The International Financial Reporting Standards (IFRS) Foundation plans to establish a global baseline for sustainability information disclosures through the International Sustainability Standards Board (ISSB) that was launched on November 3, 2021. What is noteworthy is that the global baseline serves as a sustainability-related financial disclosure, which would be differentiated from the current sustainability reporting framework centered on a wide range of stakeholders. Having adopted the prototype of the Task Force on Climate-Related Financial Disclosures (TCFD), the IFRS Sustainability Disclosure Standards require entities to disclose material information of sustainability-related risks and opportunities in terms of corporate governance, strategies, risk management, and targets. Related international discussions indicate that the IFRS Foundation is highly likely to develop the global baseline. Under the circumstances, Korea should prioritize systematically linking its sustainability disclosure framework with the international standards to be established, rather than setting up its standards for disclosure standardization.
IFRS Sustainability Disclosure Standards
The IFRS Foundation plans to develop a global baseline of sustainability disclosures through the International Sustainability Standards Board (ISSB), formed on November 3, 2021. It also intends to systemically consolidate the existing financial accounting criteria and the audit and certification framework. In this regard, it is noteworthy that the global baseline serves as a sustainability-related financial disclosure for investors, which would be differentiated from the current sustainability reporting framework centered on a wide range of stakeholders.
To this end, the Technical Readiness Working Group (TRWG) created by the IFRS Foundation is documenting the prototype of relevant standards. The TRWG comprises international standards-setting organizations, excluding the Global Reporting Initiative (GRI).1) They provide sustainability-related information, ultimately aiming for the assessment of enterprise value.2)
Upon the launch of the ISSB, the TRWG unveiled general requirements for disclosures of sustainability-related financial information.3) At the same time, it set out the environmental disclosure prototype building upon the previously disclosed prototype, which would be applied to other information standards relevant to social and governance issues. The requirements for disclosures of sustainability-related financial information have been publicized to implement the tentatively named IFRS Sustainability Disclosure Standards, and key aspects of such requirements are as follows.
Objective and scope
Sustainability-related financial disclosures aim to provide stakeholders who use general purpose financial information4) with information related to the sustainability-related risks and opportunities. The general purpose financial information should include a description of matters based on which users can predict the value, timing, and certainty of an entity’s future cash flows over the short, medium, and long term to assess the entity’s enterprise value. Accordingly, the sustainability-related financial information needs to contain material information about the sustainability-related risks and opportunities. This information might already have been reflected in financial statements as a nominal sum. However, sustainability-related financial information has a more comprehensive scope to cover corporate decisions that could affect an entity’s future cash flows. But minor sustainability factors that are hardly associated with enterprise value are not subject to the general purpose financial reporting and thus, can be omitted.
(Materiality and scope) The concept of materiality in sustainability-related financial information is the same as defined in the generally accepted accounting standards. The sustainability-related financial information is considered material if omitting, misstating, or obscuring that information could reasonably be expected to influence decisions made by the primary users of such information. In this respect, material information includes i) an entity’s impacts on society and the environment, if those impacts could reasonably be anticipated to affect the entity’s future cash follows; and ii) events considered to have a low likelihood but a high potential impact on the entity’s future cash flows.
Whether any information is material could be judged by an entity. If any information of which disclosures are required by the IFRS Sustainability Disclosure Standards is not material, there is no need to disclose it. Sustainability-related information disclosures have the same scope as the consolidated financial statements standards, but should not be limited to those standards as sustainability factors can have a material impact on the entire supply chain.
(Connectivity) The IFRS Sustainability Disclosure Standards require sustainability-related financial information to be linked to financial statements that contain general financial matters. For example, suppose a reporting entity documents its strategic judgment regarding carbon conversion as part of the sustainability-related financial information. In that case, the relevant cost should be accurately reflected in the financial statements. In addition to this, trade-offs should also be linked to the financial statements and then reported. This means that if the reduction of carbon emissions requires restructuring of a business unit, the entity needs to assess the impact of restructuring on employees’ job security and describe how to cope with relevant impacts.
The IFRS Sustainability Disclosure Standards have adopted the prototype prepared by the Task Force on Climate-related Financial Disclosures (TCFD). Although initially designed for climate-related financial disclosures, the TCFD prototype has been regarded as the general sustainability disclosure standard as it offers the entity-wide baseline for sustainability-related assessment of enterprise value. The following specifies requirements under the TCFD framework regarding governance, strategies, risk management, metrics, and targets relevant to sustainability-related risks and opportunities.
(Governance) Sustainability-related financial disclosures on governance should provide information regarding the governance processes, controls, and procedures used to monitor and manage sustainability-related risks and opportunities. In this respect, a reporting entity is required to disclose a detailed description of its governance issues, including whether a body or individual within the body responsible for sustainability-related risks and opportunities is designated; how the relevant responsibilities are reflected in bylaws or entity policies; whether the body or individual responsible for sustainability-related risks and opportunities are equipped with correct skills and competencies; and the processes and frequency by which the body and its audit committee are informed about relevant matters. Additional information to be disclosed includes whether sustainability-related risks and opportunities are considered in the entity’s strategy, significant transactions, and risk management policies; and how sustainability-related targets and related performance metrics are set out by the entity and incorporated into remuneration policies.
(Strategy) The objective of sustainability-related financial disclosures on strategy is to provide detailed information about how sustainability-related financial risks and opportunities are incorporated into an entity’s strategic planning and execution. A reporting entity should disclose its assessment of the sustainability-related risks and opportunities that could affect its business model, strategy, and cash flows over the short, medium, or long term, and the entity’s resilience to sustainability-related risks. Concerning such assessment, the entity needs to specify the processes in place to identify sustainability-related risks and opportunities; how the entity defines short, medium, and long term; how those definitions are linked to the entity’s strategic planning and capital allocation plans; and the time horizon over which each risk and opportunity could reasonably be expected to have an economic effect on the entity. Furthermore, the entity should enable information users to understand its assessment of the current and anticipated impacts of sustainability-related risks and opportunities on its entire value chain.
In terms of connectivity, the entity should disclose how sustainability-related risks and opportunities have affected its financial performance and cash flows, its sustainability strategy-related investment plans, and their anticipated impact on the financial position. And these impacts need to be assessed during the current reporting period and over the short, medium, and long term. Furthermore, the entity should shed light on how its assessment has affected judgments or present sources of estimation uncertainty in the financial statements.
(Risk Management) The objective of sustainability-related financial disclosures on risk management is to provide information on how an entity’s existing and emerging sustainability-related risks are identified, assessed, managed, and mitigated, including related policies. To achieve this objective, the entity should disclose the process by which sustainability-related risks are identified and evaluated; the likelihood and impact of such assessed risks; how it prioritizes sustainability-related risks relative to other types of risks; parameters, and assumptions used by the entity to apply an assessment model; and changes in the process compared to the prior reporting period.
(Metrics and Targets) An entity should establish the targets of sustainability-related risks and opportunities and set out indicators required to assess those targets’ performance. In connection with this, the entity should disclose which metrics it uses to measure and examine such indicators and present cross-industry, industry-based and entity-specific metrics. The relevant metrics should be defined in accordance with the applicable IFRS Sustainability Disclosure Standards and related application guidance.
(Frequency of Reporting) An entity should carry out its sustainability-related financial disclosure every 12 months, the same frequency at which its financial statements are disclosed. If an entity uses a reporting period longer or shorter than 12 months, it should reveal the period covered by the sustainability-related financial disclosure and the reason for using such a longer or shorter period. The IFRS Sustainability Disclosure Standards do not require entities to publish interim reports, as in the case of quarterly disclosures. Thus, an entity may elect to conduct its interim reporting in the interest of timeliness of relevant information.
(Reporting Channel) An entity should disclose sustainability-related financial information as part of its general purpose financial reporting. Since the sustainability-related financial disclosure is included in an entity’s management commentary, which forms a part of general purpose financial reporting, it is typically carried out via the existing financial reporting channels. In the case of Korea, the management commentary corresponds to business status and corporate governance sections in annual reports, except for financial information.
The IFRS Sustainability Disclosure Standards prototype first set out climate-related requirements upon its publication.5) The climate-related standards are scheduled to be finalized in the second half of 2022 after the review and resolution by the ISSB. Although it is uncertain to what extent the concept and structure of the prototype would be retained in the final version, related international discussions indicate that the IFRS Foundation is highly likely to develop the global baseline. Under the context, its implications can be summed up as follows.
First, existing sustainability reports being published by entities could be reconstructed based on corporate governance, strategies, risk management, and metrics and targets that reflect sustainability-related risks and opportunities. As industry-based, entity-specific metrics would be standardized to a maximum extent and then disclosed, investors are expected to benefit from greater information availability and efficiency.
Second, social and environmental impacts that entities regard as less material in terms of enterprise value could be excluded from sustainability reports. This is in line with the ISSB’s intention of ruling out immaterial information that could misguide investors in their judgment of materiality.
Third, there is a high possibility that general purpose financial information would be provided for information users in the form of an integrated report. The current sustainability report may be integrated into the annual reports by considering the connectivity between sustainability-related financial information and the existing financial information.
Lastly, entities need to disclose forward-looking information as part of their financial information to manage sustainability-related risks and take advantage of related opportunities. In terms of financial investments, this necessitates understanding all sustainability information that could affect future cash flows to assess enterprise value.
The preceding discussion suggests that Korea needs to prioritize systematically linking its sustainability disclosure framework with the international standards to be established, rather than setting up its standards for disclosure standardization. 1) The CDSB, the TCFD, the IASB, and the Value Reporting Foundation (formed from the merger between the SASB and the IIRC) are included, with the IOSCO serving as an observer. In addition, the IFRS Foundation seeks to collaborate with the GRI, the partner organization for the documentation of the EU’s sustainability standards.
2) Enterprise value is the sum of a business entity’s market capitalization and net debt.
3) General Requirements for Disclosure of Sustainability-related Financial Information Prototype, November 3 2021.
4) Compared to financial statements in the annual report, the general purpose financial information is a more comprehensive concept that encompasses sustainability-related financial information.
5) Climate-related Disclosure Prototype, November 3 2021