The launch of the ISSB and these forthcoming standards come at a critical time with the lack of relevant, decision-useful climate information is increasingly seen as a barrier in the transition to a green economy.
The IMF, in its October 2021 Global Financial Stability Report, called on policymakers to, “urgently strengthen the climate information architecture both for firms and investment funds,” to align investment flows with climate goals.3 The ISSB has the potential to become a key pillar of this architecture and in the provision of relevant, decision-useful ESG information. As the global sustainability standard-setting process kicks into gear, three issues are key to keep on the policy agenda:
1. The need for specific social and corporate governance standards
We believe the ISSB is right to prioritize climate in its initial development of sustainability reporting standards and are pleased that its general requirements prototype will provide companies with disclosure guidance related to other ESG matters on an interim basis.
In the medium-term, however, the same urgency with which the board is approaching a specific climate standard is needed on a broader set of sustainability issues, including employee-related matters and human rights.
The need for action on these issues has become painstakingly clear amid the COVID-19 pandemic with research from the United Nations Conference on Trade and Development (UNCTAD) illustrating how the pandemic has reversed years of progress toward achieving the Sustainable Development Goals (SDGs).4
At the same time, disclosure mandates related to social and governance factors have emerged around the world. Examples include:
- The Corporate Sustainability Reporting Directive (CSRD) will require EU (and some non-EU headquartered companies) to report on human rights, among other workforce data.
- In the US, the Securities and Exchange Commission (SEC) recently approved new listing rules regarding board diversity and disclosure for NASDAQ-listed companies and is drafting a set of mandatory human capital-related disclosure rules that could include a number of metrics, such as workforce turnover, skills and development training, compensation, benefits, workforce demographics including diversity, and health and safety.
- India’s largest 1,000 listed companies will soon be mandated to file a Business Responsibility and Sustainability Report (BRSR) with information covering a broad range of ESG factors including welfare benefits and median wages, gender diversity, and resource usage.
While this movement demonstrates the stakeholder demand for more information on ESG risks, it also raises the risk of fragmentation and the need for greater comparability and consistency.
2. The distinction between the enterprise- and societal-value approaches will blur over time
The ISSB has announced it will develop sustainability disclosure standards that address companies’ impacts on sustainability matters relevant to assessing enterprise value (as determined by market participants) and making investment decisions. This approach is closely aligned with the IFRS Foundation Constitution and is aligned with the “traditional” understanding of materiality.
The concept of materiality has been at the heart of varying approaches to ESG reporting – while many jurisdictions have taken an enterprise-value approach, others – most notably the European Union – have taken a broader, societal-value approach (i.e., including the impact companies have on people and the environment). What is often lost in the debate over materiality, however, is that the distinction between the enterprise-value approach and the societal-value approach is dynamic, having evolved in the past and will inevitably evolve over time, blurring as the links between externalities and direct or indirect effects on the future cash flows become clearer.
Investors recognize that as societal and financial values converge – amid broader shifts around the role of business in society – the effect of an entity on its environment (and vice versa) may not have direct cash flow consequences today, but may have material consequences that affect the entity’s long-term value and viability. Making a distinction between what is relevant only to investors and what is relevant only to other decision makers is going to be increasingly difficult.
Companies should monitor ongoing developments – at both the ISSB- and jurisdictional-levels – as the standards start to take shape.
3. The importance of balancing a global baseline with the need for localization
G20 Leaders, in their declaration following their recent Summit in Rome, welcomed the work of the IFRS Foundation to develop a global baseline of sustainability disclosure standards. At the same time, many G20 nations have moved to enact sustainability disclosure mandates – some which will align to the ISSB process and others which are jurisdiction-specific.
In the EU, for example, a jurisdiction that has expressed a commitment to build on and contribute to global efforts in the field of sustainability reporting standards including the work of the IFRS Foundation, policymakers view disclosure as a mechanism for behavioral change. The CSRD is a key element of the European Green Deal, the European Commission’s set of policy initiatives designed to make Europe climate-neutral by 2050.
Like the IFRS Foundation, we recognize the need to instill regional flexibility alongside a global standard. In the months and years ahead, it will be important to achieve an appropriate level of balance, ensuring that inefficiencies and inconsistencies are minimized.
The launch of the ISSB is the most promising development in the move toward harmonization of ESG reporting standards. Through common and consistent measurement, we will have the opportunity to benchmark progress, improve decision-making and accountability and increase trust. The coming months are an opportunity for multiple stakeholder groups to come together with collaboration and urgency, while generating the broad buy-in required for meaningful advancement.
With additional contributions from Janice Freeman (Policy Analyst, EY Global Public Policy) and Julie Croglio (Secondee – ESG Initiatives, EY Office of the Global Chairman and CEO).
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Summary
The IFRS Foundation’s establishment of the ISSB is a major step toward achieving relevant, decision-useful sustainability information for market participants that is comparable across industries and jurisdictions.
