The new IFRS sustainability standards will impact businesses large and small, says Suresh Kana, trustee and deputy chair of the IFRS Foundation.
Kana unpacked these standards and their sweeping consequences at the recent CFO Africa Conference.
What the standards entail
The two standards, named S1 and S2, were published on the 26th of June this year.
Kana described S1 as the foundational standard. “So this one is the overarching standard. You can call it the umbrella standard.”
One of the basic principles of these standards is that they’re published with financial statements.
“That’s a critical change that we’ve made. If you look at most organisations that publish sustainability reports, at the moment, they publish their annual financial statements and a sustainability report at a separate time. Often, they don’t even talk to each other,” Kana told the audience.
“We said that, to have credibility, your sustainability and financial information must be continuous. So we have that as the first principle.”
Another principle is that risks and opportunities related to sustainability must be disclosed.
“The value of any security is the present value of future cash flows. Those cash flows get impacted by two things: risks and opportunities.”
A third fundamental principle is materiality.
“You cannot produce 130 pages of a report or communication that is just waffle,” Kana explained. “We say information is material if omitting, misstating or obscuring it could reasonably be expected to influence investor decisions.”
Whereas S1 is the foundational standard, S2 is the first thematic standard concerning climate disclosures. One of its core concepts is the idea of climate resilience.
“You’ve got to look at your business model and perform a climate resilience assessment. That is, you’ve got to say, if temperatures go up by one degree, what would your business look like? What about two or three degrees? So you need to do that resilience exercise and produce a resilience report. In that context, also talk about the assumptions you’ve used as inputs.
“The ultimate aim is to assess the variability of cash flows in the different scenarios.”
S2 also requires firms to disclose emissions under three different categories. The first concerns direct emissions. The second concerns emissions companies have to purchase, such as electricity. Scope three emissions from a company’s supply chain.
S2 is the first, but not the last, thematic standard and more are expected. Kana also notes that IFRS will work on industry-specific standards.
“If we think about how sustainability affects a mining company or how it affects an airline or agri company, it’s very different. So we will be developing industry-based standards as well.”
How the standards will trickle down
Kana explained how despite the standards not being mandatory in South Africa, they will trickle down to the smallest businesses due to the role of supply chains.
“If you take a company listed in Europe. They’re going to say, ‘we need to reduce our carbon footprint by 2050.’ How are they going to do that? They’re going to set targets and look at the whole supply chain. You can be the smallest supplier in their supply chain, but you will also have to change your way of doing business because if you don’t change, they are not going to procure from you anymore.”
Kana says companies are setting net targets decades into the future because meeting them requires fundamentally shifting business models.
“If you think of the airline industry, which uses a lot of fossil fuel. They cannot change their entire fleet of planes around the world in such a short space of time. That’s why you need to give this deal with the transition over a long period of time.”
Making standards reasonable for smaller firms
“All of this isn’t easy,” admitted Kana.
“If you think about a smaller organisation ravaged by Covid recently trying to survive and now you have this requirement, it could put them out of business. So we say don’t incur undue cost in effort. You also got to consider skills. Skills are scarce in this space, capabilities are scarce, and resources are scarce.”
“There’s a kind of a proportionality element that has been built into these standards and for smaller organisations, they may start by providing qualitative disclosures rather than quantitative disclosures. But ultimately, you’ve got to get to a stage where you have quantitative information.”
Bringing order without reinventing the wheel
Kana explained that the new standards attempt to establish a global baseline while not reinventing the wheel because companies have already sunk costs into existing sustainability reporting frameworks.
For instance, the publisher of the standards, the International Sustainability Standards Board (ISSB), is working with the Carbon Disclosure Project (CDP), which has agreed to align to IFRS standards.
“There are 18 700 companies, which is about 50% percent of the global market capitalisation, reporting in terms of CDP. So to have them in the net is quite important.”
The IFRS Foundation also works with the International Organisation of Securities Commissions, a group representing many of the world’s stock exchanges.
The idea is also that the standards will be interoperable. “We’ve tried to develop our standards so that they are interoperable between any baseline. So you could use these standards in the US or you could use them in [IFRS jurisdictions].”
The advantage of the standards for CFOs
The standards are investor-focused, and auditors are set to play a key role.
“We are interested in providing information that is decision-useful for investors and also in a cost-effective manner. The way we do this is to develop globally compatible standards and disclosures that are assurable.
Kana emphasised that having standards that everyone uses or which at least align with other common standards cuts costs.
“From a finance or director point of view, you’re going to get a cost-effective basis, because you don’t need to restate things. You have a common framework around the world.”
“But also from a liability perspective, if you have common standards, directors can discharge responsibility with diligence and due care because there is a benchmark to which you can be held.”