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19 July 2023

IFRS S1 and IFRS S2 in detail

In the last week of June, the International Sustainability Standards Board (ISSB) issued its inaugural sustainability reporting standards through a series of events hosted by stock exchanges around the world, including those in Frankfurt, Johannesburg, Lagos, London, New York, Santiago de Chile and Singapore. These standards, called International Financial Reporting Standards IFRS S1 and IFRS S2, signal the first step towards the global alignment of sustainability disclosures with accounting and financial standards. And, for the first time, the Standards create a common language for disclosing the effect of climate-related risks and opportunities on a company’s prospects.

This article explains the reasons for the Standards, outlines the key definitions, features, considerations and reliefs, and details the individual requirements of IFRS S1 and IFRS 2.

1. Definitions

Sustainability

There are many definitions of sustainability, but the most universally accepted definition comes from the 1987 Report of the World Commission on Environment and Development, known as the Brundtland Report, referring to ‘sustainable development’.

Humanity has the ability to make development sustainable to ensure that it meets the needs of the present without compromising the ability of future generations to meet their own needs. The concept of sustainable development does imply limits - not absolute limits but limitations imposed by the present state of technology and social organization on environmental resources and by the ability of the biosphere to absorb the effects of human activities.

Brundtland Report

Materiality

One of the key features of IFRS S1 and S2 is the use of language and definitions consistent with the international accounting standards. As such, the definition of ‘materiality’, i.e. what is considered material information required to be disclosed, is identical to the one in the IFRS Accounting Standards:

Information is material if omitting, misstating or obscuring it could reasonably be expected to influence investor decisions.

2. Reasons for the development of the Standards

Sustainability factors are becoming a mainstream part of investment decision-making around the world, for both investors and issuers. At the same time, the myriad of voluntary sustainability reporting standards currently available (e.g. GRI, SASB, TCFD, Integrated Reporting, UN Global Compact, etc.) pose a challenge when choosing and comparing those most appropriate to use and, in many cases, provides an excuse to report partially or not report at all.

Investors, companies and international policy makers understand the need for an efficient reporting landscape and decision-useful, comparable information. Some jurisdictions (including the EU, the UK, Hong Kong, and others) have already started implementing mandatory reporting regimes, but the local requirements may not meet the global demands of investors who are in need of information that is consistent, decision-useful, cost-effective and comparable across the globe.

In response to these developments, the ISSB has developed the ISSB Standards that:

provide a comprehensive foundation of industry-specific disclosures for global jurisdictional adoption,
use a common language for comparable, decision-useful and auditable disclosures, and
are designed to meet investor needs across global capital markets.

It is important to note that ISSB Standards are not mandatory on a global scale; rather they provide a tool for individual jurisdictions to implement mandatory reporting as required. Additional building blocks can be added to meet jurisdiction-specific requirements and to meet broader multi-stakeholder needs.

3. Objectives of the Standards

A company’s ability to deliver financial value for investors is inextricably linked to the:

Stakeholders with whom it works and serves,
Society in which it operates, and
Natural resources upon which it draws.

As a result, both companies and investors require information about sustainability-related risks and opportunities, to make informed decisions.

Specifically, for companies it is important to:

Gain visibility of the sustainability-related risks and opportunities – including hot spots and efficiencies,
Implement internal reporting systems, controls, and data governance,
Attract finance and retain long term investors,
Develop and implement a coherent strategy and have a holistic view of the business, and
Be able to conduct peer alignment.

In addition, investors wish to determine:

The effects of sustainability and climate-related risks and opportunities on the company’s performance and prospects,
Understand the company’s response to, and strategy for, managing its sustainability and climate-related risks and opportunities, including its climate-related transition planning,
Evaluate the ability of the company to adapt its planning, business model and operations to these risks and opportunities, and
Understand sustainability and climate-related risks and opportunities in a company’s value chain.

In response to these needs, IFRS S1 asks for disclosure of information about sustainability-related risks and opportunities to meet investor information needs, i.e. information about all sustainability-related risks and opportunities that could reasonably be expected to affect the company’s prospects — including its cash flows, access to finance or cost of capital over the short, medium or long term.

Used in conjunction with IFRS S1, IFRS S2 requires disclosure of material information about climate-related risks and opportunities to meet investor information needs.

4. General requirements

ISSB instructs preparers to use reasonable and supportable information, available without undue cost or effort, while considering their skills, capabilities and resources. The disclosures are required to be industry-specific, as supported by accompanying guidance built on SASB Standards.

Additional help is available through guidance within the Standards and educational materials; other non-mandatory sources of guidance to identify sustainability-related risks and opportunities; and metrics and other clarifications, such as permitting qualitative scenario analysis and qualitative information on financial effects.

ISSB Standards are effective for annual reporting periods beginning on or after 1 January 2024. The standards are available for use before that date to the extent a company applies both Standards at the same time. If a company applies the Standards before 2024, it should disclose that fact.

5. Reliefs

ISSB provides certain reliefs under both S1 and S2. Financial statements and sustainability disclosures must be published at the same time, but transitional relief is available in the first year of reporting whereby companies are permitted to report their sustainability-related financial disclosures after they publish their related financial statements. In addition:

Preparers need to report only on climate-related risks and opportunities in the first year of applying IFRS S1 and IFRS S2 and can begin reporting on other sustainability-related risks and opportunities in the second year.
Companies are not required to disclose comparative information in the first annual reporting period of adopting the standards.
There is an exemption from Scope 3 GHG emissions disclosure in the first year of applying S2.
IFRS S2 gives permission to include information regarding Scope 3 GHG emissions obtained from companies in the value chain with a different reporting cycle.
A company does not need to provide quantitative information on anticipated financial effects of climate change if it lacks the skills, capabilities or resources to do so. Instead, companies are asked to provide qualitative information.

IFRS S1

The general requirements of IFRS S1 include:

Disclosure of material information about sustainability-related risks and opportunities with the financial statements, to meet investor information needs,
The TCFD architecture whenever providing information about sustainability – including Governance, Strategy, Risk management, Metrics and targets,
The need for industry-specific disclosures,
For matters other than climate, IFRS S2 refers to sources to help companies identify sustainability-related risks and opportunities and information,
A provision that it can be used in conjunction with any accounting requirements (i.e. GAAP).

IFRS S1 asks for information that enables an understanding of the connections between:

Sustainability-related risks and opportunities,
Disclosures on core content, and
Sustainability-related financial disclosures and financial statements.

The disclosures must be prepared for the same reporting entity as the related financial statements. In terms of the timing, the disclosures must be provided at the same time as the financial statements and as part of the general-purpose financial reports. And, just like the financial reporting, sustainability reporting must include data and assumptions that are consistent with the corresponding data and assumptions in the related financial statements, to the extent possible, and considering accounting requirements.

To identify relevant risks and opportunities, a company using ISSB Standards should consider SASB Standards. In addition, a company may also consider:

CDSB Framework Application Guidance,
Industry practice, and
Materials of investor-focused standard setters.

To identify what information to disclose, a company using ISSB Standards, and for matters other than climate, should consider SASB Standards, and also:

CDSB Framework Application Guidance,
Industry practice,
Materials of investor-focused standard setters,
GRI Standards, and
European Sustainability Reporting Standards.

ISSB does not specify a location for disclosure and allows for additional information to facilitate application in different jurisdictions. The reporting must include comparative information for the preceding period for amounts disclosed, and a narrative and descriptive information if useful for investors. This might relate to metrics and targets or to current and anticipated financial effects.

IFRS S2

IFRS S2 fully incorporates the TCFD recommendations, requiring disclosure of material information about climate-related risks and opportunities, including physical and transition risks. IFRS S2 also follows the structure of the TCFD.

Strategy

IFRS S2 requires the preparers to disclose details regarding its climate strategy and decision-making, covering the effects of climate-related risks and opportunities on a company’s strategy and decision-making. This includes:

How the company has responded to, and plans to respond to, climate-related risks and opportunities, including disclosures on any transition plan the company has and plans to achieve its targets,
How the company is resourcing, and planning to resource, these plans and activities, and
The company’s progress against previously reported plans.

Further, the disclosures should include details of the current and anticipated financial effects, i.e. the effects of climate-related risks and opportunities on a company’s current and anticipated financial performance, financial position and cash flows, as follows:

A company is required to disclose both quantitative and qualitative information. The quantitative information may be a single amount or a range,
A company can provide qualitative rather than quantitative information when not separately identifiable, if there is a high level of measurement uncertainty or, when for anticipated effects, this is not commensurate with the company’s skills, expertise and resources,
Anticipated financial effects – the use of all reasonable and supportable information available to the company without undue cost or effort, and the use of an approach that is commensurate with its available skills, capabilities and resources, and
A company does not need to provide quantitative information regarding anticipated financial effects if it lacks the skills, capabilities or resources to do so. Instead, they are asked to provide qualitative information.

Companies are also required to address climate resilience – the resilience of a company’s strategy and business model to climate-related changes, developments, and uncertainties. Disclosures should include climate resilience assessment including inputs and key assumptions used in the scenario analysis. When reporting on climate resilience, companies need to use climate-related scenario analysis. IFRS S2 guidance requires that the method of climate-related scenario analysis is commensurate with a company’s circumstances (i.e. stage of progression), and that the company uses all reasonable and supportable information that is available without undue cost or effort.

Metrics and targets

The key metrics required by IFRS S2 to be disclosed are the absolute greenhouse gas (GHG) emissions, measured in accordance with the GHG Protocol Corporate Standard. Disclosures should include how and why a company has used specific inputs, assumptions, and estimation techniques to measure its GHG emissions, including any changes. Specifically, S2 requires:

Scope 1: direct emissions.
Scope 2: indirect emissions from the generation of purchased energy consumed by the company.
Scope 3: all other indirect emissions that occur in the company’s value chain. Scope 3 GHG emissions disclosure is measured across the following 15 categories, when the information is material:
1. Purchased goods and services
2. Capital goods
3. Fuel and energy related activities
4. Upstream transportation and distribution
5. Waste generated in operations
6. Business travel
7. Employee commuting
8. Upstream leased assets
9. Downstream transportation and distribution
10. Processing of sold products
11. Use of sold products
12. End-of-life treatment of sold products
13. Downstream leased assets
14. Franchises
15. Investments

Companies with emissions associated with investments or other forms of financing (such as asset management, commercial banks, insurance) are required to report financed emissions.

Industry-based disclosures

S2 requires that companies provide industry-specific disclosures, but the industry-based metrics provided are for illustrative guidance rather than requirements. An exception to this is information about financed emissions which is required to be provided.

The ISSB has indicated an intention to make the industry-based metrics mandatory in the future, subject to consultation.

Climate-related targets

S2 requires disclosure of the climate-related targets a company has set, as well as those it is required to meet by law or regulation. In addition, companies are required to disclose:

The characteristics of each target, including additional disclosures related to a company’s gross and net GHG emissions targets,
How the company sets and reviews each target, and
The company’s performance against each target.

Resources

It is expected that more than 18,000 companies will collect data as required by IFRS S2 for disclosure on the CDP platform in 2024.

Please contact our team for further information.

In addition, please find below the links to further ISSB resources.

IFRS S1 and IFRS S2:

IFRS S2:

Topics

ESG