Progress in Standardizing Voluntary ESG and Sustainability Reporting

Key Highlights

• On June 26, 2023, the International Sustainability Standards Board (“ISSB”) published its inaugural standards for sustainability and environmental, social and governance (“ESG”) related disclosure: IFRS S1 General Requirements for Disclosure of Sustainability-Related Financial Information (“IFRS S1”) and IFRS S2 Climate-related Disclosures (“IFRS S2” and together with IFRS S1, the “Standards”). The Standards were introduced to help simplify the ESG reporting landscape, which has long been criticized for being overly complex.
• IFRS S1 requires disclosure of all material sustainability-related risks and opportunities that could affect an entity’s prospects.
• IFRS S2 requires disclosure of all climate-related risks and opportunities that could affect an entity’s prospects and that could be useful to primary users of general-purpose financial reports in deciding whether to provide resources, financial or otherwise, to the entity.
• The Standards come into force on January 1, 2024, with certain transition relief for the first annual reporting period. Entities looking to comply with the Standards will need to disclose any sustainability- and climate-related risks, and opportunities identified in respect of the third quarter or entirety of 2023.
• This article provides an overview of the key components of the Standards, as well as the general accompanying guidance and industry-based guidance released alongside the Standards. We also discuss the implications for Canadian businesses seeking to voluntarily disclose their ESG performance.

On June 26, 2023, the ISSB published its long-awaited Standards for sustainability and ESG-related disclosure: IFRS S1 and IFRS S2. Drafts of the proposed Standards were published in March 2022, and were followed by a 120-day consultation period, during which more than 1,400 comment letters were received from private corporations, academic institutions, accounting firms, investors, policy makers and regulators, public interest organizations and standard setters across the globe.^[1]

The publication of the Standards is a key step towards addressing one of the primary criticisms of ESG reporting: that it is overly complex and difficult to comply with. More than a dozen ESG and sustainability standards, principles and frameworks have been launched to date, including those developed by the Global Reporting Initiative, the Sustainability Accounting Standards Board (the “SASB”), the Climate Disclosure Standards Board (the “CDSB”), the International Integrated Reporting Council, and the Task Force on Climate-Related Financial Disclosures (the “TCFD”).

Many entities have struggled with choosing the appropriate framework for their business and industry, and investors have lacked a consistent framework through which an entity’s ESG performance can be evaluated individually and against the entity’s peers. As a result, it has been argued by many that the fragmented ESG reporting landscape hindered the ability to communicate and understand value.^[2]

Background

The ISSB was created in November 2021 at the United Nations Climate Change Conference (otherwise known as COP26) by the International Financial Reporting Standards Foundation. One of the primary mandates of the ISSB was to develop a global baseline for ESG disclosures and simultaneously meet capital market demands. The creation of the ISSB was met with widespread global support from the G7, G20 and more than 40 Central Bank Governors. So far, the Standards have been met with similar global approval, specifically from the World Business Council for Sustainable Development, the World Economic Fund, the International Organization of Securities Commissions, and the Financial Stability Board.

Internationally, the push towards consolidation in the ESG reporting landscape remains strong. On July 13, 2023, the Financial Stability Board, which developed the TCFD framework, announced that responsibility for monitoring progress on TCFD disclosures will transfer to the ISSB in 2024. On July 25, 2023, the International Organization of Securities Commissions publicly endorsed the Standards, and called upon its 130 members (which includes the provinces and territories of Canada) to consider the incorporation of the Standards into their respective regulatory frameworks.^[3] As the ISSB assumes a more prominent role in the ESG reporting landscape, and even as peer organizations move to report under the Standards, an entity’s investors and other external stakeholders might expect that entities will report on their ESG performance in accordance with the Standards.

At a domestic level, it was previously noted that Canada has been a strong supporter of the ISSB and the development of the Standards. The Canadian Sustainability Standards Board (“CSSB”) was formed in April 2023 to “support the uptake of ISSB standards in Canada, highlight key issues in the Canadian context and facilitate interoperability between ISSB standards and any forthcoming CSSB standards.”^[4] Accordingly, Canadian companies are encouraged to pay attention to guidance developed by the CSSB with respect to the applicability and expectations surrounding the Standards in the Canadian market.

Furthermore, the Canadian Securities Administrators (the “CSA”) has noted the importance of co-operation between the ISSB and provincial securities regulators across jurisdictions, and has expressed a commitment to adopt the Standards with any necessary modifications as appropriate in the Canadian context. Notably, the Standards could affect the disclosure requirements set out in the CSA’s proposed National Instrument 51-107 Disclosure of Climate-related Matters (“NI 51-107”),^[5] which is yet to be finalized. However, as the proposed NI 51-107 was also developed in accordance with the TCFD framework, the Standards may not affect the proposed structure of NI 51-107 too extensively.

In this article, we provide an overview of the key components of the Standards, as well as the general accompanying guidance^[6] (the “Accompanying Guidance”) and industry-based guidance (the “Industry-Based Guidance”) released alongside the Standards. We will also discuss the implications for Canadian businesses seeking to voluntarily disclose their ESG performance.

Overview of Standards, Accompanying Guidance and Industry-Based Guidance

The Standards guide disclosure of sustainability- and climate-related information that affects an entity’s financial performance and outlook. The Standards align closely with the TCFD framework, with its disclosure requirements structured around the TCFD’s four key pillars: (1) governance, (2) strategy, (3) risk management, and (4) metrics and targets (the “Four Pillars”).

IFRS S1 – General Requirements for Disclosure of Sustainability-Related Financial Information

IFRS S1 requires entities to disclose all material sustainability-related risks and opportunities that could affect the entity’s prospects, specifically its cash flows, access to finance or cost of capital over short, medium, and long terms.

IFRS S1 sets out three conceptual foundations for the disclosure of sustainability-related financial information, specifically:

1. Fair Presentation: The information must be presented fairly, such that any representations made by the entity must be complete, neutral, accurate, verifiable, timely, understandable and comparable to any representations made previously by the entity or to any representations provided by other entities in the same industry;
2. Materiality: Only material sustainability-related financial information must be presented. Information is considered material if its omission, misstatement or obscuration would influence an individual’s decision-making; and
3. Connectivity: The information must be presented in such a manner that allows users of the general-purpose financial reports (in which the sustainability-related information is being disclosed) to understand the connections between: (a) the sustainability-related risks and opportunities, and the items they affect; (b) the entity’s sustainability-related governance, strategy, risk management, and metrics and targets disclosures; and (c) the sustainability-related financial disclosures and other general-purpose financial reports.

For each of the Four Pillars, IFRS S1 requires that entities disclose the following:

1. Governance
   1. Information about the governance body(ies) (i.e., board of directors, committees or equivalent body charged with governance) or individual(s) responsible for the oversight of sustainability-related risks and opportunities.^[7]
   2. Information about management’s role in the governance process, controls and procedures used to monitor, manage and oversee sustainability-related risks and opportunities.^[8]
2. Strategy
   1. Information about the sustainability-related risks and opportunities that could reasonably be expected to affect the entity’s prospects and the time horizons (i.e., short, medium or long term) in which these impacts could occur (including a discussion on how the entity defines short, medium and long term).
   2. Information about the impacts of any sustainability-related risks and opportunities on the entity’s business model and value chain, and where those impacts are concentrated.
   3. Information about the impacts of any sustainability-related risks and opportunities on the entity’s overall decision-making, which includes a discussion on how the entity responds to, or plans to respond to, such risks and opportunities, and any “trade-offs” the entity made when identifying sustainability-related risks and opportunities (e.g., a discussion of whether the potential environmental impact of an entity’s operational facility was outweighed by the employment opportunities provided by the facility).
   4. Quantitative and qualitative information about the current and anticipated effects of sustainability-related risks and opportunities on an entity’s financial position, financial performance and cash flow, and the manner in which the entity’s financial performance will be managed over the short, medium, and long term when taking into account these sustainability-related risks and opportunities.
3. Risk Management
   1. Information about the processes and related policies the entity uses to identify, assess, prioritize and monitor sustainability-related risks and opportunities, and the extent to which these processes and policies are integrated into the entity’s overall risk management process.
   2. Information regarding the inputs and parameters the entity uses in these sustainability-related risk management procedures, the use of any scenario analyses, the manner in which the entity assesses the nature, likelihood and magnitude of the effects of sustainability-related risks, and any developments in any of the requisite processes or policies implemented by the entity.
4. Metrics and Targets
   1. For each sustainability-related risk and opportunity that could reasonably be expected to affect the entity’s prospects, entities must disclose the metrics used by the entity to measure and monitor that sustainability-related risk or opportunity and the progress the entity has made in achieving applicable targets (either set by the entity itself, by law or by regulation).
   2. Where entities have developed their own metrics to monitor performance and progress, entities must disclose how the metric is defined, whether the metric is absolute or expressed in relation to another metric or qualitative measure, whether the metric is validated by a third party (and if so, which party), the method used to calculate the metric and the inputs to the calculation, and any limitations or significant assumptions made in respect of the methodology.

The ISSB also directs entities to consider the standards developed by the SASB (the “SASB Standards”) when identifying the appropriate sustainability-related risks and opportunities that could reasonably be expected to affect the entity’s prospects, as the SASB Standards are organized by industry and contain useful industry-specific information for reporting on ESG performance. The ISSB also encourages entities to refer to the framework developed by the CDSB (the “CDSB Framework”) to identify applicable water- and biodiversity-related risks and opportunities that may be applicable to an entity’s operations. The Accompanying Guidance, which illustrates aspects of IFRS S1 but does not provide interpretive guidance, provides further detail regarding the extent to which the SASB Standards and CDSB Framework may be used to identify appropriate sustainability-related risks and opportunities.

IFRS S2 – Climate-related Disclosures

IFRS S2 requires disclosure of all climate-related risks and opportunities that could affect an entity’s prospects (specifically, its cash flows, access to finance, or cost of capital over short, medium and long terms), and which could be useful to primary users of general-purpose financial reports in deciding whether to provide resources, financial or otherwise, to the entity.

Building off the categorization in the TCFD framework, IFRS S2 also identifies two types of climate-related risks:

1. Physical Risks: Risks derived from climate change that are either event-driven (acute physical risks) or from longer-term shifts in climatic patterns (chronic physical risks).
2. Transition Risks: Risks arising from the transition to a lower-carbon economy.

IFRS S2 also points to the SASB Framework as a helpful tool for identifying climate-related risks and opportunities, and accordingly, the Accompanying Guidance for IFRS S2 provides helpful insight on the manner in which the SASB Framework can be utilized to identify such risks and opportunities.

IFRS S2 requires entities to disclose information pertaining to climate-related risks and opportunities under the Four Pillars in the same manner as that set out in IFRS S1, and the broad principles of fair presentation, materiality and connectivity apply. There are, however, certain variances between the information entities are required to disclose under IFRS S1 and IFRS S2, which are set out below:

1. Governance: To the extent disclosure under IFRS S2 would overlap with the information disclosed under IFRS S1 (i.e., to the extent that a discussion of the governance  of the entity’s sustainability-related risks encompasses the entity’s climate-related risks), there is no need to disclose any additional information under IFRS S2.
2. Strategy: Entities must use climate-related scenario analyses to assess the entity’s climate resilience.^[9]
3. Metrics and Targets: Entities must disclose climate-specific metrics, including:
   1. greenhouse gas (“GHG”) emissions, including Scope 1 GHG emissions (direct GHG emissions that occur from sources owned or controlled by the entity), Scope 2 GHG emissions (indirect GHG emissions from the generation of purchased or acquired electricity, steam, heating or cooling consumed by an entity) and Scope 3 GHG emissions (all other indirect GHG emissions not included in Scope 2 GHG emissions), alongside a description of the metrics used to measure GHG emissions;
   2. climate-related transition risks, physical risks and opportunities (specifically, the amount and percentage of assets and business activities vulnerable to such risks and aligned with such opportunities);
   3. climate-related targets (including the metric used to set the target, the objective of the target, the part of the entity to which the target applies, the period over which the target applies, the base period from which progress is measured, any milestones and interim targets, the impact of recent international agreements on climate change and, if the target is quantitative, whether it is an absolute target or intensity target);
   4. the entity’s planned use of carbon credits, including the extent to which and how achieving any net GHG emissions target relies on the use of carbon credits, any third-party schemes used to verify or certify the carbon credits, and a description of the type of carbon credit;
   5. internal carbon prices (specifically, an explanation of whether and how the entity is applying a carbon price in decision-making, and the price for each metric tonne of GHG emissions the entity uses to assess the costs of its GHG emissions); and
   6. remuneration (specifically, a description of whether, how and the extent to which climate-related considerations are factored into executive remuneration).

Industry-Based Guidance

Following the industry-based approach taken by the SASB and Global Reporting Initiative, the ISSB developed Industry-Based Guidance for entities operating in the consumer goods, extractives and minerals processing, financials, food and beverage, health-care, infrastructure, renewable resources and alternative energy, resource transformation, services, technology and communications, and transportation sectors. Inherent in the Industry-Based Guidance is the understanding that the content of an entity’s sustainability-related financial disclosures will vary based on the operational realities of its applicable industry. Accordingly, entities looking to report under the Standards are encouraged to consider the guidance set out in the applicable Industry-Based Guidance^[10] when designing their information-gathering procedures and compiling their reports.

Reporting Under the Standards: Considerations for Canadian Companies

Who Reports Under the Standards?

The ISSB has noted that profit-oriented entities (which include public and private sector businesses) and not-for-profit enterprises in the private and public sectors may apply the Standards. However, not-for-profit entities may need to amend the descriptions used for certain items in the Standards that are inapplicable, given their customary forms of financial reporting.

Location of Disclosures

The ISSB notes that the information that needs to be disclosed under the Standards (the “ISSB Disclosures”) should form part of the reporting entity’s general-purpose financial reports. The benefits of this approach are clear: in housing the ISSB Disclosures in an entity’s general-purpose financial reports, any user of the financial reports will be provided with a contextual understanding of the entity’s sustainability- and climate-related risks and opportunities, as opposed to an isolated one. However, an entity may prefer to present their ISSB Disclosures in a separate sustainability report, with the appropriate references to the entity’s applicable financial documents as required by the Standards.

In a Canadian context, entities may choose to house the ISSB Disclosures in their quarterly and annual financial statements, and management’s discussion and analysis (“MD&A”). For Canadian public companies in particular, Form 51-102F1 Management’s Discussion & Analysis and Form 51-102F2 Annual Information Form require issuers to disclose any material information that may influence an investor’s decision to purchase the issuer’s securities. Additionally, National Policy 58-201 Corporate Governance Guidelines, National Instrument 52-110 Audit Committees and National Instrument 52-109 Certification of Disclosure in Issuers’ Annual and Interim Filings provide that non-venture issuers must adopt and disclose certain corporate governance mechanisms and internal controls and procedures to identify and manage an entity’s risks and opportunities. Accordingly, the identification and discussion of any applicable sustainability and climate-related risks in accordance with the ISSB Standards might be a logical inclusion for issuers preparing their MD&As, annual information forms or other applicable disclosures in accordance with these instruments.

No Obligation to Report

The Standards are a voluntary reporting framework and there is currently no obligation for any entity to publish any ISSB Disclosures. However, the adoption of the Standards in certain legal instruments that require ESG-related disclosure (such as NI 51-107) may mean that the adherence to the Standards will be indirectly legally required when they come into force.

If an entity chooses to publish any sustainability-related disclosures in accordance with the Standards, it must provide an explicit and unreserved statement of compliance in its disclosures. However, there is no penalty specified for failing to adhere to the Standards.

Reporting Period

The Standards will come into force on January 1, 2024, with certain transition reliefs for the first annual reporting period. As the ISSB Disclosures should cover the same reporting period as the related financial report in which they are housed, entities looking to comply with the Standards will need to disclose any sustainability- and climate-related risks and opportunities identified in respect of the third quarter or entirety of 2023.

During the first annual reporting period (the “Transition Period”), entities are permitted to publish their ISSB Disclosures after publishing the related financial statements (as opposed to integrating these disclosures in the financial statements) and to comply with IFRS S2 only. Additionally, during the Transition Period, companies are exempt from disclosing Scope 3 GHG emissions and providing comparative information in respect of previous reporting periods.

Preparing to Report

Some Canadian entities already voluntarily disclose their ESG performance – whether to meet investor expectations, attract further investment or remain in line with peers. For those entities reporting under the SASB, TCFD and CDSB frameworks, the transition to reporting under the Standards should be relatively simple and would involve only slight modifications to the information-gathering and reporting procedures already implemented. For entities that have not yet adopted voluntary disclosure of ESG performance but would like to report under the Standards, the ISSB has recommended that such entities take the following steps:

1. Evaluate internal systems and processes for collecting, aggregating and validating sustainability-related information across the company, and its value and supply chains;
2. Consider the sustainability-related risks and opportunities that affect the business; and
3. Review the Standards and the SASB, CDSB and TCFD frameworks.

Conclusion

The Capital Markets Group at Aird & Berlis LLP will continue to monitor the impact of and developments related to the Standards, as well as developments in ESG-related disclosure in general. Please contact one of the authors if you have questions or require assistance.