Podcast | Mandatory climate disclosures | ISSB, IFRS

Is your business ready for the biggest change in financial reporting since the GST?

ISSB has been described as the biggest financial reporting change for businesses since the introduction of the GST. At the same time, Australian businesses have been reporting on energy and greenhouse emissions for some 20 years. So, what exactly is the International Sustainability Standards Board (ISSB) framework, and how will it affect Australian businesses?

This article captures the discussion led by Dr Nick Wood, Energetics Climate Risk Expert. Joining Nick is Dr Mary Stewart, Energetics’ CEO, and Rob Fowler, Partner in the Energy Transition Practice, at Partners in Performance and sustainable finance expert.

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The following is based on the transcript of the podcast episode.

What is ISSB and how should companies be viewing it?

(Dr Mary Stewart) ISSB and its climate disclosure standard S2 is a profound change and very different to what companies have typically seen in ESG or climate disclosures. Previously, companies spent a lot of time understanding their scope 1 and scope 2 emissions (the emissions associated directly with what they do) and to some extent scope 3 emissions. For the ambitious companies, some even looked at SBTi, science-based targets. But, ISSB requires a lot more than just disclosing your emissions inventory and paying attention to your scope 3 emissions. It requires you to unpack and understand in some detail the financial implications of climate risk to your business. You need to be able to link your scope 1, 2 and 3 emissions, your transition plan, your net zero plan, and your climate resilience to the financial outcomes that these represent to your company looking out to 2030, 2040, and 2050. So, it's not just an inventory, it's not only risks, it's also opportunities and it's integrating what was typically a sustainability data set into your financial report, which is due three months after the end of your financial year. So, it's going to be a big change and hopefully not only a barrier, but also a support for opportunities identification, which is part of the reporting requirements.

With just over half a year before companies need to make disclosures, what is the practical reality businesses are facing?

(Dr Mary Stewart) I think it's very mixed. The mandatory reporting we are going to see coming into Australia covers both public and private companies. It covers companies that have been reporting on a mandatory basis to NGER plus reporting on a voluntary basis to benchmarks like CDP and GRESB and then companies who haven't reported at all. So, the ability of companies to address this challenge is extremely mixed and very varied. Everyone needs to understand from the outset what their inventory is and then build their reach through a transition pathway and determine what your physical risk is. All of which is required to be disclosed to some extent in your first year. So, what's the capability? I am concerned. I think that there's probably capability and capacity in the market, both in inside companies and in the consulting space to address 30-40% of what's going to have to be reported. I think we have a huge gap both inside companies and in the consulting sphere.

Describe the challenge of the non-financial reporting items that now require financial valuation.

(Rob Fowler) It's an interesting time for companies. If they already have an understanding of what drives them and the value of their business, then they're likely well prepared. But, businesses that have not reached this part of their journey will have a big gap. In most companies there’s quite a long way to go to fill that gap, with only 6, 12 or 18 months to do it, depending on where you are in the scale of adoption. There's going to be, some high-risk issues that boards are going to have to deal with as this all comes to fruition.

You’ve framed the issues in terms of the three “Cs” – capability, capacity and credibility. Can you talk us through these elements and what you’ve seen in the market?

(Rob Fowler) Investors are driving this shift into non-financial reporting. But companies are the ones that must get their skates on and actually push the data through and get it signed off at senior levels.

Capability: Companies need to focus internally on what do I need to report? Do I have the capabilities already? What am I already reporting and how does that flow? What capabilities do I need and how can I fill those?

Capacity: Companies must carefully evaluate whether they have the available resources and operational bandwidth to handle the additional tasks necessitated by non-financial reporting. If you are stretched during that financial reporting season, then if you layer in a whole other range of non-financial data that needs to be flushed through and quality controlled and someone has to be accountable for it, then it just really tests a bit the capacity of the organization at that time. So again, something to think about, do you have capacity now? Is there spare? What do you need to actually do more of this reporting and processing?

Credibility: We've seen in the financial world annual reporting shift into quarterly reporting. Now we're getting monthly updates from some firms. Of course, when a company goes to their investors and talks about what's going on a recent update's really useful for the people having that conversation, leading us to credibility. The credibility question is one that the regulators in Australia and around the world are getting involved in, and that's where we get this concept of greenwashing coming through.

Will the ISSB provide insights that will help investors? Will we see companies increase their emissions reduction initiatives or better manage climate-related risk?

(Dr Mary Stewart) I think one of my concerns about seeing this mandatory framework coming through on such a large scale is it does have the potential to slow down the action that we've seen. With policy certainty in Australia’s commitment to achieving net zero, including reducing our national emissions by 43% (below 2005 levels) by 2030, we saw a significant uptake in corporate activity. Companies really committed to their net zero activities and, and we saw a lot of emissions reduction taking place. Now we're seeing a very big reporting requirement coming in and I'm concerned that we're going to see a diversion of resources (skills, people, time) just focused on building a data set to support this new disclosure framework. That should wash out through the system in the first year or two, but with this coming in, we might see a slowdown in action on emissions reduction, at least in the short to medium term.

In two or three years, once companies have adapted to the change, we’ll absolutely see improved outcomes with respect to both emissions reduction, adaptation and resilience.

(Rob Fowler) I thoroughly agree with Mary's suggestion that it's going to be a bit of a tough time for the next couple of years, but then it’ll stimulate a galloping change. To me, another interesting aspect of this whole shift is that there's going to be a whole lot more conversation around scope 3. We've been doing quite a lot of work with very large companies in Australia on how they think about scope 3, including the quality of their information and what levers they can pull to improve that performance. Therefore, stimulating the conversations between suppliers and customers around what's your emissions profile? How is that going to change over time? That conversation hasn't happened before and I think that is going to stimulate quite an interesting discussion. So, I feel like that's going to filter through and probably create a bit more awareness and weight in the efforts to improve emissions by everybody along those value chains.

Regarding external advice, what type of advisor should you be going to?

(Dr Mary Stewart) You need to look very closely at the experts that you ask for advice on this.  Many companies might go to their typical providers of information, particularly at board level, to advise them on some of the aspects of ISSB and those might not be the right people to be talking to about the complexity of aspects of this program. Scan the market and understand that your response will be informed by the quality of experts you get in on this problem, ensuring you canvas more than one opinion because this is not an easy program to address.

It's not going to be a one size fits all. Each company is going to have to tailor its own response to ISSB reporting requirements. So, look at your experts closely and make sure that you’re getting best in class support and not just default to who you usually go to.

(Rob Fowler) I agree. This is new for everybody, even the advisors. So, it's important to also unpack what companies need to provide. We've got a little bit of tradition in Australia with scope 1 and scope 2 reporting. That's something that's been captured by the government in a systematic way for quite a long time now. But, more and more companies are looking at scope 3 which require more data sets to be made available to help support that.

What are your top 3 pieces of advice for businesses seeking to understand the implications of the ISSB on future reporting requirements – and the wider implications for business decision makers?

(Dr Mary Stewart)

• Start doing something now: This isn't something you can put on the back burner. It’s absolutely something that you need to address immediately.
• Look at it from a holistic perspective: Don't try and unpack or focus in on areas too quickly. Take two steps back, review the framework, see what you've got already in place and how you can leverage what you already do to deliver the outcomes that you need.
• Look at this as the opportunity: It's not just something where you tick a box and walk away. Understand how this can help you set a course for a company that survives in a net zero economy and that’s resilient to the extreme weather effects that we've got coming. Fortune favours the brave, you've got to grab this opportunity to bring about significant change with both hands. Lean into it, don't back away from it.

(Dr Nick Wood)

• There are some very big things coming down the pipeline: One of these is the realisation, certainly in the climate policy community, of just how flawed the economic assumptions that are used in the integrated assessment models of climate change impacts have been. Some recent commentary by Dr Alberto Palazzo, former Director of War Studies at the Australian Army Research Centre, in The Climate Security Podcast, classifies the last few decades of global climate policy as denial, followed by delusion. The reality of climate impact is starting to bite, and nature is, in my view, inviting us to consider just how deep that delusion has been.
• ISSB at some point the near future is going to grapple with the need for disclosure on some quite significant physical risks
• This all adds up to an Australian sovereign risk level: One of the most puzzling features of the debate is that fact that Australian society seemed to think that the domestic policy inaction would go unnoticed, that it was somehow a “local problem”. This is incorrect. When compared with global capital markets, the level of financial risk that climate change poses to Australia is the sum of its parts, including how its corporates and governments demonstrate their ability to manage those risks. “Climate change is not an issue” may work as a tactic on a company-by-company level but when it all adds up to nothing at a sovereign risk level it gets noticed.

(Rob Fowler)

• Understand what you're actually doing already in terms of gathering non-financial information: Making sure your suppliers have all the right information and paperwork in place. It might be safety processes, performance information, supplier certifications, or energy use. These non-financial data sets need to be brought together under this new regime. So, understand how it works already in your organisation.
• Do a short sharp gap analysis and try and create a roadmap for how to get to where you want to be: This could be external advisors, or a special internal working group. But it’s an important step to understand where you are, how far you have to go, and what you need to do to get there.
• Focusing on building your internal capabilities: Your internal capabilities need to be developed and built and, and that includes the people, the processes and the systems. This task is not going to go away. It's new, and may be difficult at first, but I think we're going to see an expansion of the scope beyond climate related into nature related in the future.