Cop26 Perspectives

Material Risks to ISSB’s Global Ambition

Launched at COP26, the success of the International Sustainability Standards Board’s climate-first approach may depend on extending beyond enterprise value.

In order for investors to understand their exposure to climate-related risks and opportunities companies need to be disclosing the right information. But the quality and depth of corporate climate-related reporting is varied.

It’s not a problem confined to counting greenhouse gas (GHG) emissions. “One of the main issues surrounding corporate sustainability reporting is this fragmentation – we have multiple ESG standards, sub-standards, issue- or sector-specific guidelines and indicators, meaning there is little consistency between countries,” Morgan Slebos, Director of Sustainable Markets at the Principles for Responsible Investment (PRI), tells ESG Investor.

The International Financial Reporting Standards (IFRS) Foundation Board Trustees launched the much-anticipated International Sustainability Standards Board (ISSB) at COP26 last week. It aims to address fragmentation by introducing a baseline standard that can be adopted by companies across the globe and implemented by policymakers, with an initial focus on climate disclosures.

The ISSB will benefit from the IFRS Foundation’s reach, with its accounting standards currently adopted by regulators in more than 140 jurisdictions.

“The ISSB offers a way of providing a climate standard that can be global without dictating standardisation to the globe,” said Richard Sexton, Co-Chair of the Value Reporting Foundation (VRF) Board, speaking at COP26 last week.

The VRF was formed via a merger between the Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting Council (IIRC) earlier this year. It will be consolidated into the ISSB alongside the Climate Disclosure Standards Board (CDSB).

“The ISSB will benefit from the standards-setting experience and understanding of investor needs the existing bodies will bring to the table,” Slebos says.

The Technical Readiness Working Group (TWRG), which was appointed by the IFRS Foundation to begin the standards-defining work that will now be taken forward by the ISSB, has published the Climate Prototype and the General Requirements Prototype.

While this work has been welcomed, some industry experts fear that the continued focus on enterprise value-based reporting will not be enough for investors, as they also want to understand how a company’s business operations impact society and the environment.

“Industry experts have also been worried about how long the process for developing and implementing a global climate reporting standard will take,” adds Slebos. “We don’t have three to five years to wait for a new standard to be developed. The market needs something now.’

The prototypes, which are based on existing standards such as the Task Force on Climate-related Financial Disclosures (TCFD, also to be folded into the ISSB), are expected to be finalised next year.

Global alignment

Many countries, such as the UK, New Zealand, Japan, and Singapore have introduced mandatory disclosure requirements for TCFD-aligned reporting. Others, such as the US, are moving towards mandatory disclosure, too.

“A large number of the world’s biggest companies are based in the US, and, as the US Securities and Exchange Commission (SEC) is preparing to launch its own climate disclosure framework, it will be useful for them to understand how this can connect to the ISSB standard,” Slebos notes.

An internationally agreed baseline will also be “helpful” for the Asia-Pacific (APAC) region and serve as a key point of reference when formulating and enforcing mandatory disclosure requirements, says Rebecca Mikula-Wright, CEO of the Asia Investor Group on Climate Change (AIGCC).

She adds that the ISSB’s climate standard “is not intended to replace or limit region-specific approaches, which may have a broader scope or coverage”. The Global Reporting Initiative (GRI), which recently upgraded its voluntary reporting standards, and European Financial Reporting Advisory Group (EFRAG) are currently co-constructing the European sustainability reporting standards (ESRSs). The ESRSs will require companies to disclose both the impact of and impact on society and the environment.

“Many countries will choose to extend reporting requirements beyond this minimum baseline, and that is appropriate,” says Mikula-Wright. “Each country will need to integrate the climate standard into its domestic framework, so the ISSB’s success will hinge on how widely its standards are adopted.”

Public commitments from countries to integrate and build on the ISSB standards within their legal frameworks will be an important part of addressing systemic climate risk and will promote international alignment, according to the Investor Group on Climate Change (IGCC).

Throughout development and implementation, the board will be introducing “mechanisms for formal engagement” with jurisdictions to ensure alignment across the climate reporting landscape, Erkki Liikanen, Chair of the IFRS Foundation Trustees, said during a speech at COP26.

Baseline standards 

The two prototypes launched by the TWRG are designed to both establish a foundation for reporting on climate risks and outline the path towards broader sustainability-related reporting standards.

The Climate Prototype is based on the TCFD’s four pillars: governance; strategy; risk management; and metrics and targets. It is also building on the prototype standard published by the so-called standards-setting ‘group of five’ last year: CDP, CDSB, GRI, IIRC and SASB.

The prototype standard is aimed at delivering enterprise value-focused reporting. This includes outlining how climate-related risks are impacting their financial position and performance, the value of its future cash flows over the short, medium, and long term, and how the company is responding to these risks through its strategy and business model.

The TRWG has mirrored the seven new metric categories outlined in the TCFD’s updated guidance, including capital deployment, internal carbon price and executive remuneration.

Mikula-Wright notes that the inclusion of Scope 3 emissions and capital expenditure and “the intention to detail technical protocols for these to aid comparability” is especially welcome.

Slebos says that “ensuring consistency” between the Climate Prototype and the updated TCFD metrics guidance will be “really important for investors”.

Alignment will ensure that ISSB company disclosures are comparable with the reports produced by asset managers, asset owners and companies reporting under the TCFD framework, whether published voluntarily or under regulatory mandate.

The TWRG has also been careful to ensure companies disclosing in line with the standard will connect their climate risk assessments to their business strategies, Mikula-Wright adds, such as referencing their transition plans. “A chief concern of investors has been that disclosure is not being used to inform core organisation decisions by companies,” she says.

However, the prototype’s guidance on scenario analysis could be more detailed, Mikula-Wright notes, including “hardening the expectations of the characteristics of scenarios when they are used, including temperature alignment (including 1.5°C) and pathways (e.g. orderly versus disorderly)”.

Meanwhile, the General Requirements Prototype will serve as a guide for companies to disclose broader sustainability risks (i.e. which they deem financially material) as part of their financial reports. This means companies will not need to wait for other official sustainability-related standards to be published by the ISSB.

“The General Requirements Prototype provides a running start for everyone in the market to think about how best to prepare for reporting on other sustainability risks,” said Richard Samans, Chair of the CDSB, also speaking at the COP26 launch event.

Other sustainability-related risks that companies may deem material to disclose can include, but is not limited to, water management, biodiversity, and human rights.

For example, as well as climate risks, an apparel company may also be exposed to significant human rights risks across its value chain.

“It may result in the company needing to change suppliers, directly affecting its cash flows, or could lead to lawsuits, consumer boycotts or investor divestments,” the General Requirements Prototype report said, adding that this information is therefore material to investors and should be disclosed.

However, PRI’s Slebos notes that further clarity around the prototype’s materiality assessment is needed.

“From what the PRI has seen so far, there is not a clear definition or explanation around how a company would conduct a materiality assessment, nor an obligation to report the results of this assessment, which could deem an issue or metric as being immaterial for the company,” says Slebos. “We cannot afford for this to be a grey area.”

The debate rages on

Disclosures outlining how climate-related risks impact corporate enterprise value do not go far enough in detailing to investors the role of firms in damaging or helping the environment, according to Peter Paul van de Wijs, Chief External Affairs Officer at the GRI.

“If the ISSB wants to ensure companies are providing the full picture, then they need to ask for more. This is the approach being taken in Europe,” van de Wijs says.

The EU’s ESRSs are being designed through a double materiality lens, meaning companies falling under the Corporate Sustainability Reporting Directive (CSRD) will be required to disclose the impact their business operations have on the outside world, as well as how the outside world impacts business operations and financial returns.

“Companies globally are already voluntarily reporting on their sustainability-related impact because investors are asking for it and because they recognise it is important,” van de Wijs adds. “That is not going to stop when the ISSB Climate Standard is launched.”

Pietro Bertazzi, Global Director of Policy Engagement and External Affairs at CDP, says that the ISSB’s standards will need to adopt a “building block approach”, introducing the double materiality lens over time.

Double materiality will ensure that corporates and investors are able to “manage the full range of their impacts and contribute to the Paris Agreement objectives and UN’s Sustainable Development Goals,” Bertazzi adds.

Nonetheless, Europe and the ISSB should not be in competition, GRI’s van de Wijs emphasises, but should instead be collaborating to ensure as much alignment as possible.

“The worst thing that could happen for the world is that the EU and IFRS Foundation go their separate ways and develop their own standards without any collaboration,” he says, adding that EFRAG, the GRI and the IFRS Foundation are already working together as much as possible to minimise divergence around terminology and metrics used.

In particular, EFRAG, the GRI and the ISSB will need to agree on a global baseline for enterprise value data and metrics focused on materiality, agrees PRI’s Slebos. “This is absolutely core so that investors can actually compare companies in different jurisdictions and make informed investment decisions,” he says.

“Starting global”

Rather than starting as a standard based across a few jurisdictions that is then enhanced and expanded to cover new regions, the ISSB is “starting global”, VRF’s Sexton said at the COP26 launch event.

The ISSB will continue to receive guidance from the International Monetary Fund, the Organisation of Economic Co-operation and Development, the World Bank, and the UN.

As well as ensuring interconnectedness in reporting across jurisdictions, the ISSB has a responsibility to ensure its future standards recognise how climate-related risks connect “with a wider range of environmental factors, including water, forests and biodiversity”, says Bertazzi.

The ISSB does plan to go beyond climate, Liikanen has emphasised, noting that the ISSB will build upon the General Requirements Prototype once the climate standard has been finalised and established.

“Its ambitions are climate-first, not climate only,” he said.

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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