustainability-related Financial Information Prototype (General Requirements Prototype); (2) Climate-related Disclosures Prototype (Climate Prototype); (3) Conceptual guidelines for standard setting; and (4) Architecture of standards.
What will IFRS Sustainability Disclosure Standards require and where would entities disclose this information?
No final IFRS Sustainability Disclosure Standards have yet been issued. However, the prototypes released by the TRWG provide insight into what is likely to be required. Regardless of where sustainability information is disclosed, those charged with governance need to understand management’s objectives in sharing information, what information is being shared and the integrity of such information.
When will we be required to provide sustainability disclosures?
This will vary by jurisdiction. While in the UK certain entities will be required to disclose climate-related financial information from April 2022, other jurisdictions may require sustainability disclosures to be made by certain entities from 2023 onwards. As a result, some companies are beginning to start work efforts based on expected disclosure requirements by establishing sustainability programs, policies and related risk assessments in advance of regulatory directives.
How will our internal controls and financial reporting systems be affected?
Sustainability reporting frameworks do not in themselves require an entity to institute particular policies or procedures, nor do they require an entity to change how it operates its business. What they do require is disclosures about how an entity is addressing particular sustainability topics and the consequences. This is similar to IFRS Accounting Standards, which do not contain requirements about how entities make business decisions but do require entities to disclose information about the consequences and effects of those decisions.
How do we get started?
Boards must at a minimum consider the following initial steps: They must educate key management decisionmakers and those charged with governance; perform a sustainability assessment to identify material sustainability factors; identify information needs of the company, stakeholders and regulators, determining a suitable framework, identifying required information, and internal and external resources necessary to fill gaps; develop and augment reporting systems as necessary; report information; and reassess whether disclosures should be updated as the company’s business evolves.
This article is an abridged version of BDO’s “Sustainability Reporting – 10 Questions Boards Should Know the Answers to” paper, which was first published in February 2022.