ESG and sustainability disclosure and reporting requirements for listed and non-listed companies are rapidly taking shape. As announced at COP26, there is now an International Sustainability Standards Board (“ISSB”) tasked with encouraging global uptake of ESG reporting standards. In the EU, the European Financial Reporting Advisory Group (“EFRAG”) is the body tasked with developing mandatory sustainability and ESG reporting standards under the EU’s Corporate Sustainability Reporting Directive (“CSRD”). Both the ISSB and EFRAG have each recently published ESG and sustainability disclosure and reporting “prototypes”. These prototypes are important pieces to an emergent reporting regime that is very likely to become critical commercially—if not mandatory—for many companies. There are also encouraging signs that what has until recently been a relatively disjointed set of standards, is beginning to come together under a more harmonized agenda and institutions.
This blog presents an overview of some of the detailed climate-related disclosure and reporting metrics covered by the ISSB and EFRAG climate prototypes, and highlights critical considerations for companies as more detailed and mandatory ESG and sustainability reporting frameworks begin to take shape.
Global Context & COP26 Pledges
Major developments that emerged from the November 2021 COP26 summit included the announcement of the new Glasgow Climate Pact, a renewed emphasis on the role of the private sector in addressing climate change risks and opportunities, and the launch of the Glasgow Financial Alliance for Net Zero, a coalition of existing and new net zero finance initiatives dedicated to assisting companies realign their business models for net zero.
In addition, a critical adjunct to COP26 was the announcement of the launch of the ISSB and its work towards the development of uniform global environmental, social, and governance (“ESG”) reporting standards. The ISSB represents an effort to encourage global uptake and to merge into one the existing ESG reporting standards (including frameworks such as the Task Force on Climate-Related Financial Disclosures (“TCFD”), and Climate Disclosures Standards Board Initiative). This global baseline of ESG reporting standards aims to provide investors, capital market participants, and a wide range of other stakeholders with information about companies’ sustainability-related risks and opportunities. Similar to its sister organization the International Accounting Standards Board, the ISSB will be managed by the International Financial Reporting Standards Foundation.
Climate and Sustainability Disclosure “Prototypes”
1. The ISSB’s Climate and Reporting Prototypes
In November 2021, a group formed to undertake preparatory work for the ISSB published two disclosure prototypes for companies’ climate and general sustainability reporting that are intended to help investors understand how companies are responding to ESG issues:
(i) the Climate Prototype sets out the requirements for the identification, measurement, and reporting of climate-related financial information; and
(ii) the General Requirements Prototype establishes principles for the reporting of sustainability-related financial information, for example, concerning the definition of materiality in the ESG context or a company’s integration of sustainability reporting into its governance (e.g., committees and management’s role in assessing risks and opportunities).
The ISSB’s Climate Prototype is structured around the four thematic areas used by the TCFD for its recommendations. According to the Climate Prototype, a reporting entity would be required to provide information that enables users of general purpose financial reporting to assess a company’s:
- Governance—the governance processes, controls, and procedures the entity uses to monitor and manage climate-related risks and opportunities;
- Strategy—the climate-related risks and opportunities that could enhance, threaten, or change the entity’s business model and strategy (including the impact of climate-related risks and opportunities on its financial position, performance, and cash flows, as well as on the entity’s resilience);
- Risk management—how climate-related risks are identified, assessed, managed, and mitigated by the entity; and
- Metrics and targets—the metrics and targets used to manage and monitor the entity’s performance in relation to climate-related risks and opportunities over time.
The scope of the Climate Prototype encompasses physical climate-related risks, risks associated with the transition to a lower-carbon economy, as well as climate-related opportunities for the entity.
Pursuant to ISSB’s Climate Prototype, an entity shall disclose the following cross-industry climate metrics:
|Greenhouse gas emissions||Scope 1, 2 and 3 in metric tonnes of CO2 equivalent.|
|Transition risks||Amount and percentage of assets and business activities vulnerable to transition risk.|
|Physical risks||Amount and percentage of assets and business activities vulnerable to physical risks.|
|Climate-related opportunities||Proportion of revenue, assets or business activities aligned with climate-related opportunities (in amount or percentage).|
|Capital deployment||Amount of capital expenditure, financing or investment deployed toward climate-related risks and opportunities (in reporting currency).|
|Internal carbon prices||Entity’s internal price for each metric tonne of GHG emissions.|
|Remuneration||Proportion of executive management remuneration affected by climate-related considerations in current period.|
Importantly, the Climate Prototype foresees additional industry-specific climate metrics for companies to report on. Appendix B of the ISSB’s Climate Prototype provides a summary of the industry-based reporting requirements. It includes multiple requirements specifically identified for each industry, for example water withdrawn and consumed in water stress regions for software service companies, or palm oil supply chain reporting for companies selling household and personal products. In light of the growing interdependence between the many ongoing ESG regulatory initiatives (especially those originating in the EU), this reporting requirement should, for example, be considered in the context of recently announced national and international deforestation due diligence requirements for specified products being placed on the UK and EU markets.
2. EFRAG’s Climate Standard Prototype: Towards Harmonization?
The ISSB’s Climate and General Requirements Prototypes are particularly interesting because EFRAG released a similar framework under the Climate Standard Prototype Working Paper in September 2021. EFRAG’s framework responds to the European Commission’s legislative proposal for the CSRD, and EFRAG’s related mandate to develop draft European Sustainability Reporting Standards (“ESRS”) that would become mandatory for many listed and non-listed companies.
EFRAG is currently re-validating the compatibility of its Working Paper with the ISSB Prototypes, and is scheduled to publicly consult on its Climate Standard Prototype in December 2021, with an anticipated official proposal of a first set of standards by EFRAG to the European Commission in summer 2022. The ISSB’s Climate Prototype may therefore directly influence upcoming EU rules.
Companies may also note with interest that both EFRAG’s Working Paper and the Climate Prototype cover similar levels of reporting, focusing on sector-agnostic, sector-specific, and entity-specific reporting. The EFRAG Working Paper captures about two thirds of the ISSB’s Climate Prototype, with the remaining third likely to be supplemented with EFRAG sector-specific standards in the upcoming months.
In addition, the EU Taxonomy Regulation’s climate-oriented screening criteria are used—primarily by regulated financial institutions—to determine which economic activities count as mitigating or adapting to climate change. This Taxonomy is another sign of increasing European focus on improved transparency around climate-related activities, but it is also yet another set of criteria and metrics in an already complex picture.
In a change from the lack of consensus on sustainability reporting in recent years, we may now see the beginnings of coalescence around a regime for sustainability reporting. At a COP26 side event, for example, EFRAG’s work was examined in the context of the ISSB and the work of the TCFD.
Two main recommendations flow out of the current landscape on sustainability reporting developments.
- Companies should consider which aspects of their current voluntary sustainability reporting could be integrated into mandatory financial and non-financial sustainability reporting requirements in the future. As new standards emerge, companies have an opportunity to actively monitor developments and “best practices” within their industry and to proactively prepare for future mandatory reporting requirements. US. reporting companies should also consider how aspects of the ISSB and EFRAG disclosure prototypes might influence climate-related disclosure rules that are being considered by the U.S. Securities and Exchange Commission (“SEC”). Companies should begin to identify the relevant metrics for their sector, establish a strategy and process for identifying material risks and opportunities for their particular business operations, and develop the requisite reporting controls and procedures to ensure timely and accurate information collection and reporting.
- Companies can contribute to the sustainability standard setting debate. By engaging with ESG issues and sustainability reporting whilst the process unfolds, companies can send strong messages to regulators on these issues. Companies can also share valuable experience with policy makers before standards are finalized. Multiple public consultations from EFRAG on the European Sustainability Reporting Standards will be one venue for such participation. Companies may also consider contributing their perspectives on forthcoming SEC proposed rules on climate-related disclosure.
If you have any questions concerning the material discussed in this blog post, please contact the following members of our ESG, Capital Markets and Securities, and Business and Human Rights teams: Mellissa Campbell Duru, Sinéad Oryszczuk, Paul Mertenskötter, and Ivy-Victoria Otradovec.