ISSB Exposure Drafts: What You Need to Know

Objective

The objective of the General requirements ED is to provide information about the significant sustainability-related risks and opportunities to which the reporting entity is exposed. The ED makes it clear that the information should be useful to primary users 1 of general purpose financial reporting 2 in deciding whether to provide resources to the entity by enabling users to have a clearer understanding of the entity’s future cash flows and the assessment of enterprise value.

Enterprise value is defined as the total value of an entity. It is the sum of the value of:

• the entity’s equity (market capitalisation); and
• the value of the entity’s net debt.

[General requirements ED, App A].

The definition of enterprise value has been refined in the General requirements ED from what was previously included in the Technical Readiness Working Group’s (TRWG) General requirements prototype.

It is worth noting that the ISSB has advised that, when evaluating enterprise value, information that could be relevant is broader than information reported in the financial statements. It can include information about an entity’s impact and dependencies on people, the planet and the economy.

Scope

Entities shall apply the draft standard in preparing and disclosing sustainability-related financial information in accordance with IFRS Sustainability Disclosure Standards. Therefore, in order to have a clear understanding of the scope of IFRS Sustainability Disclosure Standards in general, and particularly the General requirements ED, the definition of ‘sustainability-related financial information’ is crucial.

The ISSB has indicated, in the General requirements ED Basis for Conclusions, that the definition of ‘sustainability-related financial information’ was intentionally set broadly, to reflect the fact that information required and relevant to assessing enterprise value will change over time. In addition, the definition is not intended to indicate what particular information is required to be disclosed, but rather to set out the overall scope of what is considered.

The scope requirements are also indifferent to the accounting framework being applied - that is, an entity can apply the IFRS Sustainability Disclosure Standards irrespective of whether its related financial statements are prepared in accordance with IFRS or other GAAP.

Core content

The EDs are based on the four-pillar approach of the TCFD’s recommendations: governance, strategy, risk management and metrics and targets. An entity is required to provide disclosures about:

[General requirements ED, para 11].

General features

The General requirements ED sets out the requirements relating to the following general features:

• Reporting entity

‘Reporting entity’ is defined as an entity that is required, or chooses, to prepare general purpose financial statements. In order to provide further clarity, the concept of ‘reporting boundary’ under the TRWG’s General requirements prototype was changed to ‘reporting entity’ in the General requirements ED. This definition now aligns with the definition in IFRS accounting standards.

• Connected information

‘Connected information’ means that the information disclosed should enable users of general purpose financial reporting to:

• assess the connections between various sustainability-related risks and opportunities; and
• obtain a better understanding of how this information (that is, the relevant sustainability-related risks and opportunities) is linked to the various types of information that is disclosed in general purpose financial reporting.

Under the General requirements ED, the concept is used to emphasise and reinforce the objective that entities must present clear and understandable sustainability-related information. The General requirements ED Basis for Conclusions explains that connected information can be used to explain the actual or potential implications of the connections between sustainability-related risks and opportunities. Providing such interconnected sustainability-related information is useful and can enable users of general purpose financial information to make informed decisions.

• Materiality

The determination of materiality is entity-specific and is based on factors that could impact the assessment of an entity’s enterprise value. As noted above, enterprise value can include information about an entity’s impact and dependencies on people, the planet and the economy.

Sustainability-related financial information is defined in the General requirements ED as being material if omitting, misstating or obscuring that information could reasonably be expected to influence decisions that the primary users of general purpose financial reporting make on the basis of that reporting, which provides information about a specific reporting entity. This is consistent with the definition of materiality within IFRS, specifically paragraph 7 of IAS 1.

The ED also clarifies that disclosure is not needed for information that results from applying the requirements but is not material to the reporting entity.

Other general features include:

• Fair presentation - The proposals under the General requirements ED require an entity to present fairly a complete set of sustainability-related financial disclosures. Fair presentation requires an entity to disclose information that is relevant and representationally faithful, referred to within the General requirements ED as the fundamental qualitative characteristics. Additionally information should be comparable, verifiable, timely and understandable. These are referred to as ‘enhancing qualitative characteristics’.

• Comparative information - Under the General requirements ED, an entity is required to disclose comparative information for:
  • previous periods for all metrics that are disclosed in the current period; and
  • narrative and descriptive sustainability-related financial disclosures, where such information is relevant to the understanding of the current period’s disclosures. Where comparative information is reported that differs from information reported in the previous period, the differences in amounts and the reason for the revision to the amounts should be disclosed.
• Frequency of reporting - The General requirements ED makes it clear that sustainability-related financial disclosures should be reported at the same time and for the same reporting period as the related financial statements. The ED does not, however, mandate requirements relating to the disclosure of interim sustainability-related financial information, and which entities would be required to disclose such information.

• Location of information - ‘Reporting channel’ under the General requirements prototype standard was changed to ‘Location of information’. The General requirements ED explains that information required by IFRS Sustainability Disclosure Standards should be disclosed as part of an entity’s general purpose financial statements. The ED acknowledges that sustainability-related financial information can be disclosed in different possible locations, and that management commentary can also form part of an entity’s financial statements.
• Sources of estimation and outcome uncertainty - The General requirements ED notes that the use of reasonable estimates is an essential part of preparing sustainability-related metrics, and that the use of estimates does not undermine the usefulness of information, provided that the estimates are clearly and accurately described and explained. In addition, where financial data and assumptions are used in sustainability-related financial disclosures, the General requirements ED is clear that such information, to the extent possible, should be consistent with the corresponding financial data and assumptions disclosed in the financial statements.
• Errors - Errors have the same definition within the General requirements ED as within paragraph 5 of IAS 8, namely:

“omissions from, and misstatements in, the entity’s sustainability-related financial disclosures from a failure to use, or the misuse of reliable information that was available at the time when general purpose financial reporting for those periods was authorised for issue and could reasonably be expected to have been obtained and considered in the preparation of sustainability related financial disclosures”.

Similar to IAS 8, any material prior period errors should be corrected retrospectively, by no later than the next general purpose financial report authorised for issue. 

• Statement of compliance - There is a disclosure requirement in the General requirements ED whereby if an entity complies with all of the relevant requirements of the IFRS Sustainability Disclosure Standards, it should include an explicit and unqualified statement of compliance to that effect. The General requirements ED makes provision for entities to not disclose information that is required by a IFRS Sustainability Disclosure Standard if a local law or regulation prohibits such disclosure. If an entity uses such disclosure relief, it can still state compliance with the IFRS Sustainability Disclosure Standards.

The Climate Exposure Draft

Overview

The proposals contained in the Climate ED set out requirements for entities to disclose information about significant climate-related risks and opportunities that will enable users of general purpose financial reporting to assess the impact of those risks and opportunities on the entity’s:

• financial position, performance and cash flows;
• enterprise value; and
• strategy and business model.

The Climate ED was issued at the same time as the General requirements ED, and, consistent with the core content under the General requirements ED, the Climate ED is based on the four pillars included in the TCFD’s recommendations: governance; strategy; risk management; and metrics and targets. In addition, the Climate ED includes an appendix (Appendix B) which provides industry disclosure requirements based on the SASB standards. This is a fundamental part of the Climate ED (see further information below).

The Climate ED is the first of the proposed thematic standards. The Climate ED uses the same approach as the General requirements ED, but it builds on the general concepts included within the General requirements ED and instead applies them to climate-related risks and opportunities.

Governance

The Climate ED states that an entity should disclose information that enables users of reporting to understand the governance processes, controls and procedures used to monitor and manage climate-related risks and opportunities.

To achieve this objective, the Climate ED provides a list of detailed disclosure requirements that should be addressed. The overarching requirement is that there should be a description of the governance body or bodies (which can include a board, committee or equivalent body charged with governance) with oversight of climate-related risks and opportunities, and of management’s role with respect to climate-related risks and opportunities.

The Climate ED emphasises that an entity should avoid duplication of the governance disclosure requirements set out in the General requirements ED, and it recommends providing integrated governance disclosures.

Strategy

The Climate ED sets out the following disclosure requirements in order for users of general purpose financial statements to understand an entity’s strategy for addressing significant climate-related risks and opportunities:

• the significant climate-related risks and opportunities that it reasonably expects could affect its business model, strategy and cash flows, its access to finance and its cost of capital, over the short, medium or long term;
• the effects of significant climate-related risks and opportunities on its business model and value chain;
• the effects of significant climate-related risks and opportunities on its strategy and decision-making, including its transition plans;
• the effects of significant climate-related risks and opportunities on its financial position, financial performance and cash flows for the reporting period, and the anticipated effects over the short, medium and long term — including how climate-related risks and opportunities are included in the entity’s financial planning; and
• the climate resilience of its strategy (including its business model) to significant physical risks and significant transition risks.

[Climate ED, para 8].

While the Climate ED is consistent with the TCFD-recommended disclosures for describing the identified climate-related risks and opportunities as noted in (a) - (e) above, and the impact that these risks and opportunities have on the entity’s business, strategy and financial planning, the ED requires more detailed information regarding the following:

• how the entity is directly responding to the risks and opportunities;
• how its strategy and plans will be resourced; and
• the expected changes in the entity’s financial position and performance over time.

Two key areas that should be considered are transition planning, and the preparation and disclosure of scenario analysis. These are discussed in more detail below.

Included in the strategy disclosure requirements under the Climate ED is the requirement for an entity to disclose its transition plans towards a lower-carbon economy, and how those plans will be resourced. A transition plan is defined in the Climate ED as an aspect of an entity’s overall strategy that lays out the entity’s targets and actions for its transition towards a lower-carbon economy, including actions such as reducing its greenhouse gas (GHG) emissions.

There are requirements within the Climate ED for an entity to disclose carbon reduction targets and the intended use of carbon offsets in achieving these targets. Disclosing such information enables users of general purpose financial reporting to assess the entity’s current and future planned responses and actions to decarbonisation-related risks and opportunities that could impact the entity’s enterprise value.

As noted, the Climate ED would require an entity to disclose the climate resilience of its strategy to climate-related changes, developments or uncertainties - that is, the capacity of an entity to adjust to uncertainty related to climate change. This is to be disclosed through the use of climate-related scenario analysis or, if this is not possible, an alternative method or technique.

Scenario analysis evaluates a range of hypothetical outcomes of climate-related risks and opportunities by looking at various scenarios under a specified set of assumptions and constraints. Scenario analysis is not intended to forecast or predict what might happen in the future, but rather to provide information around ‘what if’ scenarios.

Although no specific scenarios are prescribed in disclosing how an entity has conducted scenario analysis, the Climate ED requires disclosure of whether its scenarios align with the “latest international agreement on climate change”, which, based on the definition as written in the proposal, at the time of publication of the Climate ED would be the Paris Agreement. The Paris Agreement’s goal is to limit global warming to well below 2 degrees Celsius, and to limit warming to 1.5 degrees Celsius compared to pre-industrial levels by reducing GHG emissions.

Risk management

The risk management disclosure requirements under the Climate ED follow the structure set out in the General requirements ED. Information about the processes that an entity uses to identify, assess and manage its climate-related risks and opportunities is required to be disclosed.

The Climate ED emphasises that an entity should avoid duplication of risk management disclosure requirements set out in the General requirements ED, and it recommends providing integrated risk management disclosures.

Metrics and targets

The disclosure requirements contained in the Climate ED are intended to highlight to users of general purpose financial reports how an entity uses metrics and targets to measure, monitor and manage its climate-related risks and opportunities.

Metrics

Paragraph 20 of the Climate ED requires the following metric disclosures:

• cross-industry metrics (that is, metrics that are relevant and applicable regardless of the industry in which an entity operates);
• industry-based metrics, which differ based on the industry that the entity is reporting in or whose business model or underlying activities share common features with those of the industry;
• other metrics used by the board or management to measure progress towards the targets set by management to mitigate or adapt to climate-related risks or maximise climate-related opportunities; and
• targets set by management to mitigate or adapt to climate-related risks or maximise climate-related opportunities.

Within the seven cross-industry metrics highlighted below, there are both quantitative and qualitative categories that entities are required to disclose, to provide the basis and explanations of how certain metrics are calculated, covering the following:

• GHG emissions (in absolute and intensity terms) measured in accordance with the Greenhouse Gas Protocol Corporate Standard.
• Transition risks - disclosure of the vulnerability of assets or business activities in absolute and percentage terms (for example, the amount and percentage of an entity’s revenue from coal mining).
• Physical risks - disclosure of the vulnerability of assets or business activities in absolute and percentage terms (for example, the amount and percentage of the proportion of an entity’s property portfolio in an area subject to flooding).
• Climate-related opportunities - disclosure of the amount and percentage of assets or business activities aligned with climate-related opportunities (for example, an entity’s revenue stream from services that support the transition to a lower-carbon economy).
• Capital deployment - disclosure of the amount used by an entity towards climate-related risks and opportunities (for example, the amount an entity has invested in R&D for low-carbon products, as a percentage of annual revenue).
• Internal carbon prices that an entity uses in emission costing by metric tonne including how the entity uses that pricing for decision-making.
• Remuneration, specifically the percentage of current period executive management remuneration that is connected to climate-related considerations; additionally, qualitative considerations of how remuneration factors in climate-related considerations.

Due to the GHG Protocol allowing various approaches for emission calculations, comparability between entities could be limited. To mitigate this, the Climate ED proposes that an entity presents Scope 1 and Scope 2 GHG emissions separately for:

• the consolidated group; and
• any associates, joint ventures, unconsolidated subsidiaries and affiliates not included in the consolidated group.

The requirement to disclose Scope 3 emissions, as well as qualitative information of how the entity derived the emissions, is to emphasise the importance of considering the entity’s value chain and not just the entity itself.

There is specific illustrative guidance provided with the ED, but this does not form part of the draft standard. The guidance includes illustrative metrics for transition risks, physical risks, climate-related opportunities and capital deployment. For example, a transition risk could be the absolute and percentage value of the concentration of credit exposure to carbon-related assets.

Included within Appendix B to the Climate ED are the industry-based disclosure requirements, which are an updated version of the SASB standards. As discussed above, entities need to identify the relevant industry-based disclosure requirements which most closely align with their business model. Entities could fall into more than one industry classification, and they are advised to refer to the SASB website for help identifying their primary industry classification in accordance with the Sustainable Industry Classification System (SICS).

Once an entity has determined its relevant industry or industries, it could find that the specific industry-based requirements are a useful starting point in identifying its climate-related risks and opportunities.

Each industry-based disclosure requirement contains the following five components:

• Description of the industry - to help entities to determine the classification by defining the relevant business models, underlying economic activities and common sustainability-related impacts and dependencies in the industry.
• Disclosure topics - for each individual industry ,specific sustainability-related risks or opportunities are described. For example, within Agricultural Products, it is noted that the direct GHG emissions are produced through the processing and transportation of goods, which could increase the cost of capital. Additionally, impacts on enterprise value of those risks and opportunities are included.
• Metrics - these are included to provide useful performance information. For example, within Metals and Mining, ‘total energy consumed’ is a metric to be disclosed.
• Technical protocols - these provide guidance on definitions, scope, implementation and compilation. For example, within the Metals and Mining metric above, “the entity shall disclose the total amount of energy it consumed as an aggregate figure in gigajoules”. Further guidance is also provided on how to compile that metric.
• Activity metrics - these are intended to aid comparison by quantifying the scale of specific activities or operations of an entity. For example, within Telecommunication Services, one activity metric is ‘Number of wireless subscribers’.

Entities that have previously reported under SASB standards will note that changes included in Appendix B to the Climate ED are highlighted for ease of comparison. These specifically cover two areas:

• requirements that included reference to US legislation have been amended so as to refer to applicable global guidance, as necessary; and
• disclosure topics and metrics have been proposed for four industries in the financial sector, namely: commercial banks; investment banks; insurance; and asset management.

Targets

For users to understand and assess an entity’s targets and whether its strategic goals are being achieved, an entity should disclose not only its climate-related targets, but also the following:

• the objective of the target (for example, whether the target was set by an entity to comply with a sector or science-based initiative);
• the specific target that the entity has set for addressing climate-related risks and opportunities;
• on what the targets are based (that is, an absolute or intensity target). An intensity target, for example, is where an entity pledges to reduce GHG emissions by 20% in relation to a business metric (for example, reduce CO₂ per tonne of cement) by a certain date;
• how the target compares with those created in the latest international agreement on climate change and whether it has been validated by a third party. As noted above, this would currently be the Paris Agreement, but is left open for any future agreements;
• whether the target was calculated using a sectoral decarbonisation approach. As defined by the Science Based Targets initiative, a sectoral decarbonisation approach is a scientifically-informed method for companies to set GHG reduction targets necessary to stay within a 2 degrees Celsius temperature rise above pre industrial levels;
• the timeframe over which the targets apply;
• the base period against which the entity will measure progress;
• any milestones or interim targets; and
• the metrics that are used to assess the progress made towards reaching targets and achieving strategic goals.

Adoption and Effective Date of the EDs

It is not clear at the moment when the requirements proposed in the EDs will apply because the effective date will be determined when the final standards are issued. However, the following are proposed in the EDs:

• the ability to apply earlier than any mandatory effective date; and
• relief from providing comparative information in the year of adoption.

Local jurisdictions will need to determine whether to require adoption of the proposed ISSB standards and, as a result, they might also set their own timeframe for adoption which differs from the proposals.

Next steps

The ISSB is calling for public comment on both of the EDs by 29 July 2022. Feedback to the consultations on the General requirements ED and Climate ED will be discussed in public by the ISSB before any standards and the work plan are finalised. The process will be overseen by the Trustees’ Due Process Oversight Committee.The Board will then reflect on comments received, and it has stated that it expects final standards to be issued by the end of the calendar year 2022.

It is also expected that the ISSB will consult on its standard-setting priorities later in 2022. The consultation looks to provide feedback on the following:

• the sustainability-related information needs of investors when assessing enterprise value; and
• further development of industry-based requirements, building on SASB standards.

Since the ISSB will build on the work of existing reporting initiatives, the SASB standards will be built on as follows:

1. The ISSB will embed the industry-based approach used by the SASB into its standard-setting process.

2. Inclusion of SASB standards in the EDs.

3. Commitment to improving international applicability of SASB standards.

4. SASB standards will serve as the starting point for the ISSB’s industry-based requirements.

5. The current ongoing projects by the SASB will be transitioned to the ISSB.

6. The ISSB encourages preparers and stakeholders to support the use of the SASB standards in the transition phase.

Further details of the ISSB’s plan relating to the SASB standards can be found here.

Since the current projects ongoing at the SASB are quite extensive, entities should consider whether any are relevant to them to comment on, and they should note that these have differing timelines from the ISSB.

As discussed above, local jurisdictions will need to determine adoption. There are, however, a number of other proposals which should also be considered.

The US Securities and Exchange Commission (SEC) has published proposed rules for climate-related disclosures, and the European Financial Reporting Advisory Group (EFRAG) published 13 European Sustainability Reporting Standards (ESRS) EDs on 29 April 2022 for public consultation. EFRAG are still planning to issue additional, sector specific exposure drafts over the coming months. To achieve a global baseline for reporting, it will be important for the different standard setters to consider each other's work in order to achieve consistent and comparable sustainability-related reporting.

Further information on the SEC proposed rules for climate-related disclosures, and on the progress of EFRAG, can be found here:

• Why non-EU companies should not ignore Europe's ESG proposals - PwC In depth
• EFRAG publishes the first batch of working papers on European Sustainability Reporting Standards
• The Draft European Sustainability Reporting Standards have been released for comment
• SEC issues new rules on climate disclosures
• IFRS Talks Podcast on the ISSB EDs