Establishment of the Council for International Sustainability Standards, a step forward in defining ESG indices

Author: Laura Ciobanu, Manager, Climate Change and Sustainability, EY Romania

The Foundation for International Financial Reporting Standards (IFRS Foundation) has officially announced the establishment of the International Sustainability Standards Board (ISSB) at the 2021 UN Climate Change Conference (COP26) in Glasgow. This event marks one of the most important developments in recent decades in the field of accounting and financial reporting. The ISSB's mission will be to act swiftly to establish a comprehensive set of sustainability standards, to recognize the dynamic nature of materiality and the need for local adaptation of additional standards.

Given that there are currently around 600 Environmental, Social and Corporate Governance (ESG) reporting standards, the ISSB intends to make ESG reporting standards consistent and comparable by developing the core requirements from global level, for sustainability reporting standards.

The new board will operate in parallel with the International Accounting Standards Board (IASB) of the IFRS Foundation, the body that sets the required accounting standards for most listed companies in more than 140 jurisdictions.

Currently, two prototype standards for reporting provide the ISSB with a good starting point:

The prototype climate reporting standard, built on the recommendations of the Task Force on Climate Financial Reporting (TCFD), would require organizations to provide information to enable users to assess climate risks and opportunities in relation to governance, strategy and management. a company’s risks, and to present indicators and targets related to climate risks and opportunities that ensure coherence and comparability across all markets.

The general requirements prototype standard provides guidance for reporting other important ESG issues that affect the value of the company.

According to a recent study by asset managers by the International Monetary Fund (IMF), the lack of climate data, especially prospective data, is considered the most pressing issue to be addressed in order to facilitate investments associated with the transition to a green economy. In this context, the IMF calls on policy makers to "urgently strengthen the climate information architecture for both companies and investment funds" in order to harmonize investment flows with climate goals. The ISSB has the potential to become a key pillar of this architecture as well as providing relevant and useful ESG information in decision making.

Given that the process of global standardization in the field of sustainability is set in motion, it is essential that three issues remain on the public agenda:

1. Specific standards of corporate and social governance

As a first step, the prototype general requirements standard will provide companies, for an interim period, with guidance on publishing information on other ESG issues. However, in the medium term, the same degree of stringency is needed in the case of a wider range of sustainability issues, including those associated with workers and human rights. The need to act on these issues has become painfully clear in the context of the pandemic, and research by the United Nations Conference on Trade and Development (UNCTAD) has illustrated how the pandemic has reversed years of progress towards sustainable development goals.

At the same time, there have been obligations to report social and governance factors around the world. These include the Sustainability Information Reporting (CSRD) Directive, which will require EU companies (and non-EU companies) to report on human rights, among other information on the work.

In the US, the Securities and Exchange Commission (SEC) recently approved new listing rules related to reporting and diversity of boards for companies listed on the NASDAQ market and is developing a set of mandatory human capital reporting rules that could It includes a number of indicators, including staff turnover, skills and development, remuneration, benefits, demographics, including labor force diversity, and health and safety.

In India, the top 1,000 listed companies will soon be required to submit a report on sustainability and business responsibility, which will include information on a wide range of ESG factors, including social security benefits and average wages, gender diversity and resource consumption.

Although this development reflects the desire of stakeholders to have more information on ESG risks, it also increases the risk of fragmentation and the need for a greater degree of coherence and comparability.

2. The distinction between the value-based approach and the value-based approach will be blurred over time

The ISSB has announced that it will develop sustainability reporting standards to address the impact of companies on sustainability issues that are relevant in estimating the value of the enterprise (as determined by market players) and in making business decisions. This approach is closely linked to the status of the IFRS Foundation and to the “traditional” interpretation of the concept of materiality.

The concept of materiality has been the basis for different approaches to ESG reporting. While many jurisdictions have taken a business-based approach, others, the most notable of which is the European Union, have favored a broader approach based on social value (including the impact that companies have on people and the environment). However, what is often overlooked in materiality debates is that there is a dynamic distinction between a value-based approach and a value-based approach, which will inevitably evolve over time, fading as the links become clearer. between external factors and direct or indirect effects on future cash flows.

Investors are aware that as social and financial values ​​converge, an organization's effect on its environment (and vice versa) may not have a direct impact on current cash flow, but may significantly affect the entity's long-term value and viability. . It will be increasingly difficult to distinguish between what is relevant only to investors and what is relevant only to other decision makers. As standards begin to take shape, companies should monitor developments at both the ISSB and their jurisdictions.

3. The balance between basic, global requirements and the need for local adaptation

Following the recent summit in Rome, G20 leaders welcomed the IFRS Foundation's efforts to develop basic, global requirements for sustainability reporting standards. At the same time, many G20 Member States have taken steps to implement sustainability reporting obligations, some of which will be aligned with the ISSB process and others specific to that jurisdiction.

In the European Union, a jurisdiction that has expressed a commitment to support and contribute to global efforts in this area, including the IFRS Foundation, policy makers consider reporting a mechanism for behavior change. The CSRD is a key element of the European Green Pact, and the European Commission's policy initiative is set to make Europe climate-neutral by 2050.

In conclusion, sustainability reporting is not just about transparency, it is also about transformation. The launch of the ISSB is further evidence of the need for global standards on sustainability issues, including those related to climate risks. At the same time, it is a major step towards obtaining relevant information, useful for making decisions on sustainability by market players, that is comparable between industries and jurisdictions. These approaches will have a significant impact on a company, both strategically and operationally, bringing new challenges and even more opportunities. Company directors and members of the audit committee must act now if they are to benefit fully from this journey.