Notable

Sustainability Developments of Note

Sustainability reporting is rapidly changing. Although this is not a “blog” in the usual sense, from time to time I will post my observations about noteworthy developments here.

Asters in late summer

What are the IFRS (International Financial Reporting Standards Foundation) Sustainability Disclosure Standards IFRS S1 and IFRS S2? 

What are the IFRS Sustainability Disclosure Standards IFRS S1 and IFRS S2? 

Simply put, these sustainability-related financial reporting standards are intended to provide a comprehensive approach to sustainability reporting. 

Why is another sustainability framework/standard needed?

The sustainability reporting landscape has many general reporting standards/frameworks/questionnaires such as GRI Standards, CDP environmental questionnaires, TCFD Recommended Disclosures, SASB Industry Standards, and other, sector-specific benchmarks such as the GRESB Real Estate Assessment

Yet with the existing range of sustainability reporting standards/frameworks, the reporting landscape can sometimes seem fragmented. This has led to an increase in calls for standardization and specific connections to financial statements. The result has been the creation of, ironically perhaps, even more standards and frameworks. 

Because most of these reporting standards are voluntary, companies can select to report using as many or few as they want. What they choose to use is influenced by what is needed to assess their sustainability impacts and risks, what peer companies do, and what investors ask for.  

What are investors asking for?

According to the Chartered Financial Analyst (CFA) Institute, 

“…investors are demanding high-quality, comparable sustainability information for investment and voting decision making, which issuers are providing under their own or third-party reporting frameworks.” 

CFA Institute

The CFA Institute, as an advocate for investment industry and investment management professionals, has promoted the development of high-quality sustainability reporting standards over the last decade. CFA plays an important role in the investment industry, promoting the need for high-quality investment financial reports and independent audits. It has advocated for the creation of the International Sustainability Standards Board (ISSB).

What is in the IFRS Sustainability Disclosure Standards? In July 2021, the International Financial Reporting Standards (IFRS) Foundation created the International Sustainability Standards Board (ISSB) to develop and issue comprehensive sustainability reporting standards for consistent, comparable and high-quality sustainability reporting with investors’ needs in mind. The two standards, IFRS S1 and IFRS S2, are based on the Taskforce on Climate-related Financial Disclosures Framework, which I discussed in my last post. The four core elements of governance, strategy, risk management, and metrics and targets set the stage for the IFRS Sustainability Disclosure Standards.

IFRS S1 lays out the general requirements for how a company is to disclose sustainability-related information, and specific requirements involving a complete set of sustainability-related financial disclosures. This information is intended for users of general-purpose financial reports in making decisions relating to providing resources to the entity. As you can see below, the required disclosures are based on the four core elements from TCFD.

  • governance processes, controls and procedures the entity uses to monitor, manage and oversee sustainability-related risks and opportunities;
  • the entity’s strategy for managing sustainability-related risks and opportunities;
  • processes the entity uses to identify, assess, prioritize and monitor sustainability-related risks and opportunities; and
  • the entity’s performance in relation to sustainability-related risks and opportunities, including progress towards any targets the entity has set or is required to meet by law or regulation.

IFRS S2 involves requirements that cover climate-related risks and opportunities and are most directly related to TCFD Recommended disclosures. 

There are, however, some differences between the core content requirements in IFRS S2 and TCFD’s core recommendations. These differences are explained in detail in Comparison IFRS S2 Climate-Related Disclosures with the TCFD Recommendations, a document prepared by IFRS Foundation staff.

These differences take three forms. Specifically, IFRS S2:

  • Uses different wording but requires the same information and is considered “broadly consistent with” the TCFD Recommended Disclosures. 
  • Requires more detailed information that is in line with the TCFD recommendations.
  • Is different from TCFD guidance by providing some additional requirements and guidance than TCFD.

Here is an example of the differences from the comparison document.

TCFD Recommendations vs IFRS S2 Disclosures

Formatted text is used in the right-hand column of the table to indicate the differences between IFRS S2 and the TCFD recommendations:

black bold text: Additional specificity in IFRS S2 that is in line with TCFD recommendations;

red bold text: Requirements in IFRS S2 that are not in the TCFD recommendations.

This comparison document is useful for companies that are using TCFD and want to advance their reporting with IFRS Sustainability Disclosures. The IFRS Foundation provides helpful information about making the Transition from TCFD to ISSB.

There are some important things to keep in mind about using the IFRS Standards. They are voluntary unless your company is in a jurisdiction (i.e., country) that requires it. If this is the case, you should recognize that the country can modify the reporting requirements to fit the needs of the country. The IFRS Foundation posts the global adoption progress on its website. The other important thing to note is what it means to comply with the IFRS Sustainability Standards. Unlike the GRI Standards that provide for “in accordance” and “referenced” reporting options, you must apply both IFRS S1 and IFRS S2 to state that you comply with IFRS standards. This may change in time in order that more companies can work their way up to full compliance in stages.

Framework, Cummins, Columbus, Indiana

Taskforce on Climate-related Financial Disclosures (TCFD): Why it is important!

How did TCFD get its start?

In 2015, the G20 Finance Ministers and Central Bank Governors requested that the Financial Stability Board (FSB) create a task force to recommend climate related risks disclosures.

Why was this request so important?

The creation of TCFD by the FSB illustrated the direct connection of climate risks to global financial stability. The FSB itself was created in 2009 after the global financial crisis to promote international financial stability.

“The Financial Stability Board (FSB) is an international body that monitors and makes recommendations about the global financial system.”

Financial Stability Board

What does it do and how?

Its mandate explicitly states its purpose and how it works.

“The FSB promotes international financial stability; it does so by coordinating national financial authorities and international standard-setting bodies as they work toward developing strong regulatory, supervisory and other financial sector policies. It fosters a level playing field by encouraging coherent implementation of these policies across sectors and jurisdictions.”

Financial Stability Board mandate

The TCFD Recommended Disclosures are a set of eleven disclosures that focus on a company’s reporting of its financial impacts from climate risks and opportunities. Climate risks are classified as transition and physical risks. Transition risks can occur when societies and economies begin transitioning to a low carbon economy. If a company does not initiate lower carbon operations or products, it runs the risk that consumers may respond negatively by switching to other companies that have low carbon processes or products. The financial risks include lower revenues and decreased market share. Another transition risk is the imposition of a carbon tax that results in higher costs for carbon intensive operations. Physical risks are direct climate impacts that can be acute or chronic. Acute risks are associated with severe weather such as tornados or hurricanes or wildfire events. Chronic risks occur with rises in sea level or increases in severe weather patterns due to climate change.

The disclosure of climate related opportunities is also relevant for companies to signal their capability to address impending climate risks. Examples of opportunities include reducing operational costs with more efficient uses of resources or creating low carbon emitting products. By understanding the financial implications of climate change, investors and companies are better positioned to reduce their risks and direct their investments to sustainable opportunities and business models.

TCFD’s reporting framework has four core elements, which include the following:

TCFD Illustration

The four elements get to the heart of how companies are managing their climate related risks and opportunities. TCFD disclosures encompass how a company connects climate risks and opportunities to the involvement of top management, the incorporation of its strategy, the description of risk management processes, and the disclosure of metrics and targets.

Who were the TCFD members?

Equally important to TCFD’s purpose was its membership composition. The members were industry experts from a variety of global organizations that included insurance companies, large banks, pension funds, large non-financial companies, asset managers, accounting and consulting firms, and credit rating agencies. Michael Bloomberg, founder of Bloomberg L.P. and U.N. Special Envoy on Climate Ambition and Solutions, chaired the group.

TCFD’s influence has been profound. The four elements are the foundation for several mandated and voluntary frameworks and standards. These include the European Sustainability Reporting Standards (ESRS), the U.S. Securities Exchange Commission’s (SEC) climate related disclosures, and the International Sustainability Standards Board (ISSB) Sustainability Disclosure Standards

As of October 12, 2023, the TCFD was disbanded, but its work continues to be built upon. The FSB asked the ISSB to monitor the progress of companies’ climate-related disclosures and build on the work of the TCFD. In June The ISSB published its first standards, IFRS S1 and IFRS S2, which fully incorporate the recommendations of the TCFD.

Please Note: Many organizations in the sustainability reporting realm have switched to using only acronyms for their names, which can be overwhelming. Although many of these acronyms have become official names, I try to spell them out in my posts. A case in point is the IFRS Foundation. IFRS stands for International Financial Reporting Standards. The IFRS Foundation is now the umbrella organization that that oversees two standards boards. ISSB is one, and the other is the International Accounting Standards Board (IASB), which develops the IFRS Accounting Standards. The IFRS Foundation oversees the ISSB, IASB, SASB (Sustainability Accounting Standards Board) Industry Standards, and TCFD.

Is TCFD still relevant?

Companies just beginning their climate risks and opportunities reporting should consider using the TCFD Recommended Disclosures. It will provide an understanding of the financial implications of climate related risks and opportunities, along with practice reporting about them using a consistent set of disclosures. If a company is then required to report using ESRS or to the U.S. SEC’s climate disclosures, practice with TCFD will come in handy.

Here are some examples of companies reporting with TCFD.

In my next post, I will discuss the ISSB’s Sustainability Disclosure Standards, IFRS S1 and IFRS S2.

Air Pollution, Milan

Climate-related Risks – Why are they so important for businesses to disclose?

The impacts of climate-related risks have the attention of companies. You can see this in the increase in companies reporting on their climate-related risks and impacts through a variety of voluntary sustainability frameworks, standards, and questionnaires. These include CDP, the Task Force on Climate-related Financial Disclosures (TCFD) Recommendations, and Global Reporting Initiative (GRI).

Although these standards and frameworks are voluntary, many companies are getting disclosure requests from a range of groups such as investors, creditors, nonprofit organizations. These groups are using climate-related disclosures to assess the companies’ climate risks and related financial impacts. Ignoring these requests for information could be detrimental to a company’s ability to acquire capital, attract new customers or markets, or plan for climate change mitigation.

My primary focus for this post is CDP and climate-related disclosures. I will address the other frameworks and standards in another post.

What is CDP?

CDP, formerly known as the Carbon Disclosure Project, started with a climate change disclosure questionnaire so the name made sense. With its expanded focus on water and forests, the name was changed to just CDP. The name reflects that it is not just about carbon disclosures.  

CDP manages a global environmental disclosure system and does so as a not-for-profit organization. Over the past 20 years, it has provided a system of environmental reporting that has focused on organizations’ climate-related disclosures as a mechanism to foster positive action and leadership on environmental issues. In 2023, more than 23,000 companies responded to CDPs climate, water, and forest questionnaires. This is up 24% from 2022. In terms of market capitalization, these companies represented US$67 trillion, which is close to two thirds of the global market capitalization. This is a definite signal disclosing their climate-related risks and impacts is relevant.

(source: CDP https://www.cdp.net/en/companies/cdp-2023-disclosure-data-factsheet#2023trends)

Why are companies disclosing?

Many are requested to submit responses to CDP by investors and customers or they can submit responses without any external requests. Benefits of responding include reducing costs, increasing competitive advantage, and enhancing reputation. Companies can choose to ignore the requests, but they do so at a cost. If your company ignores a request, a grade of “F” will appear next to the company name on CDP’s website. As CDP states:

“Not all companies requested to respond to CDP do so. Companies who are requested to disclose their data and fail to do so, or fail to provide sufficient information to CDP to be evaluated will receive an F. An F does not indicate a failure in environmental stewardship.”

Keep in mind that these requests sometimes go unnoticed by companies. I have encountered several companies that were surprised to discover that they had an F. If you have not responded to CDP previously, I recommend that you do an annual search on CDP’s website.

How does CDP work?

CDP acts as the intermediary between the requestors and the responders. Investors and customers can become CDP investor and supply chain signatories, which allows them to request companies to disclose climate information through CDP.  There are fees to become a signatory, which entitles organizations access to various benefits such as CDP’s research reports.

What is in the CDP Climate questionnaire?

The questionnaire has over 130 questions which cover a range of categories such as governance, business strategy, risk and opportunities, emissions data, biodiversity, and verification. It is updated to varying degrees each year.

The questionnaire has both qualitative and quantitative disclosures about how much greenhouse gases (GHG) companies emit, along with how they manage them. Disclosure questions are intended to help companies identify risks and opportunities as they track emissions and gauge their progress on their GHG emissions reduction.

Companies have some choices about what happens to their responses. They can choose to have them scored or not. Scoring is intended to “…motivate companies to disclose their impacts on the environment and natural resources and take action to reduce negative impacts.” It is important to point out that both what a company reports and how it reports the information affect its score. For example, in responding to how climate risks will affect a company’s operations, broad responses that temperature increases will affect costs will not be sufficient. Responses should be about specific locations, types of impacts, and estimates of costs. If a company has plants in Central America, those could be affected by increasing temperatures. To combat these impacts, a company may expect to spend 20% more on cooling, resulting in $XXX in costs.

CDP provides many detailed guidance documents for responders to understand scoring. Here is one. https://cdn.cdp.net/cdp-production/cms/guidance_docs/pdfs/000/000/233/original/Scoring-Introduction.pdf?1639144388

My next post will look at TCFD disclosures.

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