Friday, April 19, 2024

Implications of IFRS S1 and S2

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On 26th June 2023, the International Sustainability Standards Board (ISSB)published the first two IFRS Sustainability Disclosure Standards IFRS S1 General requirements for the disclosure of sustainability-related financial information and IFRS S2 climate-related disclosures. The Standards contain requirements for the disclosure of material information about an entity’s significant sustainability-related risks and opportunities that are necessary for investors to evaluate the entity.

IFRS S1 and IFRS S2 are intended to improve the alignment and interoperability of global ESG standards, reducing the reporting burden for preparers and enhancing the usefulness of sustainability disclosures for investors in making decisions.

The interoperability between IFRS S1 and IFRS S2 and other emerging global standards means that companies can now take action to apply the ISSB standards to accelerate preparedness for regulatory requirements around the world.

In response to the increasing global demand for consistent, comparable, and verifiable information concerning companies’ management of sustainability-related risks and opportunities, there is a heightened need for reliable data in global capital markets. This necessitates the establishment of a robust framework that addresses these requirements. By catering to the needs of capital markets, the International Sustainability Standards Board (ISSB) aims to provide investors with the necessary information to make well-informed decisions regarding resource allocation to companies.

IFRS S1 and IFRS S2 are designed to set a global baseline to enable companies to provide information about sustainability-related risks and opportunities that is useful for investors’ decision-making.

The objective of IFRS S1 is to require a company to disclose material information about its sustainability-related risks and opportunities that is useful to investors in making decisions about providing resources to the company. The information required covers the material aspects of a company’s governance, strategy, risk management, and metrics and targets for sustainability-related risks and opportunities. To achieve this objective, IFRS S1 requires entities to follow a two-step process to identify and disclose all material sustainability-related risks and opportunities that impact the entity’s prospects:

Step one helps identify sustainability-related risks and opportunities that could affect an entity’s prospects over the short, medium and long term. Step two helps determine the disclosures to provide in relation to the sustainability-related risks and opportunities identified in step 1.

IFRS S2 requires an entity to identify and disclose climate-related risks and opportunities that could affect the entity’s prospects over the short, medium and long term. To achieve this objective, an entity is required to refer to and consider the applicability of industry-based disclosure topics as defined in the industry-Based Guidance on implementing IFRS S2

IFRS S1 and IFRS S2 are effective for annual reporting periods beginning on or after 1st January 2024, with early adoption permitted. This is subject to the endorsement of the standards by local jurisdictions.

Disclosure requirements

A company applying IFRS S1 is required to disclose material information about the sustainability-related risks and opportunities that could reasonably be expected to affect the company’s prospects, particularly current and anticipated financial effects.

The objective of IFRS S2 is to require a company to disclose material information about its climate-related risks and opportunities that is useful to investors in making decisions relating to providing resources to the company.

Implications to investors

Investors are likely to benefit from the application of IFRS S1 and IFRS S2 by avoiding costs, such as the inefficiencies of manual data collection, management and analysis of sustainability-related financial disclosures. Many of these benefits for investors stem from the greater consistency, comparability and verifiability of disclosures when IFRS S1 and IFRS S2 are applied.

Enhanced Information for Decision-Making: IFRS S1 and S2 aim to provide investors with more comprehensive and relevant information regarding a company’s sustainability-related risks and opportunities. This allows investors to make more informed decisions by considering the financial impacts of sustainability factors on a company’s prospects and performance.

Improved Risk Assessment: The disclosure requirements of IFRS S1 and the focus on climate-related risks in IFRS S2 enable investors to better assess a company’s exposure to sustainability-related risks. This helps investors understand potential financial vulnerabilities and evaluate the long-term sustainability of their investment portfolios.

Increased Transparency and Comparability: With standardized reporting frameworks, investors can compare sustainability-related information across companies and industries more effectively. This enhances transparency and facilitates better benchmarking and evaluation of companies’ sustainability performance and risk profiles.

Investors might face costs to establish or modify internal systems, data collection or data analysis processes.

Implications to companies

Improved Investor Relations: Companies that proactively disclose sustainability-related information in line with IFRS S1 and S2 can enhance their investor relations. By providing transparency and demonstrating a clear understanding of their sustainability risks and opportunities, companies can build trust with investors, attract sustainable investment, and potentially reduce their cost of capital.

Enhanced Risk Management: The process of identifying and disclosing sustainability-related risks and opportunities required by IFRS S1 and S2 helps companies develop a more robust risk management framework. It enables companies to proactively address and mitigate sustainability-related risks, leading to better resilience and long-term value creation.

Improved data quality, including higher quality of information from companies that are in the value chain of a reporting company. Improved data quality is expected to have a positive effect on areas such as governance, strategy, access to capital, cost of capital, reputation, and employee and stakeholder engagement.

In light with the new disclosures, Companies might face costs relating to: recruiting additional staff or acquiring necessary expertise, changing data collection and analysis, establishing or modifying internal systems and producing or modifying production of reported information.

 

Dr. Edward Mungai
Dr. Edward Mungaihttp://www.edwardmungai.com/
The writer, Dr. Edward Mungai, is a global sustainability expert. He is the Lead Consultant and Partner at Impact Africa Consulting Ltd (IACL), a leading sustainability and strategy advisory in Africa. He is also the Chief Editor at Africa Sustainability Matters. He can be contacted via mailto:edward@edwardmungai.com

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