This article has been written to assist candidates when preparing for the ACCA Professional Diploma in Sustainability (ProDipSust). The ProDipSust syllabus states that candidates must be able to ‘identify and explain key interactions between the IFRS Sustainability Disclosure Standards and European Sustainability Reporting Standards’ in learning outcome C3a.
The International Sustainability Standards Board (ISSB) and the European Commission Services, together with EFRAG, worked together during the development of the European Sustainability Reporting Standards (ESRS) and the IFRS Sustainability Disclosure Standards (ISSB Standards) to achieve a high degree of alignment. This means that the standards are interoperable (i.e. the standards do not have contradictory requirements, meaning that an entity could theoretically comply with both sets of standards). However, differences exist, largely resulting from the wider definition of materiality used in the ESRS as compared to the ISSB Standards.
This article will compare the ISSB Standards and the ESRS in relation to the following areas:
ESRS must be applied by companies which fall under the Corporate Sustainability Reporting Directive (CSRD) obligations. This applies to all large companies and all listed companies (except listed micro-enterprises) located in the EU. Non-EU companies with securities listed on an EU-regulated market or with substantial EU turnover also fall under ESRS reporting requirements.
ISSB Standards are mandatory if adopted into legislation in a particular jurisdiction. Otherwise, compliance with these standards is voluntary. Consultations have been happening in Canada, Japan and Singapore around the introduction or use of ISSB Standards within their regulatory frameworks.
The objective of IFRS S1 General Requirement for Disclosure of Sustainability-related Financial Information is to require an entity to disclose information about its sustainability-related risks and opportunities (sometimes referred to as SRROs) which is useful to the primary users of financial reports when deciding whether to provide resources to the reporting entity. This means providing material information about the risks and opportunities which might affect the entity’s cash flows and its access to finance or the cost of capital over the short, medium, and long term.
In contrast, ESRS 1 General Requirements states that entities must disclose information about its material risks and opportunities as well as its impacts in relation to environmental, social and governance sustainability matters (sometimes referred to as IROs). This is to enable users of the sustainability statement to understand the entity’s material impacts on people and the environment, as well as the effects of sustainability matters on the entity’s development, performance, and position. The importance of an entity’s impact on people and the environment in ESRS reflects the double materiality perspective which underpins these standards.
The concept of materiality in the ISSB Standards is consistent with the way it is used in IFRS Accounting Standards. IFRS S1 states the following:
‘Information is material if omitting, misstating or obscuring that information could reasonably be expected to influence decisions that primary users of general-purpose financial reports make on the basis of those reports.’
In contrast, ESRS 1 states that a sustainability matter is material if it meets the criteria for either financial materiality or impact materiality. This two-pronged approach is referred to as double materiality.
ESRS 1 states the following:
‘Information is considered material for primary users of general-purpose financial reports if omitting misstating or obscuring that information could reasonably be expected to influence decisions that they make on the basis of the undertaking’s sustainability statement.’
A sustainability matter is material from a financial perspective if it generates risks and opportunities which have, or could have, a material impact on the entity’s financial position, financial performance, cash flows or access to capital over the short, medium, or long term.
As can be seen from the above, the definition of financial materiality in ESRS 1 corresponds with the definition of materiality more generally in the ISSB Standards, and both are focussed on information being useful for decision making.
ESRS 1 states that a sustainability matter is material in relation to impact if it will have a material actual or potential impact on people or the environment over the short, medium, or long term. These actual or potential impacts may be positive or negative. Impacts may arise from an entity’s operations, its products or services, as well as its business relationships.
For actual negative impacts, entities should consider the severity of the impact. For potential negative impacts, entities should consider the severity and likelihood. However, with regards to potential human rights impacts, ESRS 1 states that severity takes precedence over likelihood.
There is no concept of impact materiality in the ISSB Standards. This means that the scope of the ISSB Standards is narrower than that of ESRS, and that there are fewer disclosure requirements.
IFRS S1 specifically states that an entity does not need to disclose information otherwise required by an IFRS Sustainability Standard if the information is not material.
In contrast to IFRS S1, ESRS requires certain items to always be disclosed, irrespective of the materiality assessment. For instance, ESRS 2 General Disclosures includes several minimum disclosure requirements in respect of an entity’s policies or actions to prevent, mitigate and remediate material impacts, address material risks, or pursue material opportunities. If an entity has no policies or actions to disclose, it must explain that this is the case, and provide reasons for not having adopted any.
The focus of the ISSB Standards is on the needs of the primary users of financial reports. These are current and potential investors, lenders and other creditors.
In contrast, ESRS 1 states that the information provided in sustainability statements is for the users of the statements. The ESRS definition of ‘users’ includes the same groups identified by the ISSB Standards, but also includes others, such as business partners, trade unions, civil society, governments, non-governmental organisations, and academics. When assessing materiality, particularly from an impact perspective, ESRS 1 states that entities must also engage with affected stakeholders – which means individuals or groups whose interests are positively or negatively affective by the entity’s activities and business relationships.
Both sets of standards require disclosures about the impact of sustainability-related issues on the entity in the short, medium, and long-term.
These terms are not defined in IFRS S1. The standard states that, ‘Short-, medium- and long- term time horizons can vary between entities and depend on many factors, including industry-specific characteristics.’ Instead, entities are required by IFRS S1 to explain how they define ‘short term’, ‘medium term’, and ‘long term’.
In contrast, ESRS S1 uses the following definitions:
IFRS S1 is not prescriptive about where sustainability-related disclosures are presented, as long as it is included in the entity’s general purpose financial reports.
In contrast, ESRS 1 requires an entity to present a sustainability statement, which is a dedicated section of the management report.
In 2023, the ISSB issued its first two sustainability disclosure standards. These are:
Entities apply IFRS S1 when preparing and reporting sustainability-related financial disclosures. As well as applying the principles in IFRS S1, entities must refer to other issued ISSB Standards when disclosing information about specific sustainability-related risks and opportunities. This means that entities must use IFRS S2 when preparing disclosures of climate-related risks and opportunities.
As no further ISSB Standards have yet been issued, sustainability-related disclosures on non-climate issues must be prepared using the principles in IFRS S1 only. The ISSB will eventually draft, consult on, and issue a suite of other sustainability disclosure standards but, in the meantime, IFRS S1 requires users to consider the disclosure topics covered in standards issued by the Sustainability Accounting Standards Board (referred to as the SASB Standards) and to assess whether they are applicable.
In contrast, ESRS comprises 12 individual standards. These include two cross-cutting standards, which outline more general principles and disclosure requirements, as well as 10 standards covering specific topics. These are as follows:
Cross cutting standards
Environmental standards
Social standards
Governance standard
Objective
The objective of IFRS S2 Climate-related Disclosures is to require an entity to disclose information about climate-related risks and opportunities which will be useful to the primary users of financial reports when making decisions about providing resources to the entity. These are material risks and opportunities which might affect the entity’s cash flows, or its access to finance or cost of capital over the short, medium, or long-term.
This is much narrower than the objective of ESRS E1 Climate Change. ESRS uses the concept of impact materiality, requiring disclosure of additional information. This is to help users of the sustainability statement understand:
As part of this, entities must disclose information about locked-in greenhouse gas (GHG) emissions, which are estimates of future GHG emissions which are likely to be caused by an entity’s key assets or products sold within their operating lifetime.
Both sets of standards require an entity to disclose its gross GHG emissions, expressed as metric tonnes of CO2 equivalent and classified as:
ESRS E1 also requires additional information. With regards to Scope 1 GHG emissions, entities must disclose the percentage of these emissions from regulated emission trading schemes. With regards to Scope 2 GHG emissions, entities must disclose both gross location-based emissions and gross market-based emissions. For Scope GHG 3 emissions, ESRS E1 requires the disclosure of emissions for each Scope 3 category which is significant for the entity (out of the 15 types of Scope 3 GHG emissions identified by the GHG Protocol Corporate Standard).
To keep global warming at or below 1.5°C – as called for in the Paris Agreement – emissions must be reduced by 45% by 2030 and reach net zero by 2050. Under ESRS S1, GHG emissions reduction targets must include target values for the year 2030 and, if available, for the year 2050. From 2030, target values are to be set after every five year period thereafter. The entity must also state whether these targets are compatible with limiting global warming to 1.5°C. IFRS S2 does not require this disclosure.
ESRS E1 requires entities to provide information on its energy consumption and mix. This helps users assess total energy consumption, as well as an entity’s exposure to fossil fuel-related activities. It also provides information about the share of renewable energy in the entity’s overall energy mix. Disclosures are required based on energy intensity (total energy consumption per net revenue) associated with activities in high climate impact sectors, such as mining, manufacturing, transportation, construction, agriculture, and food or beverage. IFRS S2 does not require this disclosure.
IFRS S2 requires a description of whether and how climate-related considerations are factored into executive remuneration, and the percentage of executive management remuneration recognised in the current year which is linked to climate-related issues. Although ESRS E1 requires the same information, applied to members of the administrative, management and supervisory bodies, it also requires disclosure as to whether their performance has been assessed against GHG emissions reduction targets.
IFRS S2 requires entities to refer to the Industry-based Guidance on Implementing IFRS S2. For various industries, this guidance outlines key risks and opportunities that could affect the entity’s prospects. It also provides a range of industry-based metrics that entities should consider disclosing. For example, it notes that a hotel business should consider the applicability of disclosing water consumption per occupied room.
Sector-specific standards are not available in ESRS. As such, reported information should be entity specific. However, ESRS 1 states that the ISSB Standards, as well as those issued by the Global Reporting Initiative, can be used as a source of additional disclosures.
Both sets of standards require entities to disclose information about GHG emissions targets.
If an entity states a net GHG emissions target, then IFRS S2 requires that the associated gross target must be disclosed as well. The entity must also disclose its planned use of carbon credits to achieve any net GHG emissions target. With regards to these carbon credits, the entity must also disclose:
ESRS E1 states that GHG emissions reduction targets must be gross targets. This means that carbon credits cannot be included as a means of achieving GHG emissions reduction targets.
However, carbon credits can be a way of removing GHG from the atmosphere and are a key impact which the entity will have on the environment and the climate, and users of the sustainability statement should be informed of this. As such, ESRS E1 still requires disclosures about the use of carbon credits, including the total amount of carbon credits in metric tonnes of CO2 equivalent which are verified against recognised quality standards. Moreover, many entities disclose net-zero targets in addition to gross GHG emissions reduction targets. Public claims of GHG neutrality must explain the reliance on carbon credits and provide information about the credibility and integrity of the carbon credits used.
As an entity transitions to a climate-neutral economy, there will be impacts on people. This issue is not generally relevant to ISSB Standards because of the focus on financial materiality, unless there is a material impact on the entity’s future cash flows, access to finance or cost of capital. However, as noted, ESRS is also concerned with impact materiality. The impact on people in ESRS is covered by four of the social standards: ESRS S1 – S4.
For example, ESRS S1 requires entities to disclose material impacts on its own workforce which may arise from transition plans towards climate-neutral operations. The entity should also disclose measures to mitigate these impacts, such as training and reskilling, employment guarantees, and in the case of downscaling, measures such as job counselling, coaching, job placements, and early retirement plans.
ESRS S2 requires similar disclosures about the impact of transition plans, but this time on value chain workers. The entity should also disclose impacts on affected communities, in accordance with ESRS S3, which may arise from the transition to climate-neutral operations. Potential impacts may arise from the closure of mines, increased mining of minerals needed for the transition to a sustainable economy and solar panel production. Impacts on consumers and end users are reported in accordance with ESRS S4.
This article has outlined some of the key intersections and differences between the ISSB Standards and ESRS. Some of these differences are quite detailed – for instance, the level of disclosure required in relation to GHG emissions.
What is important to remember is that the disclosure requirements of ESRS are more extensive because the materiality assessment is wider. Like the ISSB Standards, ESRS is based on financial materiality. However, the double materiality concept used in ESRS also includes impact materiality – the impact of the entity on people and the environment. This means that ESRS has a wider remit and a larger range of stakeholders. This can be seen clearly in relation to climate issues, with ESRS E1 requiring extensive disclosures about the entity’s impact on climate change, and whether its business model and plans are in line with the aim of limiting global warming to 1.5°C.
When the ISSB Standards were issued, the ISSB referred to them as a global baseline. In other words, the aim of the ISSB Standards is to provide information which is useful to investors around the world, but also to enable additional blocks of information to be added on to meet the needs which a particular jurisdiction, such as the EU, deems necessary. This means that the ISSB Standards and ESRS are interoperable. To this extent, the IFRS Foundation and the European Financial Reporting Advisory Group have published guidance to illustrate the high level of alignment between the two sets of standards, and how entities are able to apply both sets. This will help to reduce complexity and duplication for reporting entities, as well as to provide information that is useful to the users of its sustainability reports.
Written by a member of one of ACCA’s examining teams