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TAC Public Meeting October 2024 Paper 5: Resilience and scenario analysis
AGENDA PAPER 5
Executive summary
| Date | 08 October 2024 |
| Paper reference | 2024-TAC-018 |
| Project | Technical assessment of IFRS S1 and IFRS S2 |
| Topic | Resilience and scenario analysis |
Objective of the paper
This paper considers the requirements in IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information (IFRS S1) and IFRS S2 Climate-related Disclosures (IFRS S2) relating to resilience and scenario analysis. This includes consideration of the consistency of definitions and descriptions between IFRS S1 and IFRS S2; stakeholder request for guidance on scenario analysis; and ensuring the appropriate application of proportionality provisions by entities. The TAC is asked to consider whether any amendments to IFRS S1 and IFRS S2 are necessary and whether any additional transitional reliefs are needed.
Decisions for the TAC
The TAC is asked to tentatively decide to:
- maintain the requirements in IFRS S2 in relation to resilience and scenario analysis;
- engage with the ISSB to consider a definition for ‘resilience' in IFRS S1 that aligns with the definition of ‘climate resilience' in IFRS S2; and ensure that definitions of resilience in future ISSB standards are consistent;
- request the ISSB clarifies why the disclosure as to whether the entity uses scenario analysis to identify sustainability-related opportunities is not required in IFRS S1; and to provide additional guidance on the use of scenario analysis as a tool to identify sustainability-related risks and opportunities;
- suggest that the PIC consider as part of its implementation discussions whether prescribing specific scenario analysis would be beneficial, and potentially periodically setting a standardised climate-related scenario against which entities could undertake climate scenario analysis; and
- monitor the use of the proportionality mechanism for climate-related scenario analysis in order to provide feedback to the ISSB when they conduct the 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
1In relation to resilience and scenario analysis, the main requirements as set out in IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information (IFRS S1) and IFRS S2 Climate-related Disclosures (IFRS S2) are as follows:
- IFRS S1 paragraph 28, 29(e), 41–43, 44(a)(ii), Appendix A
- IFRS S2 paragraph 8, 9(e), 22–24, 25(a)(ii) (b), Appendix A, B1-B18
2IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information (IFRS S1) paragraph 29(e) sets out the general requirement for an entity to report on resilience, requiring an entity to disclose information to enable users of general purpose financial reports to understand ‘the resilience of the entity's strategy and its business model to those sustainability-related risks.' IFRS S1 does not specify that an entity must use scenario analysis in relation to sustainability-related resilience assessments. Paragraph 42 of IFRS S1 states that 'other IFRS Sustainability Disclosure Standards may specify the type of information an entity is required to disclose about its resilience to specific sustainability-related risks and how to prepare those disclosures, including whether a scenario analysis is required.' Paragraph 44(a)(ii) IFRS S1 requires an entity to disclose 'whether and how the entity uses scenario analysis to inform its identification of sustainability-related risks.'
3Similarly, IFRS S2 Climate-related Disclosures (IFRS S2) paragraph 9(e) requires an entity to disclose information to enable users of general purpose financial reports to understand ‘the climate resilience of the entity's strategy and its business model to climate-related changes, developments and uncertainties, taking into consideration the entity's identified climate-related risks and opportunities.' IFRS S2 paragraphs 22–23 set out the more detailed provisions in relation to climate resilience including the requirement to undertake climate-related scenario analysis. IFRS S2 paragraphs 24–25 address risk management including the requirement to disclose 'whether and how the entity uses climate-related scenario analysis to inform its identification of climate-related risks.'
Endorsement criteria
4The 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
5In relation to resilience and scenario analysis, this paper sets out the challenges identified in making these disclosures including:
5.1the definition of resilience. Paragraphs 6–8 relate to the potential challenges created by the absence of a definition for resilience in IFRS S1 and the inconsistencies between the description and definition of resilience in IFRS S1 and IFRS S2. These potential challenges may compromise the comparability and consistency of disclosures between entities.
5.2how scenario analysis may be used to identify sustainability-related risks. Paragraphs 9–11 consider the use of scenario analysis to identify sustainability-related risks and opportunities; and the apparent inconsistencies and consequential potential challenges in the application of scenario analysis for this purpose between IFRS S1 and IFRS S2.
5.3stakeholder request for additional guidance on scenario analysis. Paragraphs 12–15 address stakeholders' request for additional guidance on scenario analysis and how to potentially enhance the consistency and comparability of disclosures by the use of a prescribed scenario.
5.4the proportionality mechanism that allows entities to use different approaches to scenario analysis. Paragraphs 16–18 consider the application of the proportionality mechanism in IFRS 2 which permits entities that consider that they lack the skills, capabilities and resources available not to undertake advanced climate-related scenario analysis.
5.5requests for additional transition reliefs. Paragraphs 19–20 address stakeholder feedback requesting phase-in or transitional provisions for the application of the climate scenario analysis disclosure requirements.
Definition of resilience
6IFRS S1 does not include a definition of resilience in its ‘defined terms' although IFRS S1 paragraph 41, which relates to resilience, states that 'an entity shall disclose information that enables users of general purpose financial reports to understand its capacity to adjust to the uncertainties arising from sustainability-related risks.' IFRS S2 does include a definition of 'climate resilience' in its defined terms which is:
The capacity of an entity to adjust to climate-related changes, developments or uncertainties. Climate resilience involves the capacity to manage climate-related risks and benefit from climate-related opportunities, including the ability to respond and adapt to climate-related transition risks and climate related physical risks. An entity's climate resilience includes both its strategic resilience and its operational resilience to climate-related changes, developments and uncertainties.
7The definition in IFRS S2 of climate resilience therefore does not mirror how resilience is described in IFRS S1. While IFRS S1 refers only to the entity's capacity to adjust to uncertainties, IFRS S2 refers to uncertainties, changes and developments. Where IFRS S1 refers to the entity's capacity to adjust, IFRS S2 refers to the entity's capacity to manage, respond and adapt. Furthermore, while IFRS S1 refers to the effects arising from sustainability-related risks, IFRS S2 also refers to the entity's capacity to benefit from climate-related opportunities. The requirements on climate resilience in IFRS S2 are therefore much broader than the general resilience requirements set out in IFRS S1.
8The inconsistency in the description/definition of resilience in IFRS S1 and IFRS S2 may lead to inconsistencies in disclosures. In the absence of other topical standards, entities reporting on their resilience beyond climate may report a narrower set of information compared to the requirements for climate resilience. This may not meet the needs of investors. For example, a disclosure about how an entity can 'adjust' to an uncertainty may not necessarily provide enough detail as to whether and to what extent the uncertainty can be managed, mitigated, removed or converted into an opportunity. The absence of a definition for resilience within IFRS S1 may also lead to a lack of comparability and consistency of disclosures between entities. The TAC may consider engaging with the ISSB to include a definition of 'resilience' in IFRS S1 that more closely aligns to the 'climate resilience' definition in IFSR S2, and to advocate for consistency in the definition of resilience in any future standards.
Identification of sustainability-related risks
9IFRS S1 paragraph 44(a)(ii) requires an entity to disclose 'whether and how the entity uses scenario analysis to inform its identification of sustainability-related risks.' IFRS S1 44(b) further requires disclosure of ‘the processes the entity uses to identify, assess, prioritise and monitor sustainability-related opportunities.' No additional guidance or context is provided in IFRS S1 as to how this might be undertaken. Furthermore, there is no mention of the use of scenario analysis to identify opportunities.
10IFRS S2 paragraph 25(a)(ii) mirrors the requirement in IFRS S2 for entities to identify 'whether and how the entity uses climate-related scenario analysis to inform its identification of climate-related risks.' Paragraph 25(b) of IFRS S2 also requires entities to disclose 'the processes the entity uses to identify, assess, prioritise and monitor climate-related opportunities, including information about whether and how the entity uses climate-related scenario analysis to inform its identification of climate-related opportunities.'
11It is not clear why there is an inconsistency in the application of scenario analysis as a tool to identify sustainability-related risks and opportunities in IFRS S1 and IFRS S2. Whilst scenario analysis may not be appropriate for identifying all sustainability related opportunities, it may be a useful tool to do so for many sustainability matters. The absence of any further guidance in this area may also lead to a lack of comparability and consistency of disclosures between entities. The TAC may consider encouraging the ISSB to clarify why the disclosure as to whether the entity uses scenario analysis to identify sustainability-related opportunities is not required in IFRS S1; and to provide additional guidance on the use of scenario analysis as a tool to identify sustainability-related opportunities as well as risks.
Guidance on scenario analysis
12IFRS S2 provides application guidance in Appendix B on climate-related scenario analysis and explicitly references guidance published by the Taskforce on Climate-related Financial Disclosures (TCFD) in footnote 2 of IFRS 2 paragraph B1. Notwithstanding, several stakeholders have requested additional guidance in the area of climate-related scenario analysis. This request has been raised not just in the context of providing additional support to entities, but also recognising the need for consistent and comparable disclosures.
13An example of an area raised by stakeholders that would benefit from additional guidance and clarity is the requirement in paragraph 22(b)(i)(4) of IFRS S2 to disclose whether the entity has used, among its scenarios, a climate-related scenario aligned with the ‘latest international agreement on climate change.' Stakeholders have suggested that clarity could be provided as to whether an entity should use inputs that assume that international climate commitments will be met or inputs that assume that these commitments will not be met (for example, whether or not temperatures will rise to above two degrees Celsius). The TAC Secretariat's view is that whichever interpretation is taken, so long as an entity provides appropriate disclosure about the assumptions used, it should meet the requirements of IFRS S1 22(b)(i)(4) to disclose whether the entity has used, among its scenarios, a climate-related scenario aligned with the latest international agreement on climate change.
14Some stakeholders also requested further guidance on the selection of scenarios. Stakeholders noted that whilst there may be benefits in providing flexibility for entities to choose their own scenarios, this may also mean less comparability between entities. The quality of the outputs of climate-related scenario analysis and the benefits of the exercise are largely dependent on the appropriate selection of scenarios, both favourable and unfavourable. One approach to address the stakeholder comments could be for the UK Government to set specific scenarios, which are updated every two or three years, which all entities in the scope of UK Sustainability Reporting Standards would be required to assess against. In this way, entities would continue to have flexibility in determining the appropriate scenarios for their circumstances, but consistency and compatibility could also be enhanced by entities periodically reporting on a common scenario.
15The TAC may consider recommending that the UK Sustainability Disclosure Policy and Implementation Committee (PIC) consider as part of its implementation discussions whether prescribing specific scenario analysis would be beneficial, and potentially periodically setting a standardised climate-related scenario against which entities could undertake climate scenario analysis.
Sophistication of approach
16Paragraph B2 of IFRS S2 states that an entity shall use an approach to climate-related scenario analysis that is 'commensurate with its circumstances as at the time the entity carries out its climate-related scenario analysis.' To assess its circumstances the entity shall consider its exposure to climate-related risks and opportunities; and 'the skills, capabilities and resources available to the entity for the climate-related scenario analysis.' The lack of available skills, capabilities and resources could be viewed as a temporary situation that might prevent an entity from completing a sophisticated scenario analysis. Therefore, this proportionality mechanism can also be viewed as a temporary relief that can be used in the first years of reporting. At the same time, it may not be appropriate for an entity to conduct a detailed and sophisticated scenario analysis if the entity is not exposed to significant climate-related risks, which is something that is unlikely to change over the years. In this case, the proportionality mechanism can be viewed as a permanent relief that allows entities less exposed to climate-related risks to always apply an approach that is appropriate. Whilst this proportionality mechanism has been welcomed by stakeholders, some have flagged the importance of applying it appropriately and consistently.
17Notably, this proportionality mechanism is slightly different to the mechanism used for current and anticipated financial effects (in both IFRS S1 and IFRS S2), which only permits the use of a different approach if the entity does not have the skills, capabilities and resources. Additionally, the requirements for current and anticipated financial effects requires an entity to disclose that they have used this mechanism to explain why a different approach was taken. This is not the case for climate-related scenario analysis as an entity does not need to disclose that they have used the mechanism. Such a disclosure, with a description providing context and indicating whether they have plans to improve their capabilities in this area would likely be useful to investors. It could also allow the market to engage with entities that may be seen to use this proportionality mechanism inappropriately, by using it to opt out of more advanced climate-related scenario analysis that they really should be conducting.
18The TAC may consider recommending that the use of this proportionality mechanism for climate-related scenario analysis be monitored in order to provide feedback to the ISSB when they conduct the post-implementation review of IFRS S2.
Transition relief
19Some stakeholders have requested that given the challenging nature of undertaking scenario analysis, particularly for entities that have not done any scenario analysis before, a phased in approach to these requirements should be considered. The difficulty of undertaking scenario analysis with the data acquisition and data quality issues that exist were also raised as a consideration for providing transition relief.
20The proportionality mechanism set out in paragraph B2 of IFRS S2 permits an entity to use an approach to climate-related scenario analysis that is 'commensurate with its circumstances as at the time the entity carries out its climate-related scenario analysis.' It is considered that this proportionality mechanism provides sufficient flexibility to entities to phase in their own application of the requirements, appropriate to their circumstances, such that an additional explicit transitional provision should not be required.
Endorsement recommendations
Alternative options considered but not recommended
21In considering the TAC's endorsement recommendations on resilience and scenario analysis, 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.
22The TAC Secretariat considered and disregarded these alternative options, including:
22.1 Proposing the inclusion of a definition for resilience in IFRS S1 that aligns with the definition of ‘climate resilience’ in IFRS S2.
In order to clarify and ensure consistency between IFRS S1 and IFRS S2, this option was considered. However, recommending the insertion of a new definition could affect international comparability and therefore was not pursued.
22.2 Recommending the development of UK-specific guidance on scenario analysis.
This could address the use of scenario analysis to identify sustainability-related risks and opportunities as well as more general guidance on the implementation of scenario analysis. Such an approach would respond to stakeholder calls for worked examples and additional guidance, but as this is not a UK-specific issue, it was not considered appropriate to recommend the development of UK-specific guidance.
22.3 Recommending the introduction of transitional provisions for scenario analysis.
Recognising the challenges of undertaking scenario analysis, particularly for entities that have little or no experience in this area. However, the existing proportionality provision relating to scenario analysis is considered adequate and introducing UK-only transitional provisions could affect international comparability. For these reasons this option was not pursued.
Suggested endorsement recommendation
23On balance, and based on the analysis provided in this paper, the TAC is asked to tentatively recommend:
23.1 to maintain the requirements in IFRS S2 in relation to resilience and scenario analysis.
Although stakeholder feedback identified challenges with the resilience and scenario analysis disclosures, there wasn't a lack of support for making the disclosures. As such maintaining the requirements should improve the quality of corporate reporting within the UK in the long-term and maintain the global baseline.
23.2 to engage with the ISSB to consider a definition for ‘resilience’ in IFRS S1 that aligns with the definition of climate resilience in IFRS S2; and ensure that definitions of resilience in future ISSB standards are consistent with existing definitions.
As the definition in IFRS S2 of climate resilience does not mirror how resilience is described in IFRS S1, this could support UK entities in providing disclosures that are understandable, relevant, reliable and comparable.
23.3 to request the ISSB clarifies why the disclosure as to whether the entity uses scenario analysis to identify sustainability-related opportunities is not required in IFRS S1; and to provide additional guidance on the use of scenario analysis as a tool to identify sustainability-related risks and opportunities.
This would help to ensure as much consistency as possible between disclosures made under IFRS S1 and IFRS S2. Additional guidance would support consistency and comparability between entities and ensure that disclosures in this area could be made without undue cost or effort.
23.4 that the PIC consider as part of its implementation discussions whether prescribing specific scenario analysis would be beneficial, and potentially periodically setting a standardised climate-related scenario against which entities could undertake climate scenario analysis.
This would ensure a balance for entities between providing flexibility and facilitating a periodic check to facilitate consistency and comparability. This would also improve the quality of corporate reporting within the UK in the long-term as entities could learn from each other through the standardised scenario exercises.
23.5 to monitor the use of the proportionality mechanism for climate-related scenario analysis in order to provide feedback to the ISSB when they conduct the post-implementation review of IFRS S2.
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 and IFRS S2?
- Does the TAC tentatively agree to recommend to maintain the requirements in IFRS S2 in relation to resilience and scenario analysis?
- Does the TAC tentatively agree to recommend to engage with the ISSB to consider a definition for ‘resilience' in IFRS S1 that aligns with the definition of climate resilience in IFRS S2; and ensure that definitions of resilience in future ISSB standards are consistent with existing definitions?
- Does the TAC tentatively agree to recommend to request the ISSB clarifies why the disclosure as to whether the entity uses scenario analysis to identify sustainability-related opportunities is not required in IFRS S1; and to provide additional guidance on the use of scenario analysis as a tool to identify sustainability-related risks and opportunities?
- Does the TAC tentatively agree to recommend that the PIC consider as part of its implementation discussions whether prescribing specific scenario analysis would be beneficial, and potentially periodically setting a standardised climate-related scenario against which entities could undertake climate scenario analysis?
- Does the TAC tentatively agree to recommend to monitor the use of the proportionality mechanism for climate-related scenario analysis in order to provide feedback to the ISSB when they conduct the post-implementation review of IFRS S2?