A basis for the new ISSB standards

The IFRS Foundation’s Technical Readiness Working Group (TRWG) released three documents of import on 3 November 2021. The General Requirements for Disclosure of Sustainability-related Financial Information Prototype, Climate-related Disclosures Prototype and its Supplement: Technical Protocols.

Their significance is that they will form the basis of the first Exposure Drafts to be released from the ISSB. In terms of the ISSB’s due process, the Exposure Drafts will be issued for public comment and thereafter the updated versions issued as ISSB Sustainability Disclosure Standards. Each of the 140 jurisdictions that already follow the IFRS Accounting Standards will have the option of mandating use of the ISSB standards and instructing any ‘add-ons’ for local regulations and practices.

So, what’s in the General Requirements for Disclosure of Sustainability-related Financial Information Prototype, and what does it say about the hot issue of materiality, and does it offer clarity on enterprise value?

The Prototype should be seen as the overarching presentation guideline for all future standards addressing specific sustainability matters, e.g., climate, biodiversity, water. It sets out the overall requirements for disclosing sustainability-related financial information relevant to the entity’s sustainability-related risks and opportunities.

Some salient points and statements from the Prototype (headings added):

  • The aim: The standards address sustainability matters that affect the assessment of enterprise value by investors, creditors, and other lenders.
  • Enterprise value is defined in the Prototype as: The market cap of the entity plus the market value of the entity’s net debt. It is determined by capital market participants, based on their estimation of the amount, timing and certainty of future cash flows spanning the short, medium, and long term. Enterprise value reflects users’ assessments of future cash flows, including the value attributed to those cash flows by users.

Essential inputs in determining enterprise value include corporate reporting in financial statements, as well as reporting on sustainability matters that it is [reasonably likely] will affect the entity’s business model over time (that is to say, affect revenue, costs, assets, liabilities, cost of capital and/or risk profile). The term captures the notion of expected value creation, preservation or erosion over time for an entity’s equity and debt investors. This expected value creation, preservation or erosion is distinct from but fundamentally interdependent with an entity’s creation, preservation, or erosion of value for its stakeholders.

  • The extent: An entity is 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.
  • Materiality: Is defined as: To the extent it could influence the assessment of enterprise value, material information includes information about the entity’s impacts on society and the environment, and how those impacts affect its future cash flows. [This aligns with the IFRS Conceptual Framework for Financial Reporting.]
  • On connectivity: Seeks to enhance connectivity within the entity’s general purpose financial reporting, including between the entity’s financial statements and sustainability-related financial information.
  • Scope: Sustainability matters that do not affect the entity’s enterprise value are outside the scope, however, it states that reporting on such matters may inform a wider range of stakeholders (including users) who want to understand an entity’s positive and negative contributions to sustainable development
  • General purpose financial reporting: An entity’s general purpose financial reporting shall include a complete, neutral and accurate depiction of an entity’s significant sustainability risks and opportunities A complete depiction shall include all material information about significant sustainability-related risks and opportunities. [So, this captures beyond the first standard on climate.]
  • Disclosure: The Prototype follows the TCFD format …Information about significant sustainability-related risks and opportunities is built on a consideration of an entity’s governance, strategy, risk management, and metrics and targets.

Governance – the governance processes, controls and procedures a reporting entity uses to monitor sustainability-related risks and opportunities.

Strategy – the sustainability-related risks and opportunities that could enhance the entity’s business model and strategy over the short, medium and long term.

Risk management – how sustainability-related risks are identified, assessed, managed and mitigated.

Metrics and targets come into each of the above and is the information used to manage and monitor the entity’s performance in relation to sustainability-related risks and opportunities over time.

Where is this information disclosed?

  • The Prototype says it’s a part of the entity’s “general purpose financial reporting” explained as providing the financial information that is useful to existing and potential investors, lenders and other creditors. Subject to any local regulations or requirements it says there are various places within general purpose financial reporting for the disclosures.
  • It can be included in management commentary. It states: Management commentary can be known by or incorporated in reports with various names, including management’s discussion and analysis, operating and financial review, integrated report and strategic report.
  • The information which is not material can be included provided it does not obscure ISSB information.
  • ISSB information can be included by cross-reference from another report if that report to users comes out at the same time and on the same terms as the financial statements. Also, material information that is included by cross-reference means that the information forms part of “general purpose financial reporting” and hence has to comply with the ISSB standards.
  • Acknowledgment of overlap and interdependency: The Prototype states that there can be significant overlap in the scope of sustainability matters that they address. This overlap stems from the interdependency of impacts on people, the environment, and the economy, and the effects those impacts have on enterprise value because entities depend on people, the environment and the economy to generate value over the short, medium and long term.

So, what’s in the Climate-related Disclosures Prototype?

  •  As expected, the Prototype states that it incorporates the recommendations by the TCFD, and uses as its starting point the relevant components of the frameworks and standards of international sustainability bodies, as published in a prototype climate-related financial disclosure standard in December 2020.
  • The industry disclosure requirements (Appendix B) form part of the requirements, and have been derived from SASB Standards.