Sustainability performance as a value driver
At the COP26 Climate Change Summit in Glasgow, the IFRS Foundation Trustees announced the formation of the International Sustainability Standards Board (ISSB) to develop a comprehensive global baseline of sustainability disclosures for the financial markets.
The ISSB will work together with the IASB to ensure compatibility between the IFRS accounting Standards and the ISSB’s Sustainability Disclosure Standards.
Another step in the development of sustainability reporting also referred to as non-financial reporting, has been taken. Although still under construction, companies will need to prepare for this new set of mandatory standards. Let’s have a closer look.
Financial and non-financial reporting have to be combined (the so-called integrated reporting) to give a more accurate picture of company performance and value.
Growing demand for sustainability information
Put the financial performance metrics aside for a moment, a new global reporting era is just around the corner: sustainability performance. Investors, shareholders, employees, or any other stakeholders attach increasing importance to environmental, social, and governance issues. As this brings new challenges for sustainability reporting, companies need to prepare for new sustainability frameworks and standards.
Several initiatives are in full swing, be it on a global IFRS Foundation level (i.e., the creation of an International Sustainability Standards Board or ISSB), on a European level (i.e., the Corporate Sustainability Reporting Directive or CSRD), or on an organizational level with any project addressing environmental, social or governance issues.
As the demand for sustainability information continues to grow and several initiatives all over the globe emerge, the call for a single framework sounds louder than ever. Consistency and comparability are high on the agenda of investors and their investees.
Some recent developments in the European Union and at a more global scale in the IFRS Foundation are indicative for the increased focus on sustainability reporting.
The IFRS Foundation journey
Last year, a public consultation confirmed the demand for global standards and the broad support for the Foundation to play a role in developing such standards.
Currently, the IFRS Foundation Trustees are working on the creation of a new standard-setting board, the International Sustainability Standards Board (ISSB), a sister board of the IASB.
Thanks to the preparatory work of a Technical Readiness Working Group (TRWG), the project is up for a running start, enabling the ISSB to respond to investors’ urgent demands for more transparent and consistent reporting on sustainability matters. This should enable investors to assess the way a company’s sustainability performance affects value creation to make their investment decisions.
The ISSB aims to deliver sustainability-related disclosure standards that provide investors and other stakeholders with accurate and valuable information about companies’ sustainability-related risks.
It has not been announced yet what the expected date of implementation of the sustainability standards will be.
The European Union journey
Following the so-called Non-Financial Reporting Directive (NFRD), the European Union (Directive 2014/95/EU) requires certain companies to disclose non-financial information. The NFRD applies to large public-interest companies with more than 500 employees and includes listed companies, banks, insurers, and other public-interest companies.
Non-financial information is defined as related to
- environmental matters
- social matters and the treatment of employees
- respect for human rights
- anti-corruption and bribery
- diversity on company boards (age, gender, background, …)
In June 2017, the European Commission published its guidelines for a more consistent and comparable disclosure of environmental and social information. As these guidelines are not mandatory, companies may decide to use international, European, or national guidelines according to their characteristics or business environment.
In June 2019, the European Commission published guidelines on reporting climate-related information, a supplement to the existing guidelines on non-financial reporting, which remain applicable.
The Corporate Sustainability Reporting Directive
On 21 April 2021, the Commission adopted a proposal for a new directive, the Corporate Sustainability Reporting Directive (CSRD), aiming at amending the already existing reporting requirements of the old NFRD. This new directive
- extends the scope to all large companies and all companies listed on regulated markets (except listed micro-enterprises)
- requires the audit (assurance) of reported information
- introduces more detailed reporting requirements, and a requirement to report according to mandatory EU sustainability reporting standards
- requires companies to digitally ‘tag’ the reported information, so it is machine-readable and feeds into the ESEF (European Single Electronic Format) guidelines.
This proposal envisages the adoption of EU sustainability reporting standards, to be developed by the European Financial Reporting Advisory Group (EFRAG).
The first set of standards is expected in 2022.
The sustainability reporting landscape is complex, with different frameworks, standard setters, and other initiatives. How to avoid these initiatives from overlapping and creating double work?
A variety of initiatives are emerging in different parts of the world. The sustainability reporting landscape is complex, with different frameworks, standard setters, and other initiatives. How to avoid that these initiatives aiming at a more structured sustainability reporting overlap and create double work?
It is clearly in the interests of reporters and investors to have standards that are globally aligned. Let us be clear about that. EU standards should aim to incorporate the essential elements of globally accepted standards currently being developed and vice versa.
Many stakeholders have highlighted the importance of alignment in standard-setting. Working together and developing requirements from joint principles and concepts is not only common sense but is an absolute necessity for the success of globally aligned sustainability reporting.
The proposals of the International Financial Reporting Standards (IFRS) Foundation to create a new Sustainability Standards Board are relevant in this context. The proposed EU sustainability reporting standards as discussed above should build on and contribute to standardization initiatives on a global level. This will require constructive cooperation between EFRAG and the ISSB, as well as with other standard setters all over the world.
In the announcements made by the IFRS Foundation at the climate change summit in Glasgow, it was comforting to read that the standards will be developed to facilitate compatibility with requirements that are jurisdiction-specific or aimed at a wider group of stakeholders (for example, the European Union’s planned Corporate Sustainability Reporting Directive as well as initiatives in the Americas and Asia-Oceania).
Building trust through assurance
Companies tend to report only the non-financial information that makes them look good. How can we avoid this ‘greenwashing’?
For EU and ISSB standards, the expectation is that an audit (assurance) requirement for reported sustainability information would be introduced.
This will help to ensure that reported information is accurate and reliable and addresses the concerns of investors and other stakeholders about the reliability of the sustainability information that companies report today.
The purpose is to establish the same level of trust in sustainability reporting as we currently have in financial reporting. A true and fair view on non-financial reporting will be required: consistency on which metrics need to be reported and how they are reported will be key.
Debates on a ‘limited’ assurance requirement versus a more demanding ‘reasonable’ assurance requirement are ongoing, but in case of sustainability standards being adopted, it becomes unavoidable that some kind of audit assurance will be required.
The question also arises whether there is sufficient capacity and technical ability on the current market for such assurance services. The expectation is that the member states will allow firms other than the usual auditors of financial reports to assure sustainability information.
Takeaways: towards integrated reporting
There’s no way around sustainability reporting anymore. If you want to stay attractive and competitive as a company, you will need to measure and consistently report how your business affects the environment and society. Investors, employees, clients, supplies, and other stakeholders will increasingly rely on this non-financial reporting and might turn to companies that perform relatively better than their competitors in the sustainability race.
It is clear that financial and non-financial reporting have to be combined (the so-called integrated reporting) to give a more accurate picture of company performance and value.
Sustainability standards are under construction, and we expect to see them published shortly. All of these reporting developments share one common goal: bring quality, efficiency, and consistency in sustainability reporting.