The rapid development of sustainability reporting in the EU and UK

In our recent briefing, we summarised the two new sustainability reporting standards published by the International Sustainability Standards Boards (the "ISSB") on 26 June: IFRS S1 containing general requirements for disclosure of sustainability-related financial information, and IFRS S2 on climate-related disclosures. The ISSB's ambition is that they will form the core building blocks of sustainability reporting across the world; the standards aim to form a "global baseline" for reporting the material financial impacts of sustainability matters.

Material risks and opportunities under the ISSB standards mean those which can reasonably be expected to affect the entity's cash flows, its access to finance or cost of capital over the short, medium or long term. As such, the standards are particularly important in facilitating informed decision making by investors. It is significant, therefore, that the organisation of international securities market regulators, IOSCO, moved very swiftly to endorse the ISSB standards, confirming that they "are appropriate to serve as a global framework for capital markets to develop the use of sustainability-related financial information in both capital raising and trading and for the purpose of helping globally integrated financial markets accurately assess relevant sustainability risks and opportunities."

IOSCO's endorsement means that the national securities market regulators and policymakers it represents, including the UK's FCA, may now be confident that mandatory application of ISSB disclosures in their jurisdiction meets the IOSCO objective of "full, accurate and timely disclosure of... risk and other information which is material to investors' decisions".

The UK has been a vocal supporter of the ISSB standards for some time and, on 2 August, committed to make the ISSB standards the backbone of its own national sustainability disclosure requirements, to be known as "Sustainability Disclosure Standards" ("SDS"). By July 2024, the UK Government expects to have completed its assessment and (likely) subsequent endorsement of the ISSB standards, and will use them to create the first two SDS, diverging from ISSB standards only "if absolutely necessary for UK specific matters".

Once adopted, various regulators, including the Department for Business and Trade in respect of UK registered companies and limited liability partnerships, and the FCA in respect of listed companies, may make disclosures in line with the SDS mandatory.

To aid assessment of the ISSB standards in the short term and their implementation over the longer term, the UK Government has established two committees: the UK Sustainability Disclosure Technical Advisory Committee (TAC) and the UK Sustainability Disclosure Policy and Implementation Committee (PIC). The TAC has launched a call for evidence relating to its assessment of the ISSB standards, open until 11 October. From a review of the questions in the consultation document, it appears that the TAC is cognisant of some of the major issues facing entities preparing to comply with the European Sustainability Reporting Standards (discussed further below); for example, respondents are invited to comment on challenges in identifying and disclosing sustainability risks and opportunities, whether the concepts of materiality and value chain are clear, and whether there are challenges in consolidated/group sustainability reporting.

On 31 July, the Commission finalised a delegated act approving the final ESRS, developed by advisory body EFRAG over the last three years. The Commission fell only shortly behind the timetable determined by the Corporate Sustainability Reporting Directive ("CSRD") which required the standards to be in place by 30 June this year, despite making a higher-than-expected number of changes to the standards prepared for its consideration by EFRAG. Entities in the first wave of reporting, for financial years beginning after 1 January 2024, will be grateful for the Commission's timely adoption.

The Commission was keen to ensure that the standards were proportionate and feasible to encourage entities to report. This is likely to have been achieved in part by the introduction of new phase-in periods for entities with less than 750 employees, more "may disclose" rather than "shall disclose" statements, and all topical data points being disclosable only where there are material impacts, risks or opportunities for the disclosing entity. On the other hand, those same factors are bound to result in a less comparable data set. Furthermore, the already challenging process of assessing materiality becomes even more critical, and all eyes will be on EFRAG when it releases draft implementing guidance on the materiality assessment, expected in mid-August.

What will be appreciated, in particular by UK businesses with significant EU presence and therefore potentially subject to both EU and UK reporting requirements, is that the EU has taken the opportunity to align its definition of financial materiality with that used by the ISSB (as quoted above). Though the ESRS are and are likely to remain the outlier amongst sustainability standards, in applying the "double materiality" lens for disclosures, alignment with the ISSB's definition should avoid a confusing process of re-assessing risks and opportunities according to a slightly different materiality definition.

Sustainability standards refuse to stand still. As noted, EFRAG is preparing implementation guidance on materiality assessment and value chain under the CSRD. It is also working on a set of standards for listed SMEs and a further set of standards for voluntary application by non-listed SMEs, which will be less demanding than the full ESRS.

As CSRD requires sustainability information to be audited in a similar way to financial information (on a, first, limited, and potentially later, reasonable assurance basis), standards setters are also assessing whether sustainability assurance standards are fit for purpose. The International Auditing and Assurance Standards Board ("IAASB") is developing a "landmark, global sustainability assurance standard" to be known as ISSA 5000, designed to be used with the ISSB standards but potentially also the ESRS, until such time as the Commission adopts its own EU-wide standard. At present, assurance of sustainability information is typically carried out using a more generic standard, ISAE 3000 on assurance engagements other than audits or reviews of historical financial information. Entities subject to CSRD and wondering what a limited assurance report will look like may be interested in the illustrative examples in Appendix 2 of the draft ISSA 5000 standard.

The ISSB is consulting on a two year workplan which would see the development of further specific disclosure standards similar to the S2 climate standard, on topics including biodiversity and human rights. The ISSB has also launched a consultation on a common digital taxonomy "to facilitate structured digital reporting of sustainability-related financial information" based on the ISSB standards. This should not be confused with the EU's Taxonomy, which works as a classification system for sustainable investments; rather, digital tagging of the information will allow users to extract, compare, analyse and manage large volumes of sustainability data compiled by disclosing entities. CSRD also provides that entities must use the single electronic reporting format for ESRS reporting, and EFRAG is also creating a digital taxonomy to allow similar, easy manipulation of reported data; publication is expected in September.

In the UK, we await the outcome of the SDS consultation, as well as the consultation earlier in the year on the review of non-financial information reporting more generally; it will be interesting to see whether the latter is overtaken by the former.