Peter Reilly is a member of the Bailey Network, a group of former analysts and investors who are now consulting in the reporting space

Reading draft standards sometimes reminds me of the classic Sherlock Holmes story The Adventure of Silver Blaze. The story revolves around something that did not happen rather than something that did. With a draft standard, I always look for the gaps and omissions, as these can create major loopholes. This is harder than it sounds, as you have to think about what you really want rather than just critiquing what is there.

The IFRS exposure draft on IFRS S1, General Requirements for Disclosure of Sustainability-related Financial Information contains one surprising inclusion and a major omission, in my view. The surprise comes in paragraph one, which states that the aim of IFRS S1 is to provide information that is useful to users ‘when they assess enterprise value’.

The need to consider all sustainability-related topics is more land grab than mission-creep

This seemingly innocuous statement has enormous potential implications for preparers, auditors and users. It is, to my knowledge, the first time the phrase ‘enterprise value’ has been used in any financial standard.

As all readers will know, enterprise value is the total value of an entity, but there is no single accepted definition. The exposure draft defines enterprise value as market capitalisation plus net debt, which raises more questions than it answers. Some of the unknowns include the date of the share price and the treatment of lease debt, investments and pension liabilities. These are often material numbers.

Market cap monster

There is, however, a much bigger issue: the inclusion of market capitalisation. The exposure draft in effect requires the preparer to consider all sustainability-related topics that may affect the entity’s share price. This is not so much mission-creep as land grab.

Think about the conversations that will be required. Rather than just worrying about whether an issue will have a material effect on future earnings, preparers will have to consider whether the issue will affect the share price. This in turn implies that preparers have to know what is already incorporated into the share price.

Accountants have many strengths and skills but understanding equity markets is, I would respectfully suggest, not one of them. The entire active fund management industry is based on assessing what is built into a share price today and whether the future may turn out differently. The idea that the accounting industry can replicate this skillset overnight is fanciful, to say the least.

The rise of greenwashing is a daily reminder of how poor the current standards are

The drafting of paragraph 1 is also a reminder of a recurring problem with many current standards: very few standard-setters have real-world market experience. They fail to understand what users really want precisely because they have never been users.

Leave it to the market

There is a second and more subtle problem, which is that many standard-setters think that their job is to establish what something is worth. It is not. Their job is to produce robust standards that will help markets establish the fair value of an asset.

As it stands, the exposure draft will greatly expand the scope of an audit without any meaningful benefit to users. Auditors will have to become experts on what impact sustainability issues will have on share prices despite a near-total lack of experience or expertise in how markets work.

The other surprise in the exposure draft is the omission of any statement about making the world a better place for future generations. This is more than just semantics; it goes to the heart of the problem with much ESG (environmental, social, governance) reporting. We need improved disclosure on sustainability to encourage better behaviour, not as a goal in its own right. The rise of greenwashing is a daily reminder of how poor the current standards are.

As Holmes might have said when told that the new sustainability standard does not aspire to make companies more sustainable: that was the curious incident.