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TAC Public Meeting October 2024 Paper 4: Current anticipated financial effects
AGENDA PAPER 4
Executive summary
| Date | 08 October 2024 |
|---|---|
| Paper reference | 2024-TAC-017 |
| Project | Technical assessment of IFRS S1 and IFRS S2 |
| Topic | Current and anticipated financial effects |
Objective of the paper
This paper presents an analysis for consideration by the TAC of the current and anticipated financial effects requirements in IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information (IFRS S1) and IFRS S2 Climate-related Disclosures (IFRS S2). This paper addresses the identified challenges and the mechanisms used to support the application of the requirements. The TAC is asked to consider whether any amendments to IFRS S1 and IFRS S2 are considered necessary and whether any action is recommended as part of implementation.
Decisions for the TAC
The TAC is asked to tentatively decide to:
- maintain the requirements in IFRS S1 and IFRS S2 in relation to current and anticipated financial effects;
- recommend the ISSB considers providing clarity and/or guidance on current and anticipated financial effects including whether information about the combined financial effects 'would not be useful'; and
- to note in its advice to the to the Secretary of State that, as part of implementation, industry practice and disclosures related to current and anticipated financial effects, (including the use of mechanisms to support the application of the requirements), should be an area for continued monitoring to provide feedback to the ISSB during its post-implementation review of IFRS S2.
Appendices
There are no appendices to this paper.
This paper has been prepared by the Secretariat for the UK Sustainability Disclosure Technical Advisory Committee (TAC) to discuss in a public meeting. This paper does not represent the views of the TAC or any individual TAC member.
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Context
1IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information (IFRS S1) and IFRS S2 Climate-related Disclosures (IFRS S2) set out the requirements for the disclosure of current and anticipated financial effects of sustainability-related risks and opportunities. The relevant references to the requirements in IFRS S1 and IFRS S2 are as follows:
- IFRS S1 Paragraphs 28–40
- IFRS S2 Paragraphs 15–21
2IFRS S1 paragraph 34 sets out the overarching requirement as follows:
An entity shall disclose information that enables users of general purpose financial reports to understand:
(a) the effects of sustainability-related risks and opportunities on the entity's financial position, financial performance and cash flows for the reporting period (current financial effects); and
(b) the anticipated effects of sustainability-related risks and opportunities on the entity's financial position, financial performance and cash flows over the short, medium and long term, taking into consideration how sustainability-related risks and opportunities are included in the entity's financial planning (anticipated financial effects).
3Entities are required to disclose quantitative and qualitative information about current and anticipated financial effects. However, as set out in paragraph 38 of IFRS S1 an entity does not need to provide quantitative information about current or anticipated financial effects if those effects are not separately identifiable; or if the level of measurement uncertainty involved in estimating those effects is so high that the resulting quantitative information would not be useful. In addition, paragraph 39 of IFRS S1 states that an entity does not need to provide quantitative information about the anticipated financial effects (only) of a sustainability-related risk or opportunity if the entity does not have the skills, capabilities or resources to do so. Paragraph 40 of IFRS S1 states that if an entity uses these mechanisms to support the application of the requirements1 it should explain why it is using them and provide qualitative information about the financial effects. In such cases, the entity should also provide quantitative information about the combined financial effects of the sustainability-related risk or opportunity with other sustainability-related risks or opportunities and other factors unless the entity determines that quantitative information about the combined financial effects would not be useful. These mechanisms to support the application of the requirements are also mirrored in IFRS S2 in relation to climate-related financial effects.
4As set out in paragraph 37 of IFRS S1, in preparing disclosures about the anticipated financial effects of a sustainability-related risk or opportunity, an entity shall use 'all reasonable and supportable information that is available to the entity at the reporting date without undue cost or effort.' An entity shall also use an approach that is commensurate with the skills, capabilities and resources that are available to the entity for preparing those disclosures. These provisions are also included in IFRS S2 in relation to climate-related financial effects.
5The requirements in IFRS S1 and IFRS S2 are the same except that IFRS S1 refers to 'sustainability-related risks and opportunities' and IFRS S2 refers to 'climate-related risks and opportunities.'
Endorsement criteria
6The endorsement criteria applied in the analysis of this technical area include whether:
- use of the IFRS Sustainability Disclosure Standard is likely to result in an improvement in the international comparability of sustainability-related reporting in the UK;
- use of the IFRS Sustainability Disclosure Standard is likely to support companies in making disclosures that are understandable, relevant, reliable and comparable;
- use of the IFRS Sustainability Disclosure Standard is likely to improve the quality of corporate reporting within the UK in the long-term;
- companies are likely to be able to provide the disclosures required by the IFRS Sustainability Disclosure Standard within the timeframes that a company normally reports without undue cost or effort;
- use of the IFRS Sustainability Disclosure Standard is likely to be conducive to the UK's economic growth and international competitiveness, taking into account the costs and benefits of compliance; and
- the IFRS Sustainability Disclosure Standard is likely to be coherent with, and suitable for inclusion in, UK domestic legislation and regulation.
Analysis
7In relation to current and anticipated financial effects, there are two areas for the TAC to discuss:
7.1the challenges associated with providing these disclosures. Paragraphs 8–10 note that entities are still building their experience and capabilities in this area and that guidance and worked examples would be particularly useful to assist with implementation.
7.2the mechanisms to support the application of the requirements available to entities in making these disclosures. Paragraphs 11–15 consider how to ensure these mechanisms are used appropriately and consistently, particularly as reporting in this area develops and improves.
Challenges in providing disclosures
Quantitative and qualitative information required
8In November 2022, the ISSB discussed current and anticipated financial effects noting that in response to the IFRS S1 Exposure Draft 'respondents stated that the proposed current and anticipated future financial effects requirements are challenging to quantify for various reasons.' This view was echoed by UK stakeholders in response to the TAC's call for evidence. The various reasons why these disclosures are challenging are explained in the following paragraphs.
8.1Developing market practice UK stakeholders advise that calculating current and anticipated financial effects is an evolving discipline area and that entities are still building their experience and capabilities. This is the case even though the proposals relating to current and anticipated financial effects requirements build upon the existing Task Force on Climate Related Financial (TCFD) recommendations, which many entities in the UK are already reporting against. UK stakeholders advise that entities are already finding it challenging to develop financial models for climate-related risks in order to understand the financial effects. Overall, methodologies, systems and data in this area are at an early stage. The 2021 TCFD Status Report noted that
'the financial effects of a company's strategy in a longer time horizon might be characterized in terms of broad financial pathways or broad directional shifts in capital expenditures; as the strategy is implemented over time, capital budgets, project plans, and operational plans provide progressively more concrete estimates of financial effects.'
8.2Separating out the sustainability-related drivers of risks and opportunities – the requirement to disclose the effects of sustainability-related/climate-related risks and opportunities on the entity’s financial position, financial performance and cash flows can pose difficulties for entities because it is often not easy or completely possible to separate out the sustainability-related drivers of risks and opportunities from other drivers or causes. It becomes even more complex when moving from the general requirement in IFRS S1 to the topic-specific requirement in IFRS S2 where paragraph 15 of IFRS S2 requires the disclosure of the effects of climate-related and opportunities risks (rather than sustainability-related risks more generally) on the entity’s financial position, financial performance and cash flows. As noted in the 2021 TCFD Status Report
'organizations interviewed highlighted that the main challenge of estimating actual financial impact is effective attribution to climate-related events, as financial effects may have multiple drivers beyond climate.'
For example, in the case of flooding risk it may be difficult to determine what proportion of that risk is attributable to climate change. Financial effects may also arise across many items in the financial statements, making disaggregation and identification of individual sustainability-related risks and opportunities difficult.
8.3Time horizons – sustainability-related risks and opportunities are often long-term in nature, whereas financial reporting standards are, with some exceptions, typically focussed on a shorter time frame and on past transactions. Quantifying the financial effects of sustainability-related risks and opportunities is therefore likely to involve more judgement; more use of estimates; and higher degrees of uncertainty, particularly in relation to future outcomes and forward-looking statements. The level of judgement and measurement uncertainty required in this assessment may challenge the comparability of disclosures with both UK and international entities.
8.4Not all risks are easily quantifiable – UK stakeholders have highlighted that sustainability-related information such as reputational risk is very difficult to calculate in financial terms. Sustainability-related matters such as human rights and biodiversity, and the assumptions used to assess them, are also likely to be very complex to quantify.
8.5Timing of reporting – UK stakeholders have indicated that current financial effects may only be known after the financial year-end which makes it more difficult to analyse and align to sustainability-related information before the general purpose financial reports are published.
8.6Connectivity – paragraph 21 of IFRS S1 requires entities to disclose information that allows users of general purpose financial reports to understand the connections between disclosures provided by the entity within its sustainability-related financial disclosures, and between the sustainability-related financial disclosures and other general purpose financial reports published by the entity. UK stakeholders have highlighted that the difficulties they encounter in relation to preparing disclosures on current and anticipated financial effects make it even more difficult to link them to information in the financial statements.
9To work towards addressing these challenges, UK stakeholders have indicated that guidance and worked examples would be useful. Although UK stakeholders have identified that guidance in this area would be helpful, the challenges identified in providing these disclosures are not UK-specific. In November 2022, the ISSB discussed a number of proposed illustrative examples to assist preparers in making these disclosures. The meeting summary noted that ‘the ISSB will consider staff recommendations on the proposed requirements for current and anticipated financial effects and connected information, including the development of guidance to help entities apply the requirements.' The ISSB has since released a two-part webcast about current and anticipated financial effects, including worked examples, as part of its education material to support the implementation of IFRS S1 and IFRS S2.
10The TAC may consider recommending to the ISSB that additional guidance and worked examples on current and anticipated financial effects be developed. The TAC may also consider recommending that practice related to current and anticipated financial effects should be an area for continued monitoring to provide feedback to the ISSB during their post-implementation review of IFRS S1 and S2.
Mechanisms to support the application of the requirements
11IFRS S1 and IFRS S2 include mechanisms to support the application of the requirements in relation to the disclosure of current and anticipated financial effects. These mechanisms are included in the standard purposefully, sometimes applying to both current and anticipated financial effects and sometimes only for anticipated financial effects. In this way the mechanisms recognise that in general current financial effects are likely to be 'easier' to identify and disclose than anticipated financial effects. As set out in paragraph 38 of IFRS S1 and paragraph 19 of IFRS S2 an entity does not need to provide quantitative information about current or anticipated financial effects if those effects are not separately identifiable; or if the level of measurement uncertainty involved in estimating those effects is so high that the resulting quantitative information would not be useful. In addition, per paragraph 39 of IFRS S1 and paragraph 20 of IFRS S2 an entity need not provide quantitative information about the anticipated financial effects of a sustainability-related risk or opportunity if the entity does not have the skills, capabilities or resources to do so. In both cases, entities are nonetheless required to provide qualitative disclosures. Furthermore, as set out in paragraph 37 of IFRS S1 and paragraph 18 of IFRS S2, for anticipated financial effects, an entity shall use ‘all reasonable and supportable information that is available to the entity at the reporting date without undue cost or effort, as well as using an approach that is commensurate with the skills, capabilities and resources that are available to it'.
12As set out in paragraph 40 of IFRS S1 and paragraph 21 of IFRS S2 if an entity determines that it need not provide quantitative information about the current or anticipated financial effects of a sustainability-related risk or opportunity, then it should explain why and provide qualitative information about the financial effects. It should also provide quantitative information about the combined financial effects of the sustainability-related risk or opportunity with other sustainability-related risks or opportunities and other factors ‘unless the entity determines that quantitative information about the combined financial effects 'would not be useful.'
13Overall, UK stakeholders welcomed the mechanisms to support the application of the requirements in the standards. However, there was also an acknowledgement that entities might not need to rely on many of these provisions beyond the early years of implementation. There is no time limit in IFRS S1 and IFRS S2 for entities to make use of the mechanisms. However, if entities are trying to enhance their disclosures over time, including developing the skills, capabilities and resources they need to provide these disclosures, then some of these mechanisms may only be needed on a temporary basis.
14Furthermore, when entities choose to not provide quantitative information, there is no guidance in relation to determining whether information about the combined financial effects 'would not be useful' and therefore that this information would also not need to be disclosed. It might be helpful to note that paragraph 74 of IFRS S1 requires entities to disclose information to enable users to understand the judgements that the entity has made in the process of preparing its sustainability-related disclosures. However, in the absence of additional clarity or guidance, varying approaches and conclusions may be made by entities in determining whether such information is 'useful' which may compromise consistency and comparability.
15The TAC may consider recommending that practice related to current and anticipated financial effects, including when information has been determined as 'would not be useful', should be an area for continued monitoring to provide feedback to the ISSB during their post-implementation review of IFRS S1 and S2.
Endorsement recommendations
Alternative options considered but not recommended
16In considering the TAC's endorsement recommendations on current and anticipated financial effects, the Secretariat considered alternative options that have been disregarded. The criteria for amending the standards—notably that changes are considered necessary for the effective application within the UK and failure to amend the standard would be of detriment to the long-term public good—have not been met in this instance.
17The Secretariat considered and disregarded these alternative options, including:
17.1developing UK-specific guidance or worked examples of current and anticipated financial effects disclosures. Although stakeholders have identified a need for additional guidance this is not a UK-specific issue. Therefore, if guidance is to be developed, it makes sense that the ISSB should do it, thereby promoting consistency and comparability of disclosures both internationally and within the UK.
17.2limiting the mechanisms to support the application of the requirements. Stakeholders have welcomed these mechanisms in IFRS S1 and IFRS S2, however it is expected that some of these mechanisms may not be needed beyond the early implementation years. Consideration could be given to imposing a time limit on some of these mechanisms for UK implementation. However, recognising the challenges of providing these disclosures and with a view to ensuring international consistency, this option has not been pursued.
Suggested endorsement recommendation
18On balance, and based on the analysis provided in this paper, the TAC is asked to tentatively recommend:
18.1to maintain the requirements in IFRS S1 and IFRS S2 in relation to current and anticipated financial effects. Although there are challenges in providing these disclosures, connectivity between the sustainability-related financial disclosures and financial statements is a key to ensuring holistic, comprehensive and coherent general purpose financial reports. These disclosures can contribute to an improvement in the quality of corporate reporting, and assist in disclosures being internationally comparable.
18.2to suggest that the ISSB considers developing further guidance and worked examples on current and anticipated financial effects including whether information about the combined financial effects 'would not be useful.' The implementation of this mechanism may result in different assessments and conclusions being reached by entities in making these disclosures. Additional clarity and guidance in this area would ensure that entities apply these mechanisms in a consistent and comparable way. This would support the provision of disclosures that are understandable, relevant, reliable and comparable and would likely improve the quality of corporate reporting within the UK in the long-term.
18.3to monitor practice related to current and anticipated financial effects, including the use of mechanisms to support the application of the requirements, should be an area for continued monitoring to provide feedback to the ISSB during their post-implementation review of IFRS S2. This would facilitate an understanding of how the requirements are being applied by entities and whether the mechanisms to support the application of the requirements are being applied as intended.
Questions for the TAC
- Does the TAC agree with the analysis in this paper in relation the current and anticipated financial effects provisions in IFRS S1 and IFRS S2?
- Does the TAC agree to tentatively recommend maintaining the requirements in IFRS S1 and IFRS S2 in relation to current and anticipated financial effects?
- Does the TAC agree to tentatively recommend that the ISSB considers providing clarity and/or guidance on current and anticipated financial effects including whether information about the combined financial effects 'would not be useful'?
- Does the TAC agree to tentatively recommend that practice related to current and anticipated financial effects, including the use of mechanisms to support the application of the requirements, should be an area for continued monitoring to provide feedback to the ISSB during their post-implementation review of IFRS S1 and S2?
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Mechanisms to support the application of the requirements include proportionality mechanisms, permanent reliefs and transition reliefs. ↩