As part of the Deloitte Global Boardroom Program, in Q4 2021, Deloitte surveyed over 350 audit committee members in 40 countries about climate issues. In the survey, 60% of respondents said “the lack of global reporting standards makes it hard to compare their organization’s progress against meaningful external benchmarks.” The International Sustainability Standards Board established by the IFRS Foundations is developing a set of global sustainability reporting standards. Will climate disclosure rules expected from the SEC be in sync with ISSB global standards? Could some companies be subject to both climate disclosure regimes?
While we know that the Corp Fin staff is currently hard at work on a climate disclosure proposal (expected, according to Corp Fin Director Renee Jones, to be before the SEC this quarter, see this PubCo post), and it seems that some hints have been dropped around possible adoption or recommendation of a reporting framework based on the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures (see this PubCo post), we don’t really know what’s coming our way. The question posed in this article from CFO.com, is whether the U.S. will “work with the new International Sustainability Standards Board on sustainability reporting rules?”
The article, written by a trustee of the IFRS Foundation, sets the stage at the outset by asserting that “[n]either the United States, Europe, nor any other region has recognized uniform financial reporting standards on climate change or sustainability. Instead, more than 50 groups have formulated guidelines or scorecards. As a result, while most public companies have disclosed some of their sustainability efforts, CFOs have struggled to figure out precisely what disclosures should cover.”
The IFRS Foundation oversees the International Accounting Standards Board, which has issued international financial reporting standards that have been adopted in 140 jurisdictions around the world—other than the U.S. Given that history, the Foundation was asked by various regulators and investors to see what they could do on sustainability standards. At COP 26 in Glasgow in November 2021, the Foundation announced that it had established the International Sustainability Standards Board (ISSB) to “develop a comprehensive baseline of high-quality sustainability disclosures for listed companies.” Among the groups joining that initiative were the Climate Disclosure Standards Board and the Value Reporting Foundation (which is the entity resulting from the merger of the International Integrated Reporting Council and SASB, the Sustainability Accounting Standards Board). SASB, of course, has issued sustainability standards for 77 industries, providing a framework with which many U.S companies are familiar and align their reporting. (See this PubCo post.)
The author observes that the ISSB will focus on the needs of investors, that is, the “material impact of sustainability factors on the future cash flows and enterprise value of public companies rather than the broad implications for society.” That does not mean that all metrics will be strictly financial— the author maintains that “investors are also interested in nonfinancial metrics on ESG efforts.” The standards will not be generally applicable in all countries; rather, each jurisdiction will need to consider the standards and adopt the standards.
According to the author, the SEC has been actively involved in the technical readiness working group working on the standards and is a key member of the International Organization of Securities Commissions (IOSCO). However, it’s not at all clear that the SEC would necessarily sign on to the ISSB standards: the most the author offers is a “hope” that the SEC “will coordinate closely with the ISSB.”
Even if the SEC does not adopt ISSB standards, could they still apply to U.S. companies? Maybe. According to the author, “[e]arly indications are that if a U.S. company does significant business in Europe or Asia, it will likely have to comply with the sustainability disclosure standards of the countries in those regions. The European Union has already indicated it will apply its sustainability disclosure standards to any company doing business in the EU”—however “doing business” is ultimately defined. Accordingly, it could be that many companies end up subject to two (or more) regulatory disclosure mandates on climate that may or may not be harmonized. The author cautions that, “[i]f the U.S. actively participates in the ISSB’s work, it will play a significant role in shaping global standards. If not, U.S. companies doing business abroad will be subject to sustainability disclosure standards that their regulator had no hand in writing.”
So far, the Foundation has published two prototypes for disclosures “to give the new board a running start.” The prototypes are informational only and have not been subject to the ISSB’s “due process” or formally adopted. They were written by a technical readiness working group that includes experts from the organizations identified above, as well as from the TCFD (see this PubCo post) and the World Economic Forum (see this PubCo post).
The climate-related prototype “sets out the requirements for the identification, measurement and disclosure of climate-related financial information. The objective… is to require entities to provide information about their exposure to climate-related risks and opportunities. This information, along with other information provided as part of an entity’s general purpose financial reporting, assists users of the information provided in assessing the entity’s future cash flows, their amounts, timing and certainty, over the short, medium and long term. This information, together with the value attributed by users to those cash flows, supports their assessment of the entity’s enterprise value.” The draft incorporates the recommendations of the TCFD and components of other frameworks; the industry-specific disclosure requirements are based on SASB standards. The prototype would require companies to provide information about the four pillars of the TCFD framework: governance, strategy, risk management and metrics and targets.
With regard to climate metrics, the prototype would require disclosure of cross-industry metrics and industry-based metrics. Notably the cross-industry metrics include Scope 1, Scope 2 and Scope 3 GHG emissions. Scope 3 GHG emissions also would require “an explanation of the activities included within the disclosed metric. For example, an online retailer may be exposed to risks or opportunities related to the greenhouse gas emissions arising out of third-party transportation and distribution services purchased by the reporting entity for outbound logistics of products sold to customers.” Entities would also be required to disclose the amount and percentage of assets or business activities vulnerable to transition risks and the amount and percentage of assets or business activities vulnerable to physical risks, as well as climate-related opportunities.
There is also a general sustainability prototype, which would “address sustainability matters that affect assessment of enterprise value by investors and other participants in the capital markets.” The sustainability prototype also looks to the four pillars of the TCFD framework. Similar to the climate prototype, an entity would be “required to report material information on sustainability risks and opportunities, which would assist users in predicting the value, timing and certainty of the entity’s future cash flows, over the short, medium and long term and therefore their assessment of enterprise value.” The prototype is based on various standards, including the TCFD. The prototype includes:
- “a requirement to disclose a complete, neutral and accurate depiction of an entity’s significant sustainability risks and opportunities.
- a definition of materiality, aligned with the Conceptual Framework for Financial Reporting, focused on the information that serves the needs of users and drives enterprise value.
- a consistent approach for the disclosure of information about significant sustainability-related risks and opportunities built on a consideration of an entity’s governance, strategy and risk management and supported by metrics and targets.
- further requirements and guidance that support the provision of comparable and connected information.”
As defined in the prototype, “sustainability” means: (a) “activities and relationships that make impacts on people, the environment, and the economy; and (b)… activities that erode, maintain, or enhance its ability to create enterprise value over the short, medium and long term.” Among the topics identified are matters such as climate change, water use and discharge, biodiversity and employees and human rights. To illustrate, the prototype indicates that “a garment company may be exposed to significant human rights risks affecting workers or communities in its value chain[, s]uch as the use of child labour or unsafe working conditions. Such human rights risks may affect the company’s enterprise value. For example, 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 prototype includes a fairly extensive discussion of materiality. Under the prototype,
“material information includes information that provides insights into factors that could reasonably be expected to influence users’ assessment of the entity’s enterprise value including its ability to generate cash flows over the short, medium and long term and the value attributed by users to those cash flows. Material information could include but is not limited to information about: (a) an entity’s impacts on society and the environment, if those impacts could reasonably be expected to affect the entity’s future cash flows; and (b) events considered to have a low likelihood but a high potential impact on the entity’s future cash flows.”