Private Equity ESG: ISSB Issues Global Sustainability Disclosure Standards – What GPs Need to Know and Start to Do
ESG
July 7, 2023
On June 26, 2023, the International Sustainability Standards Board (ISSB) issued its first two Sustainability Disclosure Standards (ISSB Standards), setting the stage for the creation of a global common language for sustainability reporting that focuses on the needs of investors and the financial markets.
The ISSB Standards will allow companies and investors to standardize on a single, global baseline of sustainability disclosures, with any additional jurisdictional requirements being built on top of this global baseline.
The publication of these initial ISSB Standards is a watershed moment for sustainability reporting. Why? Given that the ISSB is part of the IFRS Foundation which develops the accounting rules used in more than 140 jurisdictions, widespread adoption of the ISSB Standards will most likely become the norm as the investor community looks to compare companies on an “apples-to-apples” basis – both on companies’ financial disclosures and also their non-financial disclosures.
In this note, we explain what GPs need to know now and some of the steps they should start to take.
What do GPs need to know?
IFRS S1 provides a set of disclosure requirements designed to enable companies to communicate to investors about the sustainability-related risks and opportunities that could reasonably be expected to affect their cash flows, access to finance, or the cost of capital over the short, medium, or long term. It also sets out general requirements for the content and presentation of these disclosures.
The objective of IFRS S2, which is designed to be used with IFRS S1, is to require companies to disclose information about their climate-related risks and opportunities, again that could reasonably be expected to affect their cash flows, access to finance, or cost of capital over the short, medium, or long term. More specifically, IFRS S2 will enable investors to understand the governance processes, controls, and procedures a company uses to monitor, manage and oversee climate-related risks and opportunities.
Timing. The ISSB Standards will be effective for annual reporting periods beginning on or after January 1, 2024. However, it will be up to individual countries to decide whether the application of IFRS S1 and IFRS S2 will be made mandatory. In the UK, for example, the government has indicated an intention to integrate the standards into its regulatory landscape. A formal decision is expected to be made on this point within the next 12 months.
Building on and consolidating existing initiatives. IFRS S1 and IFRS S2 are built on and consolidate the TCFD recommendations, the Sustainability Accounting Standards Board (SASB) Standards, the Climate Disclosures Standards Board (CDSB) Framework, Integrated Reporting Framework, and the World Economic Forum metrics to streamline sustainability disclosures (see chart below). Consolidation will help companies to benefit from investments they have already made in sustainability disclosures while reducing the ‘alphabet soup’ of sustainability disclosures.
Reducing duplicative reporting. The baseline approach provides a way to achieve global comparability for financial markets and allows jurisdictions to further develop additional requirements if needed to meet public policy or broader stakeholder needs. This approach helps to reduce duplicative reporting for companies subject to multiple jurisdictional requirements.
Connections with financial statements. The information required by the ISSB Standards is designed to be provided alongside financial statements as part of the same reporting package. The ISSB Standards have been developed to work with any accounting requirements, but they are built on the concepts underpinning IFRS Accounting Standards.
What steps should GPs start to take?
In terms of practical next steps, we would expect GPs to start taking the following actions:
Evaluate climate-related disclosures. Some may already have made a start on this, but with respect to IFRS S2 specifically, it would be worth being better informed on each portfolio company’s climate-related physical and transition risks and opportunities (or making a start to ascertain these). Specifically (i) the governance processes, controls, and procedures it uses to monitor, manage and oversee climate-related risks and opportunities; (ii) the strategy for managing such risks and opportunities; (iii) the risk management processes it uses to identify, assess, prioritize and monitor such risks and opportunities; and (iv) the metrics and targets used to report on a company’s performance in relation to such risks and opportunities. If prior reporting has been aligned with the recommendations of the TCFD, it may be that only minimal changes are required.
Review internal systems and controls. Whether you are an investment professional within a GP or a board member at a portfolio company (or both), now is the time to evaluate the need to recalibrate existing systems and controls to adapt to the changing paradigm for sustainability-related disclosures. For example, those who sit on audit committees should spend time with the company’s CFO and external audit partner to consider additional processes that need to be adopted so that these are hardwired into timelines and road-tested ahead of the ISSB Standards being adopted in the relevant jurisdiction.
Improve internal connectivity. Finance and sustainability colleagues who may not have had regular interaction in the past should start to foster closer working relationships and a deeper understanding of their respective processes, outputs, and timelines. Appreciating prior data collection and reporting practices and any changes to these (e.g., around emissions reporting) will be important, as will ensuring the bridge between the financial and non-financial disclosures.
Monitor future ISSB Standards. IFRS S1 and IFRS S2 are just the first in a series of disclosure standards being released by the ISSB (and consultation is ongoing on the ISSB’s priorities over the next two years). GPs and their portfolio companies should continue to stay apprised of future standards issued by the ISSB and understand the nuances between the ISSB Standards and, for example, the EU’s Corporate Sustainability Reporting Directive (and specifically how materiality/double materiality is interpreted under each) as well as the SEC’s proposed climate-related disclosure rules.
Get advice early. IFRS S1 and IFRS S2 are each over 40 pages long (with guidance to follow) and require external advice from a range of advisers. While reporting norms will emerge, the key for GPs and their portfolio companies will be understanding how and when the ISSB Standards will apply (and how SEC and/or CSRD reporting will affect reporting content) and ultimately going through that first reporting cycle. Advice will come in the form of legal, audit, and carbon accounting, as well as the practical implementation of some of the internal systems and controls that will be required.
How Petra Can Help?
As a specialized provider of ESG consultation services to private equity firms and their portfolio companies, our team has the experience and understanding to provide guidance and oversight into establishing policies, procedures, and reporting that are practical and meet the evolving requirements of regulators and investors. Learn more about our ESG offering here or get in touch with a member of our team.
