Expectations regarding the quality and transparency of reporting around climate change risk and other environmental, social and governance (ESG) matters are fast evolving. Investors and regulators alike have increasingly recognised that robust, comprehensive and comparable information on enterprise value and risk now requires a transformation in the way reporting entities consider the impact of sustainability-related issues (and climate change in particular) on financial prospects, position and performance.
While pressures abound, in Australia, organisations are yet to receive any clear or enforceable direction about how to approach climate-related disclosure in financial reports.
This is where the International Sustainability Standards Board (ISSB) has stepped in to provide reporting entities with a comprehensive global baseline of sustainability-related disclosure standards. Its recent exposure drafts of two new International Financial Reporting Standards (IFRS) – IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2 Climate-related Disclosures – suggest that the expectations on business' disclosure of sustainability-related issues are set to significantly increase.
To understand what these recent developments mean for Australian organisations, we hosted a webinar featuring some of our experts in the field. Sarah Barker (Partner & Head of Climate Risk Governance) and Rahoul Chowdry (Senior Adviser & Member of the Audit & Risk Committee) shared their insights into navigating emerging requirements for sustainability. This article summarises their key points.
Breaking down the requirements
IFRS S1 relates to the general requirements for disclosure of sustainability-related financial information. This is not limited to climate but encompasses all material sustainability risks and opportunities an organisation is exposed to.
The goal here is to apply the good faith approach and duty of fair presentation to this disclosure. This means taking a step back and assessing whether or not, when taken as a whole, the disclosure is true, fair and complete.
All disclosures also need to link back to cash flow and enterprise value. A helpful way to think about it is that all sustainability-related risks or opportunities across the value chain that could affect enterprise value fall under the scope of S1.
“Consider, for example, a mining company. If you were involved in report preparation, you would need to think about greenhouse gas emissions, air quality energy management, water management, waste and hazardous material management. You’d need to think about biodiversity, human rights, Indigenous rights ... the list goes on and on. The devil is in the detail, and it’s important that organisations consider this in a truly holistic way.”
– Rahoul Chowdry FCA, Senior Adviser & Audit & Risk Committee Chair.
IFRS S2 applies only to climate-related disclosures. This covers how climate change affects an entity’s financial position and cash flow as well as its strategy and business model over the short, medium and long term.
Both S1 and S2 propose that disclosure be centred around the 4 pillars of governance, strategy, risk management, and metrics and targets.
This basically asks that reporting entities identify and disclose exactly who, or which body within the organisation, is responsible for climate risk oversight. It also means ensuring that the organisation has the appropriate skills and competencies to oversee the climate response. And it means holistically integrating climate risk–related controls and procedures across other internal functions.
Ultimately, the ISSB is asking organisations to provide specific and meaningful information about how they are addressing climate-related risks through strategy, how they are developing resilience and responding to uncertainty, and how they are identifying and mitigating risks.
Connecting the dots
According to our panellists, the key question organisations should be asking themselves is: “What does my understanding of my future business environment imply in relation to my financial position now?”
While explicit regulatory requirements are not yet set in stone in Australia, leading regulatory bodies have begun to indicate that things will move in this direction.
The Australian Prudential Regulation Authority (APRA) is directing entities to think about climate risks and connect these to implications for their prudential risk management. The Australian Accounting Standards Board and Auditing & Assurance Board have issued joint guidance on point, explicitly stating that reporting entities should not only consider the material risks associated with climate change for financial prospects, but to connect the dots to implications for the entity's statement of financial position (balance sheet) and performance (profit and loss).
In short, the pressure to consider – and disclose - the impacts of sustainability-related issues (and climate-related risks and opportunities in particular) on business resilience and enterprise value is becoming irresistible.
Thinking laterally and proactively
In addition to the wide scope of ESG-related issues that may have material impacts on business risks, prospects and performance, the ISSB asks organisations to disclose the potential implications of these risks for their financing and cost of capital. This forces them to think proactively about what the risks mean for their ability to continue to obtain finance.
So, the ISSB is asking organisations to not only disclose how much they are spending on climate-related resilience building, but to also indicate what this looks like.
“They want to see how your entire strategy is shifting towards being able to operate in a net zero economy. You will need to show the relativity with which you are spending on business-as-usual activities versus what you are shifting across to capital expenditure in a way that is consistent with the targets you might have set to reach net zero.”
– Sarah Barker, Partner & Head of Climate & Sustainability Risk Governance.
At this point, the ISSB is not prescriptive about what information should be included in either the management discussion or main body of a financial report. This will leave many organisations seeking advice from their legal teams and advisers to ascertain a suitable path.
Navigating the legal risks
Against this background, how should Australian organisations move forward?
The first step is to review your approach to contracts. Because Australian organisations (unlike, for example, large companies in the UK and Europe) are not yet explicitly obliged by law to make climate-related financial disclosures, organisations cannot assume that all the information they will need about other companies in their value chain will be publicly available. So, how do you go about getting this information?
You need to address these data gaps through your contracts. Typically, climate-related provisions have been limited to fortifying contracts against very significant climate risks through force majeure regimes. But a lot of the work we do with our clients is actually around covering the basics. This includes ensuring reporting permissions are built into contractual relationships so that you can access the information you need from your partnering organisations for your own climate-related risk consideration and disclosure.
Second, organisations should consider the alignment of their corporate strategies with the direction and climate targets set out in the Paris Agreement. This is particularly important given the rising number of cases being brought against directors for failing to fulfil directors’ duties to act in the best interests of the company and to exercise due diligence.
But having such strategies and targets in place brings a new set of challenges. In setting a target, you are making a representation on a future matter and therefore exposing your organisation to potentially considerable legal risk. You must establish you have a reasonable basis for making the representation and also indicate that you are changing your strategy to move towards any stated target. Failing to do so raises the risk of your organisation being sued for misleading disclosure, because you are not following through on an intention you have communicated to the market.
Third, we recommend that you start to consider the implications of the ISSB exposure drafts on your financial information systems and reporting practices, now. While IFRS S1 and S2 remain in draft, with consultation not set to close until late July, ISSB has indicated that it plans to finalise the Standards by the end of the year. The AASB is also looking closely at how these Standards should then be imported into our own laws, as Australian Accounting Standards. Building capacity now – across your board and Audit & Risk Committee, executive and group finance, and legal and cosec teams - will go a long way in preparing your organisation for future regulatory requirements.
Finally, we recommend focusing on your overall maturity in climate risk governance. This encompasses a range of things, including preparing a defence against challenges based on misleading disclosure or breach of directors’ duties, and building organisational knowledge around climate change as a material and dynamic financial issue.
“You ultimately need to consider what disclosures you need to make, in the face of a huge range of uncertainty, that can adequately provide the information that report users need in order to understand the organisation’s position in relation to climate change.”
– Sarah Barker, Partner & Head of Climate & Sustainability Risk Governance.
