IFRS S1 and IFRS S2 sustainability standards: the minimum that lawyers and sustainability profession
Luciana Vianna Pereira
The month of June brought us the new sustainability reporting standards that promise to consolidate the matter and become the world's leading reporting standards.
IFRS Standards S1 and IFRS S2 were developed by the ISSB (International Sustainability Standards Board), the sustainability line of IFRS (International Financial Reporting Standards) and the sister entity to the long-standing and well-known IASB (International Accounting Standards Board).
Going back in history, the ISSB came into existence as early as 2021 with the goal of creating a standard that could be used globally, a demand that had long existed in the ESG market, especially by investors, fund managers, and the reporting companies themselves, due to the need to promote comparability between reports from different companies and in different countries. Comparability is only possible through unified standards and methodologies.
IFRS is the international organization responsible for the most widely accepted accounting standards globally and its strength in the initiative to create the ISSB was quickly proven, by the several statements of support presented by the directors of the main global associations on the subject, such as GRI - Global Reporting Standards, CDB - Carbon Disclosure Project, TCFD - Taskforce on Climate-related Financial Disclosures, TNFD - Taskforce on Nature-related Financial Disclosures, besides the incorporation, in mid 2022, of two giant international associations in the sustainability standards market: the Climate Disclosure Standards Board (CDSB) and the Value Reporting Foundation (VRF), which already housed the widely known and used SASB standards.
The initiative was also supported by the International Organization of Securities Commissions (IOSCO), the Financial Stability Board, the G20, and the G7 leaders.
In early 2022, IFRS released drafts of what would be IFRS S1 - General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2 - Climate-related Disclosures, seeking standardization of disclosures regarding climate impacts and sustainability impacts.
In June 2023, after an extensive public consultation and after reviewing hundreds of comments received from the market, IFRS S1 and IFRS S2 were released, forming a very relevant framework for ESG or sustainability reporting.
| An Integration between Sustainability and Financial Disclosures
The integration between accounting and sustainability is at the root of the new standards. Sustainability reports, prepared under IFRS S1 and IFRS S2, must necessarily follow the conceptual framework applicable to IASB accounting standards, already accepted and recognized by the legislation of most countries in the world, and the intention is that the disclosure of sustainability information is compatible and meets the needs of the same recipients of the financial statements.
| Focus on the impacts of sustainability on finances
IFRS S1 and IFRS S2 are aimed at for-profit companies, which are required to disclose information about their sustainability risks and opportunities that are considered useful to primary users of financial statements in their decision whether or not to provide resources to the company. In other words, IFRS reports must contain information that may reasonably impact the company's cash flow, access to financing, or cost of capital in the short, medium, and long term. The information must be complete, neutral, and correct.
The focus of IFRS standards is clearly inward looking and should allow the investor to assess the effects of sustainability-related risks and opportunities on the company's financial position, performance, and cash flow in the period under review, as well as how the projection of sustainability risks and opportunities will affect these three elements, as per the company's financial planning.
The information to be disclosed should be both quantitative and qualitative. From the quantitative point of view, it should include information on how sustainability risks and opportunities may require material adjustment for the following fiscal year, how the company's financial position may be altered because of a sustainability risk or opportunity in the short, medium and long term, the investment projections and financial availability, forms of financing for the implementation of strategies related to the theme.
Sustainability reports prepared under IFRS S1 standards will be considered adequately presented if they disclose material information about sustainability risks and opportunities that could reasonably impact the company's results and if they follow the principles of comparability, verifiability, timeliness, and understandability.
Another very important point of IFRS S1 is that it directly absorbs the SASB sustainability standards, requiring companies to reference and consider the applicability of SASB topics by industry and business sector in materiality assessment and preparation of their sustainability reports. In the same vein, IFRS S1 integrates the CDSB's water resources and biodiversity questionnaires.
IFRS thus leverages and integrates the SASB standards and the CDSB questionnaires for the materiality definitions of topics to be assessed by each company in each sector already mapped, although it allows companies to assess within the SASB disclosure topics and CDSB questionnaires which ones are actually material.
The definition of materiality approved by IFRS S1 is information that if omitted, misstated, or obscured, has the potential to reasonably influence the decision of users of that information in their decision, based on the company's reported financial statements: (a) to buy, sell, or hold equity or debt securities of the company; (b) to lend or extend credit to the company; (c) to exercise voting rights, or otherwise influence actions of the company's management that affect the use of the company's economic resources.
| Interoperability with GRI and the European Standard
Furthermore, in the absence of an IFRS standard for a specific topic, the company may also resort to other standards such as GRI and the European Sustainability Reporting Standard - ESRS in its decision can identify information that is relevant to the user's decision making and that has represented or represents a sustainability opportunity or risk.
On the other hand, IFRS S2 complements IFRS S1, specifically with regard to climate risks and opportunities, and if a company determines that climate risks and opportunities could reasonably affect the company's financial results, it is required to apply IFRS S2 when preparing its disclosures on such risks and opportunities.
In the case of IFRS S2, IFRS has not taken advantage of or referred to existing industry standards but has chosen to create industry standards and metrics specifically for physical and transitional weather risk. There are 68 industries covered, divided into 11 economic sectors, among them the financial sector, with specific volumes for fund managers and custodians, banks, insurance companies, investment banks, and broker and dealer companies. The industry guides are derived from the SASB Standards and provide parameters to help companies identify risks and opportunities when applying IFRS S2. They are aligned with the TCFD Guides on Metrics, Objectives and Transition Plans.
Furthermore, IFRS S2 also follows and includes definitions on Scope 1, Scope 2, and Scope 3 reporting for greenhouse gas emissions, following the nomenclature and reporting requirements of the GHG Protocol, which, in fact, should be the guide for emissions inventory reporting under IFRS S2. IFRS S2, however, adds some requirements to the emission inventories, such as categories that a company should adopt when measuring Scope 3 emissions and inputs to be used for such measurements.
The IFRS Standards require the reporting of information on governance, strategy, risk management, and metrics and objectives, as well as the connections among these elements and between them and the information in the financial statements.
Individually, (i) regarding governance, the disclosures shall address the governance processes, controls and procedures the company adopts to monitor and manage the company's sustainability risks and opportunities; (ii) regarding strategy, the company's approach to managing sustainability risks and opportunities shall be informed; (iii) with regard to risk management, the processes the company uses to identify, assess, prioritize and monitor sustainability risks and opportunities in the short, medium and long term and the assessment of the likelihood of such risks and opportunities affecting the company's financial results; and (iv) with regard to metrics and objectives, the company's performance with respect to sustainability risks and opportunities must be included, including progress against the objectives set by the company or that it must meet under legal or regulatory obligations.
| Beyond the direct impacts, the value chain
It is also noteworthy that, following market trends, reporting should not only cover the direct risks of the activity performed by the company, but also the risks related to its value chain. In the case of IFRS S2, the reporting should cover the physical climate risks and also the transitional climate risks, i.e., those necessary to adapt to new laws, policies, technologies, and market changes aimed at a low-carbon economy, and include the direct risks arising from the activity (Scope 1), related to energy supply (Scope 2), and from the value chain (Scope 3).
With respect to the business model and value chain, companies should map and disclose where sustainability-related risks and opportunities are concentrated in the business model and value chain, with respect to geographical area, types of assets, company units, etc.
| For the first time, the trade-offs
Another interesting point is the requirement that companies report the trade-offs between sustainability-related risks and opportunities, in relation to their strategy and decision-making. Thus, companies are required to inform which points that generate risk and opportunity were considered in the expansion of economic activity to a certain location, for example, and how the decision was made and the trade-offs between the risks and opportunities mapped out. Information that, in Brazil, would typically be restricted to an EIA/RIMA or environmental study, is now part of the companies' sustainability financial reports.
It is important to note that the IFRS Standards do not require the preparation of a separate report, indicating that the information could integrate the management comments to the financial statements, integrating them, when the company so chooses. In fact, there is an express requirement that financially material sustainability disclosures be simultaneous and cover the same reporting period as the financial statements.
| And when will they be mandatory?
Finally, although the IASB standards are accepted in more than 140 countries, the binding and mandatory use of IFRS sustainability standards by these countries is not automatic. And, in this sense, IFRS has declared that it will now begin a phase of negotiation with countries, international bodies, and companies to adopt the sustainability standards.
In Brazil, the Federal Accounting Council has created a group to monitor the ISSB and has been working on the internalization of the standards, observing the particularities of the Brazilian legislation.
We have presented above some of the main points related to IFRS S1 and IFRS S2. In any case, it is important to follow the implementation of the standards over the next few years, especially considering that reporting, disclosure and transparency of information, and focus on the investor, shareholder, and lender are the essence of what ESG is all about.
It will also be quite interesting to follow the movement in Europe and the United States on this topic.