ISSB Standards: IFRS Update on ESRS Interoperability

The IFRS Foundation has recently introduced a comprehensive guide on the voluntary application of ISSB Standards, designed to meet the growing demand for high-quality, globally comparable sustainability-related financial disclosures. Institutional investors such as BlackRock, Vanguard, and Neuberger Berman have amplified this demand, recognizing the crucial role of sustainability data in investment decisions, risk management, and ownership activities. To respond to these demands, the IFRS Foundation promotes the voluntary application of the International Sustainability Standards Board (ISSB) Standards, specifically IFRS S1 (General Requirements for Disclosure of Sustainability-related Financial Information) and IFRS S2 (Climate-related Disclosures).

Core Elements of ISSB Standards and IFRS Guidelines

The ISSB Standards are designed to consolidate various sustainability frameworks into a unified, coherent system that enhances the comparability and decision-usefulness of financial disclosures. At the core of this system are IFRS S1 and IFRS S2, which form the foundation for sustainability-related financial reporting.

1. IFRS S1 sets out the general requirements for sustainability disclosures, ensuring companies provide a complete and accurate picture of their sustainability-related risks and opportunities. It facilitates the disclosure of material information that influences the economic decisions of investors.
2. IFRS S2 specifically addresses climate-related financial disclosures, requiring companies to report on climate-related risks and opportunities, governance structures, and climate risk mitigation strategies. The focus here is to provide investors with reliable and comparable data on climate risks, enabling informed decision-making.

These standards help companies navigate the increasingly complex landscape of sustainability reporting, ensuring that disclosures are aligned with global frameworks like the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-related Financial Disclosures (TCFD). By using these frameworks, companies can meet the demand for globally comparable sustainability disclosures and support investor decision-making processes.

Investor Influence Driving ISSB Standards Adoption

The voluntary adoption of ISSB Standards is largely driven by investor pressure. Institutional investors—such as BlackRock, Vanguard, and Neuberger Berman—are placing increased emphasis on sustainability-related data. Through proxy voting guidelines and other engagement methods, these investors are pushing companies to align their reporting with ISSB Standards.

This investor-driven demand is rooted in the recognition that sustainability data, particularly data related to climate risk, is financially material. In the past, sustainability reporting frameworks were often fragmented, leading to a lack of consistency and comparability across markets. The ISSB Standards seek to remedy this issue by offering a globally accepted framework that consolidates existing standards, ensuring that the information provided is not only decision-useful but also comparable across different jurisdictions.

Voluntary Application of ISSB Standards

The IFRS Foundation’s voluntary application guide is designed to help companies navigate the transition from various reporting frameworks to a standardised approach under IFRS S1 and IFRS S2. This transition is critical for ensuring that sustainability-related financial information remains consistent across markets, meeting both investor expectations and regulatory requirements.

For instance, IFRS S1 requires companies to disclose material sustainability risks and opportunities in their general-purpose financial reports. This includes ensuring that the information is decision-useful and can influence investors’ decisions regarding a company's long-term sustainability strategy. The voluntary application of ISSB Standards provides companies with a "passport" for meeting investor and regulatory demands globally, allowing for a unified reporting approach that satisfies both IFRS and European Sustainability Reporting Standards (ESRS).

ISSB Standards and ESRS

For organizations looking to comply with both ISSB Standards and ESRS, the ESRS-ISSB Interoperability Guidance is a key resource. This interoperability guidance helps companies understand how to meet the disclosure requirements of both frameworks, particularly in the context of climate-related disclosures. It bridges the gap between IFRS S1, IFRS S2, and ESRS, ensuring that organizations can meet multiple regulatory requirements without duplicating efforts.

The alignment between IFRS S1 and ESRS is especially notable in the area of materiality assessments. Both frameworks require companies to assess the materiality of sustainability-related risks and opportunities, but ESRS goes further by incorporating impact materiality—a concept that evaluates not just financial risks but also the environmental and societal impacts of a company's operations.

This dual-lens materiality is critical for organizations operating in jurisdictions with stringent environmental regulations, such as the European Union. The ESRS framework requires companies to assess both the financial materiality (as defined by IFRS) and the impact materiality, ensuring that they capture the full scope of their sustainability-related risks and opportunities.

Application of IFRS S1 and IFRS S2 in Practice

The implementation of IFRS S1 and IFRS S2 in practice provides firms with a structured approach to sustainability reporting. IFRS S1 ensures that companies report on their sustainability-related risks and opportunities, giving investors a holistic view of the company’s sustainability strategy and performance. It also includes performance metrics that align with globally recognised frameworks such as TCFD and SASB, ensuring consistency in reporting.

On the other hand, IFRS S2 focuses specifically on climate-related disclosures, requiring organisations to disclose governance structures, risk management strategies, and metrics related to climate risks. Companies must report on both physical risks (such as those related to climate change impacts) and transition risks (such as those related to regulatory changes or market shifts). By doing so, they provide investors with the data they need to evaluate the company’s preparedness for climate-related challenges.

Navigating the Patchwork of Frameworks

Before the ISSB Standards, companies faced challenges in navigating a plethora of sustainability frameworks, leading to inconsistencies and a lack of comparability in disclosures. The ISSB Standards aim to resolve these issues by offering a globally accepted framework for sustainability disclosures.

However, aligning with IFRS S1 and IFRS S2 alone may not be enough for companies operating in jurisdictions that have adopted more stringent frameworks like ESRS. This is where the ESRS-ISSB Interoperability Guidance plays a crucial role. It helps companies transition smoothly between these frameworks, ensuring that they meet both global and regional regulatory requirements.

For example, IFRS S2 requires companies to conduct scenario analysis to assess their climate resilience, while ESRS E1 encourages but does not mandate such analysis. Companies seeking to comply with both standards will need to ensure that their scenario analysis is comprehensive enough to meet IFRS S2 requirements while also addressing ESRS disclosure needs.

Disclosures for Greenhouse Gas Emissions

Another critical area of alignment between IFRS S2 and ESRS E1 is the reporting of greenhouse gas (GHG) emissions. Both standards require extensive reporting on Scope 1, Scope 2, and Scope 3 emissions, but there are key differences in their approaches.

IFRS S2 offers companies the flexibility to choose between the equity share or control approaches for measuring GHG emissions. In contrast, ESRS E1 mandates a control-based approach and requires companies to include emissions from entities not fully consolidated in their financial statements (such as joint ventures and unconsolidated subsidiaries). This discrepancy means that companies complying with both frameworks must provide disaggregated data to ensure full compliance.

Key Differences: Incremental and Additional Disclosures

While there is a high degree of alignment between IFRS S2 and ESRS E1, ESRS introduces several incremental and additional disclosures that are not explicitly required by ISSB Standards. These disclosures primarily relate to impact materiality and climate mitigation performance.

For example, ESRS E1 requires companies to disclose the use of carbon credits in alignment with recognised quality standards, while IFRS S2 takes a broader approach, focusing on the planned use of carbon credits for achieving net GHG emissions targets. ESRS E1 also mandates additional disclosures related to energy consumption, requiring companies to report on their energy mix (including renewable and non-renewable sources) and energy intensity—disclosures that go beyond the scope of IFRS S2.

IFRS S2 and ESRS E1: Climate-related Opportunities and Financed Emissions

Both IFRS S2 and ESRS E1 address climate-related opportunities, but ESRS E1 requires more detailed disclosures. Companies must report on the potential market size for low-carbon products and services, while IFRS S2 mandates disclosures on business activities aligned with climate-related opportunities. The additional granularity required by ESRS E1 ensures that companies provide a clearer picture of their climate-related strategies and opportunities.

Moreover, IFRS S2 contains specific requirements for disclosing financed emissions under Scope 3 Category 15, which are related to asset management, commercial banking, and insurance activities. While ESRS does not directly address financed emissions, the interoperability guidance encourages the use of IFRS S2 disclosures to meet ESRS requirements, especially in the absence of sector-specific standards.

Strategic Importance for Global Investors

The ISSB Investor Advisory Group (IIAG) plays a pivotal role in shaping the ISSB Standards, ensuring they meet the needs of the global investment community. Managing over $54 trillion in assets, the IIAG represents leading asset owners and managers who demand high-quality, comparable sustainability-related financial disclosures. The ISSB Standards, particularly IFRS S1 and IFRS S2, provide companies with the tools they need to meet these investor demands, enhancing their appeal to a global investor base.

By adopting ISSB Standards, companies can improve the quality of their disclosures, aligning with investor expectations and regulatory requirements. This, in turn, has a positive impact on their cost of capital, investor relations, and overall market reputation. Furthermore, by adhering to both IFRS and ESRS, companies can ensure compliance with both global and regional frameworks, positioning themselves as leaders in sustainability reporting.