ISSB and EFRAG draft standards on sustainability disclosures: a comparative analysis

Keywords: Mazars, Thailand, Sustainability, ISSB, EFRAG, IASB, IFRS, TCFD, VRF, SASB, IIRC, GRI, CSRD

22 July 2022

Given the high stakes involved in this work, we present a preliminary comparative analysis of the main proposals of the International Sustainability Standards Board (ISSB) and the European Financial Reporting Advisory Group (EFRAG) to help stakeholders form an opinion on the recently published draft standards, which are open for comment until 29 July 2022 and 8 August 2022 respectively.

At first glance, it can be observed that these drafts both follow the usual structure familiar to stakeholders who are accustomed to IFRSs issued by the IASB (notably with appendixes that form an integral part of the draft standard, along with basis for conclusions). The main reporting principles of the ISSB and EFRAG are also very similar to those known and applied in the publication of IFRS financial statements.

While the two standard-setters, ISSB and EFRAG, have exchanged views on their respective work in recent months in order to minimise divergences between the two frameworks (to the extent that they currently exist on either side), some of the fundamentals are different, which in practice is likely to create some disparities in sustainability disclosures. This being so, given the fundamentals adopted by EFRAG and the granularity of the information required, entities required to comply with the future European standards should be able to meet the requirements of the ISSB's framework.

Different ambitions and agendas

ISSB's “building blocks” approach to developing a comprehensive global benchmark

31 March 2022 saw the international publication of the ISSB's first two exposure drafts:

• IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information (available here) describes how to disclose sustainability information in general terms, following the IFRS framework applied by the ISSB, including what to do in the absence of previously published standards on particular topics. IFRS S1 is thus the counterpart to IAS 1 – Presentation of Financial Statements and IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors. In practice, IFRS S1 sets out general principles for sustainability reporting based on the four pillars identified by the Task Force on Climate-related Financial Disclosures (TCFD) – governance, strategy, risk management, and metrics and targets – as the key aspects of how an entity operates with respect to sustainability;
• IFRS S2 Climate-related Disclosures (available here) clarifies the disclosures to provide in the area of climate risk. This draft incorporates the TCFD recommendations and sectoral reporting requirements derived from the standards set by the Sustainability Accounting Standards Board (SASB). The ISSB's current approach is thus sectoral, requiring an entity to publish different – but sometimes also redundant – metrics for each of the sectors in which it operates.

The ISSB expects to publish both standards in their final form by the end of the year, depending on the comments received. The IFRS sustainability reporting framework will then be gradually supplemented by other “IFRS S”, as the ISSB aims to develop standards that serve as a comprehensive global baseline for sustainability reporting.

For the time being, the ISSB is taking a “building blocks” approach aimed at compatibility with other standards already applied voluntarily by companies or imposed by certain jurisdictions. This step-by-step construction of an internationally recognised sustainability reporting framework is based on:

• the consolidation of the Value Reporting Foundation (VRF) into the IFRS Foundation. The VRF itself represents the relatively recent consolidation of the Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting Council (IIRC): on 25 May, the IFRS Foundation announced the next steps in this process, with the forthcoming release of the VRF's Integrated Reporting Framework directly by the IFRS Foundation. The consolidation of the VRF is expected to be completed by 30 June. As a first step, the IFRS Foundation will encourage the voluntary application of this integrated reporting framework in its current form. In a second phase, the ISSB and IASB will work with the Integrated Reporting Council, which will emerge from the VRF, to determine how to reflect this framework and its principles in both Boards' standard-setting projects and the resulting disclosure requirements;
• convergence with the Global Reporting Initiative (GRI), agreed in March, which should eventually, and where possible, align terminology, standard structure and metrics, thus helping to reduce the cost of sustainability reporting to entities.

The “success” of IFRS S will be dependent on the widespread use of these standards for sustainability reporting, as has been the case with the IASB's IAS and IFRS accounting standards for financial statements. This was emphasised by the ISSB in a statement on 18 May to mobilise stakeholders around its work.

EFRAG standards to support the European green deal

For its part, EFRAG launched its public consultation at the end of April and has been working urgently for several months (initially in project mode) to meet the agenda imposed by Europe's green deal, in part led by the Corporate Sustainability Reporting Directive (CSRD). The basis for conclusions of the draft standards have just been published (available here with all the draft standards).

The final text of the CSRD should be ready by the end of June. It will set out the main principles for sustainability reporting by European entities and will require the application of standards prepared by EFRAG to ensure comparability of the information they disclose.

Given Europe's commitment to sustainability reporting, the first set of standards prepared by EFRAG and endorsed by delegated act in Europe is expected to include 14 European Sustainability Reporting Standards (ESRSs). Thirteen drafts were published at the end of April. The draft ESRS SEC 1 on segment classification will be published later.

Ultimately, the European sustainability reporting framework will include not only standards applicable to all entities regardless of their business sector (the subject of the first set currently under public consultation), but also sector-specific standards and a dedicated standard for small and medium-sized enterprises (subject to the final provisions of the CSRD). In other words, at this stage, the disclosures required under the first ESRSs will be sector-agnostic but will need to be supplemented by entity-specific disclosures if necessary (the latter are likely to decrease as the ESRS framework is expanded to include sector-specific standards).

To meet the reporting obligations of the draft CSRD, the draft standards currently include no fewer than 136 disclosure requirements or DRs, each DR requiring the disclosure of several items of information. Each DR is in principle mandatory, as long as it is material for the entity, given its particular circumstances. The result of the materiality analysis (see below) will confirm whether an entity should actually provide a given disclosure, based on its ability to rebut the presumption of materiality of any particular information covered by a disclosure requirement.

Although organised differently, the four TCFD pillars are reflected in the architecture of the ESRSs, which are structured around three headings:

• strategy, covering how sustainability is integrated into the overall strategy, how the governance of sustainability is organised and the process and outcome of the double materiality analysis. This heading addresses the TCFD’s strategy and governance pillars, and that part of the risk management pillar relating to the identification of risks and opportunities (through the materiality analysis in accordance with ESRSs);
• operational implementation, covering policies and procedures, action plans, targets and resources. The first of these correspond to the rest of the TCFD's risk management pillar, the second to its strategy pillar, while target-setting reflects a part of the metrics and targets pillar; and
• performance measurement, which covers past and future performance and the future trajectory until the targets are achieved – corresponding to the remaining part of the metrics and targets pillar.

Therefore, risk management is becoming very much integrated with strategy and the way in which impacts, risks and opportunities are taken into account in adjusting strategy and the business model.

In more detail, for the European standards that “mirror” ISSB standards, we can observe that:

• ESRS 1 General Provisions does not contain any disclosure requirements but explains how the other standards are organised and, in particular, the relationship between ESRS 2, another cross-cutting standard, and the topical standards. ESRS 1 also explains how the three layers of disclosures (sector-agnostic, sector-specific and entity-specific) are aggregated. In addition, key concepts, such as double materiality and the value chain, are presented and explained;
• ESRS 2 sets out the disclosure requirements for general information, such as the key features of the entity’s value chain. The standard also includes the strategic and business model disclosures, disclosures on sustainability governance, and disclosures on the materiality analysis performed to identify the material impacts, risks and opportunities to which the entity is exposed, all of which are intended to be supplemented with the disclosures required by the topical standards. Overall, the requirements in terms of general reporting principles and specific aspects of governance, strategy, risk and opportunity management and targets are broadly similar across the two sustainability reporting frameworks. Nevertheless, ESRS 2 tends to be more detailed and more prescriptive than IFRS S1, since the European approach is generally more rule-based whereas the ISSB approach is more principle-based;
• ESRS E1 Climate change is the standard corresponding to IFRS S2. While the two standards are broadly similar in many respects, the draft European standard has some distinctive features. The first of these concerns the centrality of alignment with the Paris Agreement (limiting the temperature increase to 1.5°C) when defining the climate transition plan and setting the corresponding targets, whereas the ISSB's draft merely asks whether and to what extent the transition plan takes the Paris Agreement into account. The second distinctive feature is the inclusion of metrics for energy consumption and energy sources, distinguishing between renewables and other sources. These metrics are absent from IFRS S2. Finally, ESRS E1 is significantly more granular, in terms of both the actual disclosures to be provided, and the guidance to be followed in doing so (particularly with respect to calculation methods and scenario analysis).

Effective date and transitional arrangements

No effective date is proposed at this stage in the ISSB's exposure drafts. This date will be set when the standards are published and will only affect those jurisdictions that decide to make the application of the standards mandatory. Given the challenge that first-time application of these standards may pose, the ISSB has provided for phased-in implementation whereby no prior period disclosures are required in the first year of application.

The introduction of the European standards will follow a timetable that will ultimately be decided by the CSRD. At this stage, it is likely that only large entities will be affected by application to the 2024 reporting period (i.e. for publication in 2025). Beyond issues of scope and timing, the actual content of the first applicable ESRSs remains to be defined. EFRAG's public consultation contains a number of questions about their phased-in implementation. However, ESRS 1 also provides for an exemption from providing the usual comparative information in the first reporting year.

Different underlying principles and less important divergences

Single vs double materiality

The ISSB and European approaches to this key issue are distinct in the following respects:

• the ISSB has prioritised its work by focusing on the needs of investors, which has led it to adopt an approach based solely on financial materiality, with the objective of providing disclosures on those sustainability topics that are relevant to assessing an entity’s enterprise value. The disclosure requirements therefore only focus on the main risks and opportunities, i.e. those that could reasonably be expected to affect the entity's business model, strategy and cash flows over the short, medium or long term;
• in Europe, however, the focus is on addressing the sustainability reporting needs of all stakeholders, not just investors. EFRAG has therefore had to develop standards around the fundamental principle of double materiality, which states that reporting should cover not only financial materiality (reflecting the impacts of environmental, social and governance issues on entities) but also impact materiality (in the sense that the entity's activities have an impact on the climate and on people). The disclosure requirements on impacts, absent in the ISSB reporting framework, are thus very detailed and numerous in ESRSs.

Materiality analysis

Another significant point of divergence lies in the way in which an entity identifies significant risks, opportunities and (for ESRSs only) impacts. This is an essential precondition for determining what disclosures are required to cover these aspects.

In both reporting frameworks, the entity is required to disclose how it conducted its materiality analysis and the outcome. In both cases the final decision as to what is or is not material is entirely a matter for the entity's own judgement.

However, the description and the structure of the materiality analysis process are very different. For example, IFRSs do not say what the materiality analysis consists of, or what aspects should be considered; whereas under ESRS 2, the materiality analysis performed by the entity should follow a fairly structured process, including a review of its own circumstances and engagement with stakeholders, and an analysis of pre-defined criteria.

Audit of disclosures

The information disclosed in sustainability statements will have to be audited in Europe, which is not foreseen by IFRS S1 and S2. This is consistent with the fact that the ISSB framework is only a “tool” for each jurisdiction, which is then free to decide whether or not to demand an audit.

Time horizons

The publication of forward-looking information requires the prior definition of short, medium and long-term time horizons.

Unsurprisingly, the ISSB framework is not prescriptive in this respect, taking account of the fact that these time horizons can vary and depend on many factors, including the characteristics of the sector to which the entity belongs.

In contrast, ESRS 1 is prescriptive, as the draft standard defines the short, medium and long-term horizons as one year, two to five years, and more than five years, respectively, from the end of the reporting period in question.

Location of disclosures

IFRS S1 requires sustainability disclosures to be located in an entity's general purpose financial reporting, which also includes its financial statements. In practice, IFRS S1 allows sustainability disclosure to be included in the management report, without imposing any requirements, in order to facilitate compatibility with local regulations. The draft standard does not otherwise contain any requirements as to how the disclosures should be organised.

ESRS 1, following the requirements of the CSRD, requires this information to be provided in the management report, in clearly identified sections that constitute “sustainability statements”. The draft standard offers three reporting options, at the entity's discretion:

• either in a single dedicated section of the management report, under four headings (general information, and disclosures relating to the environment, social aspects and governance). This is the preferred option;
• within existing parts of the management report, which means that the disclosures are more fragmented, but continue to respect the breakdown into four headings;
• or in an even more disaggregated manner, with a presentation by standard, in the appropriate parts of the management report.

Reporting frequency

Sustainability disclosures under ISSB procedures would be published at the same time as the financial statements to which they relate and should cover the same reporting period. If interim reporting is required by a local jurisdiction or regulation, IFRS S1 sets out the principles to be applied.

On the European side, the CSRD covers the subject directly, imposing annual reporting only (to be confirmed once the final text is available).

In spite of this, a convergence on the major principles

The materiality of disclosures

Both reporting frameworks emphasise the materiality of disclosures, as a second step once the significant risks, opportunities and impacts (if applicable) have been identified.

In practice, in both cases an entity will be able to decide what constitutes material information, which must therefore be disclosed, and what is not and can accordingly be omitted.

IFRS S1 defines information as material if omitting, misstating or obscuring that information could reasonably be expected to influence decisions that the primary users of general purpose financial reporting make on the basis of that reporting, which provides information about a specific reporting entity.

ESRS 1 also requires an entity to exercise judgement in ultimately assessing whether information is material, which in practice could lead it to omit disclosures relating to an impact, risk or opportunity that has been identified as material as a result of the materiality analysis. Under the draft standard, information is material when it is necessary to illustrate the importance of the phenomenon to which it relates, when it meets the needs of stakeholders (including by allowing for proper decision-making), and when it satisfies the public interest need for transparency. Assessing the materiality of disclosures will involve defining thresholds and/or criteria. As in the case of IFRS S1, EFRAG gives no particular guidance in this area.

Value chain

While sustainability disclosures are made from the perspective of the reporting entity (at the individual or consolidated level), both IFRS S1 and ESRS 1 require material disclosures about the key risks, opportunities and impacts (if applicable) identified across the company's value chain, a concept that is defined in both reporting frameworks in a broadly similar way.

Qualitative characteristics 

IFRS S1 and ESRS 1 both describe the characteristics of high-quality information (IFRS S1 making reference to the IASB’s Conceptual Framework), mentioning relevance and faithful depiction as the key features. They also emphasise comparability, verifiability and understandability as secondary characteristics. IFRS S1 also mentions timeliness.

Reporting scope

In both frameworks, the scope of sustainability statements must be identical to that used when presenting financial statements. In practice, the consolidation scope (where applicable) is therefore unchanged.

Connected information

Both frameworks emphasise the need to disclose information that enables users to assess the connections both between the material aspects of sustainability and, more importantly, to the financial statements published elsewhere by the entity. In practice, connectivity means using mutually consistent data and assumptions, but also the avoidance of duplicated disclosures as much as possible. This can be achieved by using cross-references, under the conditions set out in the draft standards.

Comparative information

The two approaches are identical, as the quantified information for a given period should be presented in comparison with the previous year's data. In some cases, EFRAG calls for more than two comparative periods to be provided. In addition, where necessary to understand the figures provided for previous periods, qualitative information or descriptions for those periods should also be disclosed.

Estimations and uncertainties

Some metrics can require the use of estimations. In such cases, both frameworks require the entity to identify those metrics that have significant estimation uncertainty, disclosing the sources and nature of these uncertainties and the factors affecting them. Where an estimation has changed from one period to another, the entity must make this explicit and restate the historical data where practicable. When it is impracticable to do so, the entity must disclose and explain this fact.

Statement of compliance

Both frameworks require entities to issue a statement of compliance with the framework applied, though the draft ESRSs call for more granular information, in particular about the entity-specific disclosures an entity has made.