Nancy Xie (South Pole) on the new IFRS S1 and IFRS S2 standards

06 July 2023 Consultancy.com.au 6 min. read

Last month, the International Sustainability Standards Board (ISSB) released its first two standards: the IFRS S1 and IFRS S2. Nancy Xie, Senior Managing Consultant at South Pole, provides a rundown of the standards and shares her perspective on how Australian organisations should prepare.

The first standard, IFRS S1, defines the requirements for companies to communicate their sustainability-related risks and opportunities.

The second, the IFRS S2, sets out specific climate-related disclosure requirements covering a holistic climate strategy such as greenhouse gas (GHG) emissions, transition plans, the impacts of climate risks using scenario analysis, and mitigation/ adaptation plans.

Nancy Xie (South Pole) on the new IFRS S1 and IFRS S2 standards

It is anticipated that the IFRS S1 and IFRS S2 standards will gradually be adopted by regulators. Australia, Canada, the United Kingdom, Singapore and Hong Kong have already announced intentions to align their mandatory sustainability reporting requirements with the ISSB.

The standards will apply to annual reporting periods starting from January 2024, with companies issuing disclosures against the standards in 2025. However, as the ISSB is a voluntary standard, applicability depends largely on adoption timeframes in specific jurisdictions.

Building on the TCFD

The standard draws heavily upon the Task Force for Climate-related Financial Disclosure (TCFD) which has to date been considered the gold standard for sustainability disclosure and has been adopted in multiple jurisdictions globally. From 2024, the ISSB will also take over the monitoring of progress on companies reporting against the TCFD.

The climate-specific standard IFRS S2 adopts an identical structure to that of the TCFD, following the same four pillars of governance, strategy, risk management, and metrics and targets.

Yet in some areas, it also goes further than the TCFD. Some key examples include:

Risk management now integrates climate opportunities
While the TCFD's risk management pillar focused specifically on climate risks, the expectation from the IFRS S2 is that the disclosure and integration of processes to identify, assess and manage climate risks will now include climate opportunities too.

More detail is also expected on the extent and nature of the integration that will take place within enterprise risk management processes and on how the nature, likelihood and magnitude of climate risks and opportunities are to be determined.

Scope 3 emissions must be disclosed
The IFRS S2 framework requires the disclosure of scope 3 emissions in addition to scope 1 and 2. Under the TCFD, scope 3 was encouraged if it is deemed to be material but was not mandatory. The change ensures that the reporting shows the full impact of the company and its value chain.

Financed emissions (scope 3, category 15) must also be disclosed by entities involved in asset management, commercial banking or insurance.

Disclosed scope 2 emissions must be location-based
The GHG Protocol outlines two methods for calculating scope 2 emissions: location-based scope 2 emissions reflect the average emissions intensity of grids, while the market-based approach reflects emissions from electricity that companies have purposefully chosen (or not chosen) to procure, e.g. by using contractual instruments.

The ISSB stipulates that location-based scope 2 emissions should be used for disclosure, but that this should also be supplemented by information on any contractual instruments that are relevant (e.g. renewable energy certificates), so as to give the most informed understanding of the entity's scope 2 emissions.

Clearer requirements for key disclosure areas

In other areas, the ISSB makes existing expectations under the TCFD framework more explicit. Examples include the following:

Quantified financial impact of climate risks and opportunities
The ISSB standards specifically require companies to disclose information on their financial position, performance and cash flows in the reporting period, whether as a range or single amount. This reinforces the TCFD's expectation that companies provide information about their sustainability impacts and their efforts in their financial statements in order to reflect the financial impacts that climate issues can have on companies.

In assessing climate risks and opportunities, entities must also disclose the amount and percentage of assets or business activities that are vulnerable to climate-related transition and physical risks, and which are aligned with climate-related opportunities.

Greater focus on transition plans
Reporting entities must outline how they plan to transition to a low-carbon economy and achieve set climate targets. This should also include current and anticipated changes to a company's business model, strategy, resource allocation and capital as a result of its exposure or vulnerability to climate change risks and opportunities.

Climate-related skills and competencies on your Board and within your management teams
Entities must disclose how the governance body(s) or individual(s) determine whether the appropriate skills and competencies are available or will be developed to oversee strategies designed to respond to climate-related risks and opportunities

While this may seem overwhelming for some, the standards include a proportionality principle which clarifies that the ISSB only expects companies to use reasonable and supportable information that is available without undue cost or effort and within consideration of its skills, capabilities and resources to fulfil the disclosure requirements.

Next steps

Companies globally welcomed the IFRS S1 and IFRS S2 standards because they consolidate many existing reporting frameworks in which they are already participating – both voluntarily and, increasingly, as mandated by governments and stock exchanges. Investors are also appreciative of the standards as they prioritise financial materiality instead of requiring double (social and environmental impact) materiality.

No matter where your company is on its climate disclosure and action journey, you should take the ISSB into account before you take your next steps. We recommend that you prepare ahead of potential mandatory ISSB disclosure requirements in your jurisdiction(s). Each jurisdiction will define the specific scope of companies that may need to comply with its disclosure requirements.

However, it is good practice for companies to start aligning with ISSB voluntarily, especially if you're looking to be an industry leader.

For companies who are at the beginning of their climate journey or not yet reporting against the TCFD, the best way to start is to review your readiness using the ISSB standards. This can help locate your alignment gaps and the results can be used as inputs for the development of a roadmap or holistic climate strategy.

For more advanced companies who are already familiar and aligned with the TCFD, you should focus on the key areas where the ISSB requires more extensive disclosure compared to the TCFD and update your sustainability planning accordingly.