If the financial world held a contest for its phrase of 2024, ‘ESG backlash’ would be among the favourites. It encapsulates back-tracking by governments, regulators, the courts and investors over action to promote environmental protection and ‘woke’ social and governance behaviour.
Yet underneath all this, the march towards improved sustainability reporting is inexorable. In early December, the UK Sustainability Disclosure Technical Advisory Committee decided to advise the government to endorse IFRS S1 and S2 as developed by the International Sustainability Standards Board. This year will see a consultation on a draft UK sustainability reporting standard.
In the EU, companies will start to publish information under the Corporate Sustainability Reporting Directive and have begun work on a related due diligence duty, focused on human rights and environmental impact. Adjustment mechanisms will apply taxes to imports that have not already paid carbon prices. Some of these measures, for good or ill, are in line with the re-emergence of protectionism.
Long journey
At a granular level, IFRS S1 and S2 represent evolution not revolution. The new standards rightly stick with the International Accounting Standards Board’s longstanding definition of materiality: ‘Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that primary users of financial statements (hereafter, investors) make.’ If companies don’t know what matters to investors, they should ask them. The answer will not be a simple number.
Investors are in the business of assessing corporate value. Standardised disclosures help with judgments about internal consistency – including connectivity between sustainability reports and the financial statements – and external comparability. The tension between reliable (historic) numbers and relevant, typically forward-looking, information for forecasting is perennial.
S1 and S2 may be overly prescriptive but it is up to users of accounts to up their game
That tension extends to requirements for companies to anticipate changes in future cashflows and asset values, even though it is investors who bear responsibility for using the information available. IFRS S1 and S2 may veer towards being overly prescriptive about short, medium and long-term projections, increasing the burden on companies. But the challenge is also thrown down to users of accounts to up their game.
The provision of examples in the IFRS exposure draft on climate-related and other uncertainties in the financial statements is reassuring but it does add to the detail. Reliance on the Greenhouse Gas Protocol to measure emissions up and down the value chain – whether controlled by the company or not – has prompted some scepticism about measurement.
Better data
But again, it is evolution: important numbers in the financial statements already rely on estimates, forecasts and sensitivity tests. More rigour in factoring climate-related factors into assumptions is to be welcomed. The chief problem with forward-looking information (apart from the obvious one that no one knows the future) is estimation uncertainty, which will increasingly be captured via ranges and qualitative commentary.
Much of this can be seen as unfolding logically from the IAS 1 requirement to provide additional information to enable users ‘to understand the effect of transactions and other events … on the entity’s financial position and financial performance’.
The biggest risk is of divergence between a zealous EU and a US that is on pause in the climate-related stakes
The UK Endorsement Board, in its comment letter on the exposure draft, suggests tweaking the standard to require ‘the disclosure of sources of estimation uncertainty with a significant risk of material adjustment to the carrying amount of assets and liabilities after more than one year, with a description of the nature of the risk, and qualitative factors’.
These new standards should remind boards that what gets measured gets managed. For investors, the resulting improvement in data quality will help them do their job of valuing companies for the short, medium and long term, and allocating capital accordingly.
The biggest risk is of divergence between a zealous EU and a US that is on pause in the climate-related stakes (the UK remains mid-Atlantic). My hope would be that the former becomes more pragmatic and the latter, home to the biggest international companies, quietly converges with cross-border requirements. After all, climate change is no respecter of borders.
More information
Read ACCA’s report Making information connections for sustainable value creation and watch on-demand the related session ‘Connecting sustainability to business strategy’ from ACCA’s Accounting for the Future conference.
