Despite macro-economic challenges and a shift in political focus being outcome of global measures to cope with C-19 and military invasion in Ukraine, global and EU sustainability and ESG reporting initiatives are live and vivid.
Before giving overview of future reporting requirements and considerations it is worth briefly outlining the progress to date.
One of the global drivers of the reporting agenda is Basel-based Financial Stability Board, a not–for-profit association servicing G20 governments, and its Taskforce on Climate-related Financial Disclosures (“TCFD”). The TCFD developed voluntary set of recommendations, which later were turned to be a part of the regulatory framework in many jurisdictions, including the European Union.
The TCFD has developed a reporting framework based on a set of consistent disclosure recommendations for use by companies as a means of providing transparency about their climate-related exposures to investors, lenders and insurance underwriters. The TCFD’s 11 disclosure recommendations embrace such areas as governance, strategy, risk management, and metrics and targets.
On Jan 1st 2022 EU Taxonomy Climate Delegated Act has been enforced. With that, the climate change mitigation and adaptation objectives become mandatory. EU law has adopted the Technical Screening Criteria for activities that contribute substantially to climate change mitigation and adaptation objectives. The Act is significant for the following reasons:
- Investors and companies can now start reporting against the EU Taxonomy to meet disclosure requirements under Sustainable Finance Disclosure Regulation (SFDR) and the Taxonomy Regulation;
- It gives the market a clear environmental performance benchmark, setting a common language for investors, companies, and other stakeholders;
- It sets a technologically neutral performance threshold for electricity generation in the energy sector;
- It provides the basis for other important legislative initiatives in the EU’s renewed sustainable finance strategy, linked to sustainability reporting, financial advice based on sustainability preferences, labelling and standards for sustainability-themed financial products.
- Investment firms serving EU clients must inquire about the individual sustainability preferences of their clients under the revised rules of the MiFID II starting August 2022. Clients that have a sustainability preference can voice it with reference to the EU Taxonomy and/or SFDR.
Effective 1 Jan 2022 EU issued Non-financial Reporting Directive (“NFRD”). In line with the Directive large public-interest companies, which count over 500 employees, are required to disclose information on the way they operate and manage social and environmental challenges and follow the rules on disclosure of non-financial and diversity information. This directive amends the Accounting Directive 2013/34/EU. Such companies have to publish information related to environmental matters, social matters and treatment of employees, respect for human rights, anti-corruption and bribery, diversity on company boards.
UK develops their own Green Taxonomy, which uses metrics of the EU taxonomy as its basis. Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2021 became effective 6 April 2022. UK Green Technical Advisory Group is to review these metrics to ensure they are appropriate for the local market. Qualifying companies, preliminary big businesses, including the financial service industry, will have to make disclosures in compliance with the taxonomy. Qualifying product level disclosures will also be required. The government intends to assess implementation and compliance progress at the end of 2023. By end of 2022 final rules are to be set on initial policy proposals.
UN, IOSCO and other international, governments’ mandated organisations set the tone as to global accountability and reporting on the topic.
Future
In November 2021, the IFRS Foundation Trustees announced the creation of a new standard-setting board—the International Sustainability Standards Board (ISSB). The intention is for the ISSB to develop a comprehensive global framework for sustainability disclosures for the capital markets. On 31 March 2022 the Board launched a consultation on its first two proposed standards. IFRS S1 “General Requirements for Disclosure of Sustainability-related Financial Information”, and IFRS S2 “Climate-related Disclosures” that specifies climate-related disclosure requirements.
The Exposure Draft IFRS S1 sets out the overall requirements for an entity to disclose sustainability-related financial information about all its significant sustainability-related risks and opportunities. Framework for the disclosures is based on TCFD’s pillars: governance, strategy, risk management, and metrics and targets for all disclosure topics, not just climate. Companies must disclose information about all sustainability-related risks and opportunities. Sustainability disclosures must be made available at the same time as financial statements.
The Exposure Draft IFRS S2 builds upon the recommendations of the TCFD and incorporates industry-based disclosure requirements derived from SASB Standards. SASB Standards have been developed by Sustainability Accounting Standards Board under the Value Reporting Foundation, which effective August 1, 2022 consolidated into the IFRS Foundation.
SASB Standards guide the disclosure of financially material sustainability information by companies to their investors. Available for 77 industries, the Standards identify the subset of environmental, social, and governance issues most relevant to financial performance in each industry.
The Exposure Draft IFRS S2 suggests cross-industry metrics, 7 items applicable to all entities: emissions, transition risks, physical risks, opportunities, capital deployment, internal carbon pricing, remuneration. ED included SASB industry requirements ‘as is’ with changes marked. Most significant change is the addition of financed and facilitated emissions for financial institutions.
The market feedback on the proposed IFRS S1 and S2 was closed on 29 July 2022. The ISSB will review the feedback in the second half of 2022 and aims to issue the new Standards by the end of 2022. ISSB intend to use SASB for future topics.
EU market should also expect further mandatory regulatory developments. The EU has reached provisional agreement on the Corporate Sustainability Reporting Directive (CSRD). The Directive will cover NFRD requirements and ensure more forward-looking information, information on intangibles (social, human and intellectual capital), materiality process, and Sustainable Finance Disclosure Regulation links.
In the CSRD EU entrusted the European Financial Reporting Advisory Group (EFRAG) a new role to draft EU Sustainability Reporting Standards (ESRS) and/or draft amendments to the standards. In May this year, EFRAG issued 13 exposure drafts of ESRSs. The CSRD requires that these standards would apply to listed and large companies located in the EU and certain foreign companies or groups that generate revenue in the EU.
CSRD becomes effective 1 January 2024, and the first tier companies will need to apply ESRSs for 2024 year ends. Other companies will apply them in phases.
Besides listed companies, ESRSs will also be applicable to any companies meeting 2 of the 3 criteria: balance sheet total exceeding €20 million, turnover exceeding €40 million, average number of employees during financial year exceeding 250 FTE.
In attesting compliance with the standards limited assurance would be required initially, and reasonable assurance later. Sustainability information will need to be included in the management report. All CSRD impacted companies will need to report in the Standard Reporting Format (SBR). A digital XBRL tagging for this information will be required as part of the digital taxonomy.
Development of KPIs would be required relating to four key sustainability issues: environment, social and employee issues (including Board diversity), human rights, and bribery and corruption. CSRD would require visible materiality analysis and stakeholder engagement process, ESG metrics from a company and a group including its subsidiaries, short, medium and longer term targets and KPIs for all material ESG issues/activities.
In April 2022 the European Commission has also adopted a set of technical standards to be used by financial market participants when disclosing sustainability-related information under the Sustainable Finance Disclosures Regulation. The Regulation specifies the exact content, methodology and presentation of the information to be disclosed, thereby improving its quality and comparability. Under these rules, financial market participants will provide detailed information about how they tackle and reduce any possible negative impacts that their investments may have on the environment and society in general. These new requirements will help to assess the sustainability performances of financial products. Compliance with sustainability-related disclosures is expected to contribute to strengthening investor protection and reduce greenwashing. The requirements are now subject to scrutiny by the European Parliament and the Council. They are scheduled to apply from 1 January 2023.
To resume, in the table below we outlined ISSB, EU and US similarities and differences in regulation of Sustainability Reporting.
| Major Similarities | Major Differences |
| ISSB and EU require all sustainability-related topics to be disclosed. | US proposals address climate only. |
| ISSB ED cover only one topic initially: climate. | EU proposes an extensive amount of topical and industry requirements. |
| ISSB and EU proposals generally do not affect the financial statements, though entities may include certain disclosures in the financial statements if they wish. | US proposals include requirements affecting the financial statements. |
| Many climate disclosure requirements are based on the TCFD’s Recommendations. | Preliminary analysis would conclude that application of EU proposals would not result in compliance with ISSB proposals and vice versa. |
| EU Taxonomy is a significant additional requirement with no direct equivalent in the ISSB or US proposals. |
In view of further quick developments on the regulatory scene for sustainability reporting, companies’ shareholders and management have to question themselves as to:
- Which implications have key ESG drivers, e.g. CSRD for the business model of their company, and which chances/opportunities exist?
- Which regulatory developments are important for their company and how can they be influenced?
- Which expectations exist from investors, creditors, customers and other relevant stakeholders?
- How should ESG be more fully integrated into the corporate strategy and story?
- What is the general ambition with regard to ESG?
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