As we addressed here, the International Sustainability Standards Board issued its first two exposure drafts, General Sustainability-related Disclosures and Climate-related Disclosures, which were both open for comment until July 29, 2022.
The draft on climate-related disclosures includes the following proposed requirements:
- An entity shall disclose information that enables users of general purpose financial reporting to understand the resilience of the entity’s strategy (including its business model) to climate-related changes, developments or uncertainties—taking into consideration an entity’s identified significant climate-related risks and opportunities and related uncertainties. The entity shall use climate-related scenario analysis to assess its climate resilience unless it is unable to do so. If an entity is unable to use climate-related scenario analysis, it shall use an alternative method or technique to assess its climate resilience. When providing quantitative information, an entity can disclose single amounts or a range.
The basis for conclusions addresses why the proposal doesn’t require scenario analysis in all cases:
- Although scenario analysis is a widely accepted approach, its application to climate-related matters in business, particularly at an entity level, and its application across sectors is still evolving. Some sectors, such as extractives and minerals processing, have used climate-related scenario analysis for many years; others, such as consumer goods or technology and communications, are just beginning to explore applying climate-related scenario analysis to their businesses….
- Preparers raised other challenges and concerns associated with climate-related scenario analysis, including: the speculative nature of the information that scenario analysis generates, the potential legal liability associated with disclosure (or miscommunication) of such information, limited data availability and the potential disclosure of confidential information about an entity’s strategy….
- …the proposed requirements are designed to accommodate alternative approaches to resilience assessment, such as qualitative analysis, single-point forecasts, sensitivity analysis and stress tests. This approach would provide preparers, including those in smaller entities, with relief, recognizing that formal scenario analysis and related disclosure can be resource intensive, represents an iterative learning process, and may take multiple planning cycles to achieve. It is noted that by making climate-related scenario analysis a requirement subject only to whether an entity is able to conduct it, over time an increasing number of entities would be expected to apply this form of analysis.
There’s some agreement with this approach, for example from the Australian Institute of Company Directors:
- Notwithstanding an increasing take up of (the recommendations of the Task Force on Climate-Related Financial Disclosures) by larger entities, there are many entities which are yet to implement it, especially those not listed on market exchanges. Implementation of TCFD often takes several years to embed effectively and is not cost-effective for smaller entities, that could be subject to this Standard (depending on the final scope of application).
- Some flexibility as proposed here is appropriate. A similar approach was taken by the Australian Prudential Regulation Authority which supervises institutions across banking, insurance and superannuation. There should be recognition in the Standards that full adoption of the TCFD is likely to be an iterative process for entities – disclosure in year one of adoption is likely to be materially different in terms of quality and scale than disclosure in say year three.
The Australian QBE Insurance Group Limited saw it much the same way:
- Positions on scenario analysis by industry are only in their early stages of development and are expected to need considerable time to take shape. While the issue of the standards might give impetus to these developments, the process would need to be subject to wide-ranging consultation with the affected industries. QBE considers that the standards will need to accommodate situations in which the techniques are being continually developed and refined.
- QBE would support the use of alternative assessments if scenario analysis is not available or not applicable for an entity. Undertaking detailed scenario analysis is not applicable or achievable for all entities and should not be mandated.
The European Securities and Markets Authority (ESMA) though agrees with the proposal only reluctantly, if at all:
- While we acknowledge that scenario analysis may be challenging for some companies to prepare, the fact that it can be replaced by a different type of analysis de facto indicates that it is considered perfectly fungible with other types of analysis. Ultimately, this approach will impair comparability for investors. ESMA also notes that this will represent an area of divergence with the draft (European Sustainability Reporting Standard) which requires disclosures of climate scenario analysis and does not envisage any substitutes for it. If this approach is maintained, ESMA suggests requiring issuers that do not use scenario analysis to explain the reason why they were unable to do so.
I’d certainly agree with that last point, and more generally, I think the ISSB should push as hard as it can in this respect. Recall that even if the standards are finalized relatively quickly, they won’t be mandated in any jurisdiction, unless and until local regulators determine that they should be. Given the timelines involved in that, any mass adoption is several years away, by which time we’ll be even deeper in the climate change hole we’re digging for ourselves. It seems to me then that the ISSB is best advised to set a high bar, allowing local regulators to grant issuer-specific or broader exemptions from specific aspects of the requirements if they see fit. But as the ISSB will still be finding its feet for a while, who knows?…
The opinions expressed are solely those of the author