ISSB’s Standards are a Major Boost for Market Transparency on Sustainability

Published: July 14, 2023

The recent launch of the International Sustainability Standards Board’s (ISSB’s) two standards for sustainability-related financial reporting – covering general requirements (IFRS S1) and climate-related disclosures (IFRS S2), respectively – is a major milestone in raising the status and promoting the standardisation of sustainability-related financial reporting globally.

The ISSB has already received support from bodies such as the G7 and several jurisdictions, including Australia, Japan and the UK, are consulting on how to integrate ISSB into their mandatory reporting regimes, while the Hong Kong Stock Exchange says it will phase in mandatory ISSB-aligned reporting from next year.

At Sustainable Fitch, we expect the standards to become the de facto global baseline amid growing demand for a solution to the current patchwork of disclosure rules and the uneven quality of reported information. Uptake and adoption are therefore likely to be strong. As the standards become more widely used, we anticipate steady improvements in the consistency and comparability of financially material sustainability and climate-related information available to investors. Greater transparency will, in turn, aid the pricing-in of climate and sustainability-related risks, increase visibility around opportunities – potentially hastening the shift in capital towards greener assets – and bolstering investors’ ability to engage with companies on their transition plans.

More detail and consistency

The ISSB sets out detailed requirements to report climate and sustainability-related risks, opportunities, and dependencies that are relevant for investors to assess enterprise value. In particular, S2 requires entities to set out – and preferably quantify – their exposures to physical and transition climate risks, and their systems to manage climate-related risks and opportunities over the short, medium, and long term. It requires entities to explain how their transition plans fit within their overall strategy, identify relevant targets (including baselines, units and whether they have been validated by a third party), the role of offsets in achieving these targets (including the type of credit and who verified them), and whether and how performance is tied to executive remuneration.

On carbon emissions, the standard requires entities to report Scope 1, 2 and 3 emissions (the latter by category and including financed emissions) in accordance with the GHG [greenhouse gas] Protocol unless a jurisdiction specifies another accounting system. Transparency in the use of climate scenarios, which are increasingly relied on by investors, is also required, including specifying the named scenarios, time horizons, and underlying analytical assumptions.

Interoperability benefits, but implementation challenges ahead

The standards are designed to work with existing frameworks and systems. They build on and extend the Task Force for Climate-related Financial Disclosures’ (TCFD) recommended disclosures and adopts the TCFD’s ‘four pillars’ structure – governance, strategy, risk management, and metrics targets – which is already familiar to market participants and are reflected in many jurisdictions’ mandatory reporting rules. The ISSB has also integrated the Sustainability Accounting Standards Board (SASB), whose 77 industry standards provide the primary reference for determining the materiality of information for specific industries.

The SASB standards will also form the basis for future industry-specific reporting standards (topic-specific standards, e.g. on nature, are also planned). The SASB’s well-entrenched position in the US could assist ISSB adoption there even though US entities follow generally accepted accounting principles (GAAP) accounting rules, not those of the International Financial Reporting Standards (IFRS), which is the ISSB’s sister standard-setting board.

The ISSB has acknowledged that compliance could prove challenging for many reporting entities due to capacity and data issues, particularly for entities with less experience disclosing sustainability-related information. As a result, it announced a limited set of optional exemptions that will apply during the first year. For example, reporting entities can prioritise climate-related information (rather than all sustainability-related issues), do not need to include Scope 3 emissions and do not need to use the GHG Protocol to measure their emissions if they are currently using a different system. They can also publish ISSB disclosures later than their main financial statements, e.g. with half-year results, but thereafter sustainability-related disclosures will need to be included with an entity’s main financial reports.

However, even with these exemptions, many entities are likely to struggle with the levels of granularity required by the ISSB, particularly in such regions as Asia Pacific and North America, where the proportion of companies whose reporting aligns with TCFD is lower than in Europe. SMEs, which generally lack capacity for detailed sustainability reporting, may find developing these capabilities becomes necessary for tapping certain sources of financing as the ISSB becomes entrenched and expected by investors.

Entities within the scope of mandatory regimes that also require them to disclose their impact, i.e. double materiality – notably the European Sustainability Reporting Standards (ESRS) – face the prospect of additional costs and reporting burdens.