New IFRS Reporting Standards: how to bring climate and money together?

Фото: © Depositphotos.com/malpetr

On 26 June 2023, the International Sustainability Standards Board (ISSB) issued the first set of standards – IFRS S1 «General Requirements for Disclosure of Sustainability-related Financial Information» and the first topic standard IFRS S2 «Climate-related Disclosures» both of which become effective on 1 January 2024 and apply to reports published in 2025.

The ISSB was created under the auspices of IFRS and operates in parallel with the International Accounting Standards Board (IASB). It is expected that the new Standards will follow in the footsteps of IFRS financial reporting standards, which are applied in almost 150 jurisdictions, and will also gain global acceptance by becoming part of national legislation. Similarly, to accounting standards, IFRS S1/S2 may become mandatory for large companies, joint stock companies, commercial banks, listed companies, medium-sized enterprises and state-owned enterprises.

IFRS S1/S2 aim to bring together the many different sustainability and climate-related disclosure standards and become universally applicable around the world to meet investors' demands for reliable and comparable information from public companies.

Why do we need new reporting standards when there is already plenty of them?

I remember numerous discussions at the climate conference in Bonn in 2016 about the importance of mitigation and adaptation measures to reduce losses from natural disasters. Then the unanswered question was floating in the air: «How should one know where it’s best to allocate funds in order to save as much as possible and lose as little as possible?». Traditional risk factors were no longer sufficient to answer this question, and the non-financial reporting standards that existed at that time still did not allow climate or sustainability risks to be seen in monetary terms.

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Pressure from financial institutions, insurance companies, investors and lenders led to the development of TCFD recommendations in 2017 to provide future and existing investors with information on how the value of a company's assets, and therefore its creditworthiness, would change if climate-related risks materialized. IFRS S1/S2 have entirely incorporated those TCFD recommendations and translated them into more detailed reporting requirements, thereby taking up the torch of disclosing the impact of climate-related risks on companies' financial performance.

IFRS S1/S2 builds on existing systems of standards, combining best practices rather than inventing new ones. In 2021, previously disparate sustainability standards bodies, including SASB, IIRC, VRF and CDSB, began joining the ISSB to create a single, universal framework for sustainability disclosures to provide investors with like-for-like comparison when making decisions about business development funding.

Although the key concepts and terminology of traditional financial reporting standards formed the basis of IFRS S1/S2, the timeframe of the latter is different. Since the climate is inherently uncertain, conservative financial planning five years ahead is no longer sufficient. Thus, instead of the usual historical data, the new Standards require companies to forecast the future in the short, medium, and long term along with the disclosure of all assumptions, judgements, and inputs.

Lastly, the main distinguishing feature of the new Standards may be their mandatory nature. Historically, non-financial reporting standards have remained voluntary in most jurisdictions, but the requirements for the preparation of financial statements built into IFRS S1/S2, are ready to change this tradition on a global scale.

A Pact for People and Planet

Despite the fact that each jurisdiction will independently decide on the introduction of new standards, G7 and G20 have already come out in support of IFRS S1/S2. The International Organization of Securities Commissions (IOSCO) calls on member countries to integrate the new Standards into national legislation as soon as possible. Mandatory application of the Standards in the next two years is supported by the global initiative «Principles of Responsible Investment» (PRI), as well as the world's largest stock exchanges of London, Hong Kong, and Singapore. They are echoed by institutional investors represented by the European Bank for Reconstruction and Development (EBRD) and the International Finance Corporation (IFC).

Given the fact that IOSCO regulates 95% of the world's securities markets in approximately 130 jurisdictions, including Kazakhstan, Uzbekistan and Azerbaijan, and the PRIs have become fundamental in the development of the Investment Policy Concept of the Republic of Kazakhstan and the Sustainable Development Policy of the Kazakhstan Stock Exchange, it is highly likely that the new Standards will be applied in Central Asian region and the Caucasus in the near future.

Why is it becoming unprofitable to ignore the climate?

We already know examples of how neglecting climate risks can lead to bankruptcy. California's largest electricity provider has filed for bankruptcy twice in the last 20 years due to drought and wildfires. In Kazakhstan, drought is predicted every four years, heat waves - every five years[1], which can lead to shallowing of reservoirs that support the operation of hydroelectric power stations. It means a loss of 10% of the country's energy potential and production downtime, especially in regions that depend on river energy.

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Given the dependence on foreign business partners for spare parts and equipment, in addition to your own, it is important to assess climate risks along the entire value chain, i.e. consider risks to suppliers' core production assets as well as supply chains. So, for instance, the exposure of sea and river ports, roads and railways to such risks has already become critical. Last year, floods in neighboring China disrupted supplies and forced the closure of a Nissan car plant; the shallowing of a key European artery, the Rhine River in Germany, forced the weight of transported goods to be halved; forest fires in Canada have stopped thousands of freight cars.

On the other hand, regulatory pressure on companies is growing. Tighter climate regulations may increase the likelihood of assets being retired prematurely and having their useful lives reduced earlier than previously expected. Therefore, companies will need to consider whether such events and circumstances indicate impairment of their assets. Back in 2020, oil and gas giants Shell and BP slashed the values of many of their assets by tens of billions of dollars and announced that some future projects would remain permanently undeveloped. Among other things, the impetus for this was the race to decarbonization.

At the same time, by not disclosing climate opportunities, companies are missing out on the chance to attract investors. Recent research among energy companies[2] shows that transition climate risks are not built into the company's economic model and therefore do not reflect the falling costs of carbon-intensive energy sources given increasing regulatory pressures. Meanwhile, renewable energy suppliers underestimate their prospects in terms of cash flow growth. This altogether means that investors do not see potential losses or returns on their investments, and companies miss out on growth opportunities.

Are companies ready to disclose information under IFRS S1/S2?

Most companies in Central Asia and the Caucasus have not yet begun to identify and assess the impact of climate risks on the financial health of their business and their development strategy resilience. At the same time, for global investors, information about the impact of these risks on revenues is no longer «desirable» but «required» when selecting projects for financing.

IFRS S1/S2 symbolizes a new stage in the evolution of reporting standards, crowning a multi-year race for sustainable development that curbs global warming. The new Standards combine the world's best practices in the field of financial and non-financial reporting into a single system of standards, thereby demonstrating that the link between sustainable development, in particular climate change, and financial well-being is no longer a theorem that requires many years of proof, but an axiom which is unprofitable to ignore.

Anara Samambayeva, Senior Expert, Climate Change and Sustainability Services, EY Kazakhstan

Victor Kovalenko, Partner, Leader in Central Asia, Caucasus and Ukraine, Climate Change and Sustainability Services