The government also introduced transition plan requirements for companies to meet the UK’s 2050 net zero target.
By Paul A. Davies, Michael D. Green, and James Bee
On 3 November 2021, the International Financial Reporting Standards (IFRS) Foundation Trustees Chair, Erkki Liikanen, announced the long-awaited formation of the International Sustainability Standards Board (ISSB). The ISSB aims to address to one of the key issues that companies and investors have faced in relation to environmental, social, and governance (ESG)-related corporate reporting over recent years — the wide variety of different reporting frameworks and a lack of an authoritative market leader.
Liikanen also announced the consolidation of two of the leading sustainability disclosure organisations into the ISSB by June 2022, and introduced prototype climate and general disclosure requirements (the Prototypes), which the ISSB will consider as the basis of its work.
The UK government has frequently welcomed the preparation for the ISSB in the past year, and has often indicated that the ISSB will form a key pillar of the UK’s future ESG reporting regime. The timing of COP26 has also (unsurprisingly) coincided with additional commitments from the UK government in relation to the UK’s non-financial reporting regime and new requirements for certain UK companies to publish net zero plans in the coming years.
Investors’ calls for greater availability of corporate information on ESG matters have been growing for several years. However, despite this increasing demand and the proliferation of a number of voluntary standards to which companies can report, no single, authoritative, and global standard has emerged — leading to fragmentation and a lack of comparability that has, at times, frustrated investors.
Given the IFRS Foundation’s success in creating an authoritative standard-setter in financial reporting (the International Accounting Standards Board, or IASB), stakeholders proposed that a similar body be set up in the context of non-financial/ESG reporting. A plethora of key institutions — including the G20 in June 2021 — championed the ISSB to take on this function, despite the fact it had not yet been formed, let alone produced any standards at that time.
With this announcement, the ISSB has committed to issue a set of IFRS Sustainability Disclosure Standards (Sustainability Disclosure Standards), which will provide investors with information on ESG metrics, such as a company’s impact on the climate, the natural environment, gender and ethnicity pay disparity, and other key ESG issues. The Sustainability Disclosure Standards will build on a number of the market-leading standards already in use (including those of the Sustainability Accounting Standards Board (SASB) and Climate Disclosure Standards Board (CDSB), and the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD)). Stakeholders hope that these standards will ensure credibility and offer practical utility for companies and investors.
The ISSB’s Chair will be based in Frankfurt, with additional ISSB offices located in Montreal, London, and San Francisco.
Consolidation of Other Entities
To help ensure that the ISSB’s formation leads to a single, authoritative set of ESG reporting standards rather than simply adding another acronym to the sustainability reporting world’s “alphabet soup”, it was confirmed that two of the current market leaders will be consolidated into the ISSB by June 2022. Those entities are the Value Reporting Foundation (VRF), which itself is the result of a 2021 consolidation between SASB and the Integrated Reporting Framework, and the CDSB. As noted above, the ISSB proposes to use the work of these entities to help inform its own standards, and to build on TCFD recommendations on climate reporting. Stakeholders will be particularly interested in the similarities and differences between the final set of standards and these pre-existing frameworks.
Publication of Prototype Standards
The Prototypes were released alongside the announcement of the ISSB to assist the ISSB in efficiently producing the Sustainability Disclosure Standards. The Prototypes, one focused on climate-related disclosure and the other on general sustainability-related financial information, were produced by the Technical Readiness Working Group (TRWG), a group that the IFRS Foundation formed specifically to undertake preparatory work for the ISSB, and which includes individuals from IASB, VRF, TCFD, CDSB, and the World Economic Forum.
The Prototypes provide recommendations for the ISSB to consider, which have not yet been subject to the full due process of the IFRS Foundation or the groups involved in its preparation. The Prototypes will not be consulted on, but they are expected to inform the ISSB’s initial work on the Sustainability Disclosure Standards, a first draft of which will be consulted on more fully in due course.
A key takeaway from the Prototypes is that materiality in the context of the general sustainability-related financial information standard is defined as information that “serves the needs of users and drives enterprise value”. This is aligned with the Conceptual Framework on Financial Reporting and does not appear to constitute “double materiality”, which is the preferred approach at the EU level.
The ISSB will commence work on a first draft of the Sustainability Disclosure Standards for consultation.
The UK Reaction
On 3 November 2021, the UK government joined 37 governments from six continents in welcoming the ISSB’s establishment. This support comes as no surprise, as the UK government (as discussed above) previously announced that the ISSB will play a key role in underpinning its proposed corporate ESG disclosure regime, and has been an enthusiastic supporter of the project since its inception. That disclosure regime took another step forward on 28 October 2021, when the UK government published its response to a consultation on climate-related financial disclosures by publicly quoted companies, large private companies, and LLPs.
The response confirmed that the UK government intends to legislate largely in line with the consultation document proposals, but with two changes. First, entities will be required to undertake scenario analysis, although this analysis may be quantitative or qualitative. Second, the disclosure requirements will be even closer the TCFD recommendations than was proposed at consultation stage. The current proposals cover solely climate-related information, and not the wider range of ESG-related disclosure requirements.
The draft regulations for companies (with those for LLPs to follow) have now been published and are awaiting parliamentary approval. The UK government intends that the regulations will come into effect for both companies and LLPs on 6 April 2022.
Net Zero Transition Plans
On 3 November 2021, UK Chancellor Rishi Sunak announced that large UK companies and financial institutions will be required by 2023 to demonstrate how they intend to move their businesses to a low-carbon future in line with the UK’s 2050 net zero target. Firms will set their own transition plans, which will not be mandatory or legally enforceable, but will need to include targets to reduce greenhouse gas emissions and the steps that firms plan to take to assist in those reductions.
A taskforce composed of industry leaders, regulators, academics, and other groups will set a “gold standard” for the transition plans, but Mr Sunak confirmed that the market will determine the credibility of individual plans.
The ultimate impact of the requirement to publish these plans will be seen in due course, and a number of institutions that would be subject to the new rule have already implemented such plans voluntarily, but the additional transparency will hopefully assist investors in identifying companies that are well prepared (and those that are less well prepared) to thrive during the transition to net zero.
The announcement of the ISSB and the draft legislation on the UK’s climate-related disclosure regime highlighted an important week for the UK’s attempt to increase investor visibility of UK companies’ resilience to climate change and the changing economy.
Latham & Watkins will continue to monitor developments in this area.
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