Climate Resilience in Financial Reporting: Understanding the IFRS S1 and S2 standards

Introduction 

The growing popularity of ESG and ESG reporting over the last couple of decades led to the emergence of a host of ESG frameworks and standards. This resulted in a fragmented landscape where both preparers, as well as users of sustainability information, were often left confused as to which standards to refer to. 

One of the key objectives of the International Sustainability Standards Board (ISSB), part of the IFRS Foundation, is to establish a global baseline ESG standard to facilitate decisions and useful information for investors. To that end, the ISSB has merged within its ambit some of the popular ESG standards and frameworks such as the Sustainability Accounting Standards Board (SASB), the Taskforce on Climate-related Financial Disclosures (TCFD) and the Integrated Reporting (IR) framework. 

On June 26, 2023, the ISSB released its first set of standards, the IFRS S1, and S2. In this blog, we will be looking at the components of the 2 standards and understand how the requirements of the standards translate to useful information for the investor community. 

IFRS S1

IFRS S1, or the General requirements for disclosure of sustainability-related financial information, is a cross-cutting standard that is applicable to all companies across industries. It consists of concepts, principles and requirements for disclosures. 

Identification and disclosure of sustainability-related risks and opportunities 

To determine which sustainability matters to disclose, an organization first has to identify the potential sustainability-related risks and opportunities, followed by narrowing them down to determine which are the most material. The entire value chain of the entity, along with all key resources and relationships must be considered while determining material topics. 

Only material sustainability matters need to be disclosed, except climate change as a topic. To determine the material matters to disclose, the IFRS S1 does not insist on any specific requirements. However, guidance can be taken from sources such as: 

1. Topics mentioned under SASB’s industry-based standards 
2. The CDSB framework for water and biodiversity disclosures 
3. Other standard settings bodies whose requirements align with the interests of investors 
4. Metrics disclosed by industry peers or associations 
5. ESRS and GRI standards 

The ISSB borrows the structure of its requirements from the TCFD, dividing the content into governance, strategy, risk management, and metrics and targets. 

Governance 

This section primarily consists of how the material sustainability risks and opportunities are governed. This includes the individuals or bodies responsible, their roles and any policies relevant to the material topic. 

Strategy 

This section is particularly important for investors since it talks about the strategy to manage sustainability-related risks and opportunities. Here, an entity must disclose the identified risks and opportunities, the financial effects of these risks and opportunities, and how they may affect the entity’s business. 

Risk Management 

This section requires the entity to deeply dive into the process used to identify and assess the sustainability risks and opportunities, as well as how these risks are tied to the entity’s overall risk management processes. This includes any inputs and assumptions used, as well as details of the scenario analysis if performed, on the identified risks. 

Metrics and targets 

One key aspect of the disclosures is the quantitative metrics and targets since these make it easier to visualize the scope of the risks and targets, as well as the progress towards mitigating risks and taking advantage of opportunities. For each of the identified risks and opportunities, the entities are expected to disclose the associated metrics, targets, and progress toward achieving the set targets. 

Current and anticipated effects 

For decision-making by investors, being one of the primary users of the ISSB disclosures, the entities need to disclose the current and anticipated effects of the risks and opportunities throughout its value chain. The effects can be in the form of quantitative or qualitative. Though quantitative is preferred, if the quantitative effects are uncertain or cannot be obtained through reasonable effort, it is acceptable to provide qualitative effects. 

IFRS S2 

IFRS S2 is the first topical standard released by ISSB, and it consists of climate related disclosures. The principles outlined in S1 apply to S2 as well. In cases where there are chances of duplication, the information can be provided in either of the standards. 

Similar to S1, entities need to identify the climate-related risks and opportunities as the first step. This can be done by considering the topics defined in ‘Industry-Based Guidance on Implementing IFRS S2’, which is in turn, based on the SASB standards. 

Climate risks can broadly be categorized as follows- 

1. Physical risks – These are more physical in nature and can be further classified as chronic risks, which are long-term in nature such as sea-level rise, and acute physical risks which are shorter-term events such as floods and hurricanes 
2. Transition risks – These are related to adaption to technological or legal changes arising from climate change mitigation 

Entities need to identify both these types of risks in their identification and assessment process. 

Similar to the IFRS S1, the requirements of S2 are structured into 4 areas – Governance, Strategy, Risk Management, and Metrics & Targets. 

Governance 

The governance section of S2 is very similar to S1, encompassing the roles and responsibilities of individuals or bodies who govern climate change-related risks and opportunities, as well as any related policies. 

Strategy 

This section would likely be of high interest to any investors or other primary users. It consists of the strategy to manage the identified climate related risks and opportunities. This includes the financial effects of the risks and opportunities, the plan to achieve climate-related targets as well as the transition plan, and any key assumptions used. In case quantitative disclosures are not relevant or cannot be obtained through reasonable effort, qualitative disclosures may be used. 

One key aspect of the strategy is the scenario analysis. Entities are expected to perform scenario analysis to inform users of the impacts in various ‘what-if’ scenarios regarding climate change. The ISSB does not specify any specific scenarios to be used, as the scenarios are entity-specific. 

Risk Management 

Similar to S1, this section requires the entity to delve into the process used to identify and assess the various climate-related risks and opportunities, and how it is tied to the overall risk management framework. 

Metrics and Targets 

In this section, the entity is expected to disclose any qualitative and quantitative metrics and targets it has set to achieve its climate-related goals. The entity may use cross-industry, industry-specific, or entity-specific metrics. The requirements also include details of the metrics and targets such as the approach, objective and scope. 

The entity is required to disclose Scope 1,2, and 3 emissions as per the GHG protocol, subject to transition provisions. For any GHG emissions targets set, the entity should disclose details such as whether Scope 1,2 and 3 are covered, whether the targets are gross or net, the approach used and the planned use of carbon credits. 

Conclusion 

The ISSB standards are primarily focused on providing investors with useful disclosures. As evidenced by the contents of the standard above, the disclosures aim to provide investors with information such as the financial effects of climate change and other sustainability matters on the business, as well as the strategies, action plan and targets. This makes it easier for investors and other primary users to analyze the disclosures to better inform their decisions.