As we’ve addressed many times, the International Sustainability Standards Board issued its first two exposure drafts, General Sustainability-related Disclosures (S1) and Climate-related Disclosures (S2), which were both open for comment until July 29, 2022.

Here’s an extract from the S1 document:

• An entity shall provide information that enables users of general purpose financial reporting to assess the connections between various sustainability-related risks and opportunities, and to assess how information about these risks and opportunities is linked to information in the general purpose financial statements.
• An entity shall describe the relationships between different pieces of information. Doing so could require connecting narrative information on governance, strategy and risk management to related metrics and targets. For example, to allow users of general purpose financial reporting to assess connections in information, an entity might need to explain the effect or likely effect of its strategy on its financial statements or financial plans, or on metrics and targets used to measure progress against performance. Furthermore, the entity might need to explain how its use of natural resources and changes within its supply chain could amplify, change or reduce its significant sustainability-related risks and opportunities. The entity may need to link this information to the potential or actual effect on its production costs, its strategic response to mitigate such risks and its related investment in new assets. This information may also need to be linked to information in the financial statements and to specific metrics and targets. Information that describes connections shall be clear and concise.

It’s hard to imagine many people disagreeing with the basic premise and asserting that the two forms of reporting should be largely disconnected. That doesn’t necessarily mean it’ll be entirely easy of course. The Canadian Bankers Association commented as follows:

• While we agree with the general objective of improving connectivity between sustainability-related risks and the financial statements, there is no standard approach for measuring or quantifying the financial impact of sustainability-related factors. The requirement to disclose the financial impact in the absence of a standard is likely to result in a lack of comparability and unreliable disclosures that are not decision useful. Furthermore, we caution that adding such a requirement could potentially be viewed as monetizing sustainability-related issues, specifically social matters such as diversity and inclusion. Qualitative disclosures are more likely to be relevant in this regard while meeting the ISSB’s stated objective.

These comments are from Shell International B.V.:

• it should be noted that drivers of decisions and trade-offs within a reporting entity are not always linked solely with sustainability related risks and opportunities. Sustainability is often one of many considerations when an entity makes decisions, e.g., investments and divestments. Therefore it is important to note that sustainability-related risks and opportunities are not always separately identifiable from delivering the overall business strategy.

Insurance Europe argued:

• At best, the (standards) will be designed in a way that connected information is, in as many cases as possible, disclosed by complying with the disclosure requirements …implicitly/automatically…particularly, but not only, where companies choose a fully integrated disclosure format. In addition, connectivity can only be limited where sustainability and financial reporting follow a different rationale (eg, scope or time horizons may vary). Any relevant differences that may reduce (perceived) connectivity should be outlined and explained. The principles-based approach also facilitates the building blocks approach as it mitigates concerns about issues across jurisdictions.

And from the same industry, Legal & General:

• …we note that these interconnections are not always straightforward and may not always be easily measurable, an allowance for a narrative description of the nature of connectivity should be helpful. We would also urge the ISSB to continue to encourage companies to disclose connectivity between their sustainability narratives and associated financial impacts and their financial statements. Avoiding inconsistency between the front and back half at the very least, will help give the sustainability disclosures credibility…. . The successful incorporation of sustainability factors into the assessment of enterprise value is contingent on sustainability reporting that is supported by the company’s financial reports. In this regard it is important to note that the impact from these connections may not impact on the current financial statements for the reporting period

And from the law firm Pinsent Mason LLP:

• We think more guidance should be provided on how reporting entities should use assumptions and estimates in explaining the connections between sustainability-related risks and opportunities and financial reporting, and guidance around how reporting entities should consider trade-offs between different sustainability-related risks and opportunities and connect those trade-offs to the financial reporting.

And there’s much more like that. Regulators and others have frequently commented on inadequate connectivity between MD&A and financial statements – for example where the events and trends described in the former don’t seem to be evidenced in the latter – even though in those instances establishing connectivity shouldn’t be inherently difficult. As indicated above, sustainability versus financial reporting brings new challenges, and of course more guidance by the ISSB and others will likely be necessary. Insurance Europe above is surely also correct though in suggesting that when an entity takes a maximally holistic or integrated approach to corporate disclosure in all its forms, the connectivity challenge will be at least somewhat reduced…

The opinions expressed are solely those of the author