Consortium provides prototype climate-related financial disclosure standards, following earlier pledge to collaborate.

By Paul A. Davies and Michael D. Green

A group of leading sustainability and integrated reporting organisations has published a paper addressing standards for reporting on enterprise value and presenting prototypes of climate-related financial disclosure standards (the Paper). The co-authors include the Carbon Disclosure Project (CDP), the Climate Disclosure Standard Board (CDSB), the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC), and the Sustainability Accounting Standards Board (SASB) (the Organisations). The Organisations released the paper on 18 December 2020, several months after pledging to collaborate to provide market guidance on sustainability standards.

The Paper’s publication comes amid numerous initiatives seeking to streamline environmental, social, and governance (ESG) disclosure. These initiatives aim to address the connection between ESG-related concerns, on the one hand, and value creation and financial risks, on the other hand. (Additional details on these initiatives can be found in this post.)

The Paper

The Paper aims to “demonstrate how certain components of [the Group’s] current frameworks and standards, along with the recommendations set out by the Task Force on Climate-related Financial Disclosure (TCFD) can be used together to provide a starting point for the development of global standards for sustainability-related financial disclosures”. The Group suggests that, although not directly involved in the prototype development exercise, the International Financial Reporting Standards Foundation (the IFRS Foundation) can use the Paper to broaden its role beyond setting financial reporting standards, a matter on which the Foundation has just closed a consultation.

The Paper also emphasises the distinction between sustainability-related financial disclosure and sustainability reporting, with a focus on the former. Although the two concepts are viewed as being interrelated, sustainability reporting is “designed to illuminate a company’s most significant impacts on the environment, people and economy”. In contrast, sustainability-related financial disclosure focuses on a narrower range of sustainability matters that are considered sufficiently likely to influence enterprise value.

The Standards Prototypes

The Paper discusses two distinct Standards: a Sustainability-related Financial Disclosure Presentation Standard and a Sustainability-related Financial Disclosure Standard. While the former prescribes the basis for presentation of the relevant information, so as to ensure comparability of data sets, the latter sets out the disclosure requirements that are to be used by management for the purpose of providing the relevant information. In the view of the Organisations involved, the International Accounting Standards Board’s Conceptual Framework for Financial Reporting can be smoothly adapted for sustainability-related financial disclosure.

The Sustainability-related Financial Disclosure Presentation Standard (The Presentation Standard)

Similar to the way that the IFRS Foundation standardises presentation of the financial information, “sustainability-related financial information would benefit from a common approach to presentation that enables comparability across reporting periods and with the sustainability-related financial information reported by other entities”. Additionally, the Paper regards the four pillars of the TCFD (namely Governance, Strategy, Risk Management, and Metrics and Targets) as a useful structure for organising the presentation of climate-related financial information. Accordingly, the Paper recommends that the prototype of the Presentation Standard follow this format.

The Sustainability-related Financial Disclosure Standard (The Disclosure Standard)

The Disclosure Standard is meant to be interpreted in conjunction with the Presentation Standard, and should also be aligned with the TCFD. It should focus on the following information categories — for which the Paper details the type of content to be disclosed, so as to ensure transparency of key metrics.

  • Governance: The objective is for the primary users of the information being disclosed under the Disclosure Standard (the primary users) to understand the governance processes, controls, and procedures. The disclosure should describe the board and the management’s role in assessing and managing climate-related risks and opportunities. It should also describe how the board holds management accountable for the implementation of climate-related policies, strategies, and targets (including whether such performance metrics are incorporated into remuneration policies). This category should also discuss board skills and competencies needed to govern and manage the strategic       response to climate-related risks and opportunities.
  • Strategy, business model, and outlook: The objective is to allow the primary users to understand the way in which the implications of climate-related risks and opportunities are integrated into the entity’s strategy, as well as the possible implications for the entity’s business model. The disclosure should describe climate-related risks and opportunities that may enhance, threaten, or change the entity’s business model/strategy. It should also describe how such risks and opportunities impact the entity’s decisions and plans, as well as the entity’s general resilience in the face of such scenarios.
  • Risk management: The objective is to enable the primary users to understand how climate-related risks are identified and managed. Entities should describe how they assess such risks; how they assess the impact of such risks; the policies, objectives, activities, and processes they use to manage climate-related risks; and whether they ultimately integrate such risks into the organisation’s overall risk management.
  • Metrics and targets: The aim of this section is to help the primary user understand the metrics and targets used to assess and manage climate-related risks and opportunities. The entity should disclose cross-industry and industry-specific matters. For each matter, the entity should disclose the metrics used to measure and manage climate-related risks and opportunities, metrics that reflect the impact of such risks and opportunities on the entity’s financial performance/position, and targets that management sets to mitigate or adapt to climate-change related risks. The section should also describe the methodologies used to calculate or estimate metrics and targets.

By providing this information, the Disclosure Standard aims to shed light on:

  • The nature, type, and extent of risks and opportunities arising from climate change, to which a certain entity is exposed.
  • The impact of climate-related risks and opportunities on the entity’s financial position and performance.
  • The impact that the management’s use of resources has on the entity’s response to the opportunities and risks of climate change.
  • The company’s capacity to adapt its business model and operations to manage climate-related risks and opportunities.

The Paper was also accompanied by a webinar, where the Organisations’ leaders further discussed next steps. Of note is the Organisations’ reconfirmed commitment to collaborate with the IFRS Foundation. However, in the view of the Organisations involved, the IFRS Foundation would first need to assess the responses to its newly closed consultation and decide on threshold questions, such as the role the IFRS Foundation should play in sustainability-related reporting, the target that the IFRS Foundation should seek to achieve and the definition of materiality that should be used. The Organisations noted that they are also keen to collaborate with the EU, but they consider that the EU must first fully develop and enunciate its own stance on climate-related disclosure.

In addition, the Organisations’ leaders emphasised that any comprehensive reporting system will serve two goals: driving systemic, regulatory change and also providing stakeholders with the necessary information they need in order for their investments to effect change. Nonetheless, the Organisations highlighted their view that none of these ambitions can be achieved unless disclosure is made mandatory; in the Organisations’ view, it is no longer possible to rely on companies making voluntary disclosures.

Latham & Watkins will continue to monitor developments in this area.

This post was written with the assistance of Sabina Aionesei in the London office of Latham & Watkins.