The UK government proposes new corporate sustainability disclosure standards based on global benchmark

Snapshot

Last year, the International Sustainability Standards Board (“ISSB”), a standard-setting body of the IFRS Foundation operating alongside the International Accounting Standards Board, released its inaugural sustainability disclosure standards (“ISSB Standards”). The ISSB Standards are intended to provide a global benchmark for reporting corporate sustainability information alongside financial statements in the same reporting package. The purpose of having a global benchmark is to facilitate reporting of globally consistent and comparable sustainability-related financial information, moving beyond disparate reporting frameworks.

There has been strong international support for the ISSB Standards, with many countries consulting on adopting them into national law. The UK government plans to introduce new corporate sustainability disclosure standards (“UK SDS”) based on the ISSB Standards, intended to be published by July 2024, after which time they could be referenced in law or regulation for UK entities. We already have a very good idea what the SDS will contain, as the UK government has said the UK SDS will only diverge from the ISSB Standards “if absolutely necessary for UK specific matters”.

In this briefing we highlight what you need to know about the proposed SDS and what companies can do now to prepare.

Overview of the ISSB Standards

The ISSB Standards are geared toward meeting the sustainability information needs of users of general-purpose financial reporting, namely, existing and potential investors, lenders and other creditors. The goal is to provide users with useful information so they can make an informed decision as to whether to provide resources to an entity.     

Currently, there are two ISSB Standards, one comprising general requirements for disclosing sustainability related financial information (“IFRS S1”) and the other specifically focused on climate-related disclosures (“IFRS S2”). Further thematic standards are expected in due course, likely to focus on nature and social topics.

The core content requirements of the ISSB Standards are organised into four thematic areas that reflect those of the Recommendations of the Task Force on Climate-related Financial Disclosures (“TCFD”): governance, strategy, risk management and metrics and targets. Companies that have already adopted or report in accordance with the TCFD’s Recommendations may therefore find transitioning to reporting in line with IFRS S1/S2 – and, therefore, the planned UK SDS – relatively straightforward.

IFRS S1: general requirements for disclosure of sustainability-related financial information

The required disclosures under IFRS S1 are of the sustainability-related risks and opportunities that could reasonably be expected to affect an entity’s prospects. This means the 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. Sustainability-related risks and opportunities that could not reasonably be expected to affect an entity’s prospects are outside scope.

Only material information should be disclosed and, as for IFRS Accounting Standards, information is material for the purposes of IFRS S1 and S2 if omitting, obscuring or misstating it could be reasonably expected to influence decisions that the users of general-purpose financial reporting make on the basis of that reporting. This is known as a financial, ’single’ or ‘outside in’ approach to determining the materiality of sustainability information (i.e., how an entity is impacted by sustainability issues). This is one critical respect in which IFRS S1 and S2 diverge from the new  EU sustainability reporting regime, which also requires disclosure about how an entity’s activities impact society and the environment (i.e., the so-called ‘double’ or ‘inside out’ materiality approach).

IFRS S1 says more about ‘how’ material information must be disclosed to be useful, described as ‘fundamental qualitative characteristics’, all of which are familiar from IFRS Accounting Standards. An entity’s sustainability-related disclosures must be fairly presented (i.e., complete, neutral and accurate), must be for the same reporting entity as the related financial statements and must enable the user to understand certain connections (including connections between the various sustainability risks and opportunities disclosed and connections between the entity’s sustainability-related disclosures and its related financial statements).

Core content requirements

The core content requirements of IFRS S1 are summarised below. IFRS S1 contains further specific instructions as to what an entity must disclose in respect of each:

• Governance: disclosure to enable users to understand the governance processes, controls and procedures an entity uses to monitor, manage and oversee its sustainability-related risks and opportunities—for example, information about how a designated governance body (e.g., a board or committee) is informed about sustainability-related risks and opportunities and how that body takes into account sustainability-related risks and opportunities when overseeing the entity’s strategy, its decisions on major transactions and its risk management processes and related policies;
• Strategy: disclosure to enable users to understand an entity’s strategy for managing sustainability-related risks and opportunities—for example, a description of the current and anticipated effects of sustainability-related risks and opportunities on the entity’s business model and value chain, and quantitative and qualitative information about how sustainability-related risks and opportunities have affected its financial position, financial performance and cash flows for the reporting period;
• Risk management: disclosure to enable users to understand an entity’s processes to identify, assess, prioritise and monitor sustainability-related risks and opportunities, including whether and how those processes are integrated into and inform the entity’s overall risk management process;
• Metrics and targets: disclosure to enable users to understand an entity’s performance in relation to its sustainability-related risks and opportunities, including progress toward any targets the entity has set, and any targets it is required to meet by law or regulation—for example, how a metric is defined and whether it’s validated by a third party, and for each target, the metric used to set the target and to monitor progress towards reaching the target.

Importantly, IFRS S1 provides for the omission from disclosure of a sustainability-related opportunity (but not risk) that is commercially sensitive if: (i) information about the sustainability-related opportunity is not already publicly available; (ii) disclosure of that information could reasonably be expected seriously to prejudice the economic benefits the entity would otherwise be able to realise in pursuing the opportunity; and (iii) the entity has determined that it is impossible to disclose that information in a manner (e.g., at an aggregated level) that would enable the entity to meet the objectives of the disclosure requirements without serious prejudice to its interests.

Technical requirements

IFRS S1 contains further general requirements, as specified below:

• Sources of guidance: companies must refer to and consider the applicability of the disclosure topics in the SASB Standards¹ to help identify their material sustainability-related risks and opportunities (although, an entity is entitled to conclude that the disclosure topics in the SASB Standards are not applicable in the entity’s circumstances). Entities may also refer to other frameworks, including the most recent pronouncements of other sustainability standard-setting bodies whose requirements are designed to meet the same information needs as the ISSB Standards, and to any sustainability-related risks and opportunities identified by entities that operate in the same industry(s) or geographical region(s).
• Location of disclosures: sustainability disclosures must be provided as part of an entity’s general purpose financial reports. Sustainability-related financial information must be clearly identifiable and not obscured by other information. An entity can also include sustainability-related disclosures by cross-reference to another report it has published (subject to further requirements set out in IFRS S1 Appendix B).
• Timing: sustainability disclosures must be reported at the same time and cover the same reporting period as an entity’s related financial statements.
• Comparative information: an entity must disclose comparative information in respect of the preceding period for all amounts disclosed in the reporting period (unless an ISSB Standard permits or requires otherwise). Amounts reported might relate, for example, to metrics and targets or to current and anticipated financial effects of sustainability-related risks and opportunities. If it is useful for an understanding of the sustainability-related financial disclosures for the reporting period, an entity must also disclose comparative information for narrative and descriptive disclosures.
• Statement of compliance: an entity whose disclosures comply with all the requirements of the ISSB Standards must make an “explicit and unreserved” statement of compliance. 

IFRS S2: climate-related disclosures

As with IFRS S1, the required disclosure in IFRS S2 is of climate-related risks and opportunities that could reasonably be expected to affect an entity’s prospects. 

IFRS S2 (like the TCFD’s Recommendations) speaks in terms of two types of climate-related risk: (i) physical, i.e., risks that arise directly from climate change (and can be either acute or chronic), and (ii) transition, i.e., those risks that flow from the transition to a lower-carbon economy, including policy, legal, technological, market and reputational risks.

The core content requirements of IFRS S2 (i.e., disclosures about governance, strategy, risk management and metrics and targets) reflect those of IFRS S1 but with a focus on climate and  supplemented with specific climate-related concepts and terminology, such as climate-related reporting metrics, including quantitative data measuring the entity's greenhouse gas (“GHG”) emissions. IFRS S2 requires that an entity disclose its absolute gross GHG emissions generated during the reporting period, expressed as metric tonnes of CO2 equivalent, classified as Scope 1, Scope 2 and Scope 3. With regard to Scope 3 emissions, the entity must disclose which of the 15 categories of (upstream and downstream) Scope 3 emissions described in the Greenhouse Gas Protocol Corporate Value Chain (Scope 3) Accounting and Reporting Standard (2011) have been included in the calculation. (Note that in light of the complexity for companies to measure Scope 3 emissions, transitional relief in IFRS S2 allows companies not to disclose Scope 3 emissions in the first year that it applies the standard.)

IFRS S2 does not require that an entity have a climate-related transition plan but does require an entity to disclose any plan it does have, including information about key assumptions used in developing its transition plan and dependencies on which it relies. In addition, an entity must disclose information to enable understanding of the resilience of its strategy and business model to climate-related changes, developments and uncertainties; to assess its climate resilience, an entity must use climate-related scenario analysis that is commensurate with its circumstances considering its exposure to climate-related risks and opportunities as well as the skills, capabilities and resources available to it. The entity must disclose both (i) the process it used for such climate-related scenario analysis (i.e., how and when it was carried out, including inputs and assumptions) and (ii) the substance of its assessment of its climate resilience, enabling understanding of the implications of the entity’s assessment of its climate resilience for its strategy and business model, including how the entity would need to respond to the effects identified in the climate-related scenario analysis; the significant areas of uncertainty in the assessment; and the entity’s capacity to adjust or adapt its strategy and business model to climate change.

Also, whereas IFRS S1 mandates that entities refer to and consider the (possible) applicability of the SASB Standards, IFRS S2 places a similar obligation in respect of IFRS S2 – Industry-based Guidance on Implementing Climate-related Disclosures (“IFRS S2 Industry-based Guidance”).²

One-page summary

For one-page summary overviews of IFRS S1 and IFRS S2, see the infographics here.

Looking ahead 

From now, the ISSB Standards may be used on a voluntary basis. Once the UK government adopts UK SDS into law, expected this summer, it may be referenced in any legal or regulatory requirements for UK entities. Decisions regarding such mandatory disclosure requirements, including regarding the entities that will be in scope, will be taken either by the UK government, for UK registered companies and limited liability partnerships, or by the FCA for UK-listed companies. In any case, there will likely be at least a six-month preparation period until the following fiscal year to begin the required reporting.

The FCA has said in its Primary Market Bulletin No.45 that it expects to consult in the first half of 2024 on proposals to implement disclosure rules referencing IFRS S1 and IFRS S2 for listed companies with the aim to bring new requirements into force for accounting periods beginning on or after 1 January 2025 and the first reporting from 2026.

Although the UK government has not given a clear indication of which entities will fall within scope of any UK SDS regulation, it has been speculated that the scope may reflect that which currently applies to TCFD-aligned mandatory reporting of climate-related financial disclosures under the Companies Act and the equivalent regime for LLPs, meaning UK listed companies or ‘large’ UK private companies and LLPs with an annual turnover of more than £500 million and having at least 500 employees.

As with all ESG regulation however, the impact of the UK SDS will be felt by a much broader range of companies outside its direct scope. To comply with their reporting obligations, large organisations will need to engage with and extract relevant data from smaller organisations within their value chains. Any companies with significant commercial relationships with large corporate entities that are likely to be within scope of UK SDS will all be indirectly affected to some extent. For example, to satisfy their corporate stakeholders’ Scope 3 GHG emissions reporting obligations under IFRS S2, such companies are likely to receive more frequent and/or more detailed requests for data relating to their carbon emissions.

What to do now

Large organisations that are likely to be within scope (or close to the anticipated scope threshold/s) of UK SDS should begin to take the following actions:

• Take stock of what (if any) sustainability and/or climate-specific data collection or reporting the company is already doing (voluntary or mandatory), including in respect of the company’s metrics and targets;
• Engage with relevant internal and external stakeholders – including the Board, executive management, in-house legal and sustainability teams, external legal counsel and auditors –  to understand the requirements of ISSB Standards, the SASB Standards and the IFRS S2 Industry-based Guidance and carry out a gap analysis against the company’s current position. As noted above, the ISSB standards draw heavily on the recommendations of TCFD and therefore organisations that are already TCFD-aligned (whether voluntarily or as required by the Companies Act) should find themselves relatively well advanced.
• Appoint a cross-functional working group to develop a draft plan of action for obtaining any missing data required to be disclosed under IFRS S1 and IFRS S2;
• Undertake an organisational financial materiality assessment, which will guide what is reported as a sustainability- or climate-related risk and opportunity that could reasonably be expected to affect an entity’s prospects;
• Review, assess and execute on the draft plan of action, such as by formulating and/or implementing new procedures to collect new relevant data, which could include implementing new sustainability data systems and processes;
• Review the company’s governance arrangements, and formalise any changes to governance such as responsibility and accountability around monitoring, managing and overseeing sustainability-related risks and opportunities;
• Monitor further developments in respect of the ISSB Standards and UK SDS; and
• In the context of a multi-national business, particularly one with significant operations and/or doing significant business in the UK, EU and/or the US, consider areas of interoperability and divergence between the ISSB Standards / UK SDS, the new EU sustainability reporting regime (the Corporate Sustainability Reporting Directive (“CSRD”)) and the proposed new SEC climate disclosure requirements.

Companies not likely to be directly affected should nonetheless map their key large corporate or institutional stakeholders (e.g., investors, lenders, suppliers, customers, landlords, tenants or corporate partners/sponsors), assess which are likely to be within scope and form a view on how (and how significantly) they are likely to be indirectly affected. This mapping, together with an assessment of the potential wider commercial and reputational advantages of voluntarily aligning with the ISSB Standards, will help inform proportionate and sensible steps forward. At a minimum, a company should take stock of its current ESG-related data collection and reporting, ensure relevant individuals are knowledgeable and on top of the requirements of the ISSB Standards / UK SDS and consider what if any new processes and procedures might need to be put in place to satisfy any forthcoming data requests.

Positioning a company on the front foot with respect to these upcoming changes will put it in a strong position to smoothly and efficiently align with the anticipated regulations when they come into force.  

Please email your Charles Russell Speechlys contact for more information and tailored advice as needed.

[1] The ISSB now also has responsibility for the SASB Standards, which identify the sustainability-related issues most relevant to investor decision-making in 77 industries.

[2] This lengthy document (running to more than 530 pages) gives guidance in respect of 11 sectors (consumer goods, extractives & minerals processing, financials, food & beverage, health case, infrastructure, renewable resources & alternative energy, resource transformation, services, technology & communications and transportation), which is further broken down by specific industry. The guidance notes that it suggests possible ways to identify, measure and disclose information about climate-related risks and opportunities that are associated with particular business models, economic activities and other common features that characterise participation in this industry. Therefore, while it suggests possible ways, it does not create additional requirements. The guidance was derived from the SASB Standards.