Asia-Pacific

Japan FSA Calls for Sharper Focus on ‘Transition’ Concept

FSA’s Satoshi Ikeda says corporate disclosures need to capture genuine progressive efforts towards achieving carbon net zero, not just point-in-time snapshots.

Good coordination between the International Accounting Standards Board (IASB) and the IFRS Foundation is a necessity for the adoption of International Sustainability Standards Board (ISSB) standards across Asia, according to Satoshi Ikeda, Chief Sustainable Finance Officer of Japan’s Financial Services Agency (FSA).

Ikeda was speaking at Regulation Asia’s ‘ESG Technology & Data Asia 2021‘ event on 26 November. He said the establishment of the ISSB was the most significant announcement during COP26.

The establishment of the ISSB under the IFRS Foundation came amid a regulatory trend towards mandatory ESG disclosures. Ikeda believes that by putting them these together, significant progress can be made in corporate data ESG disclosures.

However, Ikeda cautioned there was still a long road ahead in Asia to “complete the construction of an ecosystem supporting ESG investment.”

Common language

The ISSB is significant because it “can bring about an ESG common language that is currently lacking,” Ikeda said. This lack of a common language has resulted in a large number of ‘data gaps’ and ‘data holes’ that require filling to enable proper ESG based decision making.

Explaining the difference between data gaps and data holes, Ikeda said he followed the definition put forth by the Future of Sustainable Data Alliance (FoSDA) – where data gaps are defined as instances where reporting frameworks exist and databases can be requested and collected, but they are not always adequately populated.

Data holes, on the other hand, “represent instances where there are immediate robust frameworks, guidance or best practices, but at times there is uncertainty about what data would be needed or most useful,” Ikeda said.

He believes the standards set out by the ISSB will address most of the data challenges. “The ISSB’s standards will be well positioned to populate sustainability rated data derived from wider corporate communities in a variety of jurisdictions.”

The consistency and comparability of data will be ensured through a baseline anchored by the ISSB’s standards. In the Asian context, the international financial reporting standards developed by the IASB and the IFRS Foundation have already been overwhelmingly adopted by jurisdictions in the region, Ikeda said.

“The ISSB’s standards aspire to be a comprehensive global baseline of high quality sustainability disclosure standards,” he said. “Its ultimate role is to provide a baseline of corporate data disclosure requirements on which each jurisdiction would add further guidance if necessary.”

However, Ikeda added, ensuring an enabling environment for forward looking assessment of ESG risks and opportunities is a challenge that “goes beyond just making sustainability related data more readily available through enhancement of corporate disclosures.”

Corporate disclosures

The objective of financial reporting in corporate disclosures is to show the historical financial performance of a company. However, this financial information is supplemented by non-financial information, which includes sustainability data.

“I would like to argue for the importance of transition as a guiding concept in ESG based work, and at the same time as an integral component of ESG disclosures,” Ikeda said, emphasising the journey from the current state to a desired state in sustainability.

“After all, in determining enterprise value, a company must be judged not only on the basis of its current status in E or S in ESG, but also in terms of its rate of improvement in E or S in ESG,” he said.

According to Ikeda, judging whether a sustainability related transition plan taken by a company is credible and science based is a fundamental backbone to ESG investment decision making.

He said the massive changes that will come from decarbonisation create great uncertainty about future markets and industry, which will in turn give rise to transition risks and influence the enterprise value of a company.

“What is really needed is a framework that sheds light on whether a particular company manages such financial risk by being on the right path toward achieving carbon neutrality, and how that connects to the corporate mission of that company,” Ikeda added.

“Certainly information on the current level of carbon emission is important. But what is more important in assessing enterprise value is information on the trajectory of future carbon emissions, what kind of commitment to reduce carbon emissions the company in question has made, and how the company plans to transform its business model to make the commitment a reality.”

In other words, corporate disclosures that are most useful to investors will need to capture genuine progressive efforts by companies towards achieving carbon net zero, rather than just taking a snapshot at a certain point in time, Ikeda said.

“At the end of the day, a plan itself will not achieve carbon net zero but rather technologies developed under such a plan will achieve this.”

Sectorial roadmaps

Recognising this, the Japanese government has developed guidelines on transition finance and is developing technology based roadmaps for how to abate sectors such as steel, chemical, cement, energy, and oil and gas.

In this vein, Ikeda discussed the formation of the Asia Transition Finance (ATF) Study Group, an initiative facilitated by the Japanese government, with core members that include Asian and global commercial banks.

The study group aims to provide practical guidelines for transition finance, as well as put forward recommendations to policymakers. Its key objectives are to develop decarbonisation pathways, energy mix scenarios and technology roadmaps.

“The roadmaps are intended to be credible and science based, and set out what kind of low carbon and zero carbon technologies should be adopted by companies in those sectors and specify the time for such adoption,” said Ikeda.

A roadmap for the steel sector has already been developed, while roadmaps for other sectors will continue to be developed into next year.

Ikeda’s hope is that these roadmaps will guide financial institutions in making forward looking judgments on the credibility of financial plans and assisting systemically important Asian manufacturing companies to spread this idea throughout Asia.

According to Ikeda, 40% of the abatement necessary to achieve carbon net zero must come from climate technology that is not quite ready. Another 25 to 30% will come from technologies that are demonstrated but not yet mature, while a further 10 to 15 percent will come from those currently in the R&D phase.

An iterative process

Developing a common language for ESG will be an iterative process for the time being, involving two critical components: first, a disclosure framework of ESG-related KPIs that are material to enterprise value; and second, a framework for making judgments on assessing the credibility of committed improvements in such KPIs in the future.

While expectations on the development of taxonomies are high, they are just one of the KPIs for measuring how much of corporate activities or project activity will be considered sustainable, and they do not provide a framework of quality judgment on their own, Ikeda said.

“This is why I advocate for sharpening up the concept of transition. This is fundamentally important,” he said, adding that the next challenge will be to create a framework for judgment for assessment of the credibility of ESG related commitments.

“Even with the progress made in COP26, we still have a long road ahead to complete the construction of an ecosystem supporting ESG investment,” said Ikeda.

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