IASB publishes illustrative examples for reporting climate-related uncertainties in financial statements
The International Accounting Standards Board (IASB) has today published a near-final draft of seven illustrative examples of disclosures on uncertainties in financial statements using climate-related examples.
This is the latest development in the standards setter's effort to address investor concern over perceived inconsistencies in companies' climate-related risk reporting inside and outside the financial statements.
The IASB started addressing these concerns in 2019, with the publication of an article by Board member Nick Anderson discussing how existing requirements within IFRS standards relate to climate-related and other emerging risks and by releasing educational materials on applying the standards to climate-related matters in 2020, followed by an update in 2023.
Based on market feedback, the Board felt it needed to do more and developed illustrative examples which were issued for consultation in July last year, and preliminarily approved at the June board meeting this year.
Anderson, who laughs when called 'the father of this project' by Corporate Disclosures and is quick to argue he was "inspired by the work of others", took the time to discuss with us this latest development and the implications for the future of corporate reporting.
You are releasing a 'near final draft', why? And how different will the final document be?
In substance it's for board members, who will vote to approve the final draft, to have seen this a number of times already so any of their concerns or editorial suggestions can be incorporated by the staff.
I can't guarantee there won't be any further changes when we publish the final version, which will be towards the start of Q3, but there won't be anything of substance that changes, it will be editorial.
It's a pragmatic approach by the board to get these into the market in a timely fashion. These aren't new requirements, they illustrate existing requirements.
Normally, when we publish new requirements, you have a period of time to implement these, and we give an effective date. That can last, depending on how big the change is, for perhaps up to two years, perhaps sometimes three years.
Because these illustrate existing requirements, we can't give an effective date. But we want to give companies sufficient time to digest the examples, to think about what changes they need to make to their disclosures where appropriate, and to make sure we have smooth consideration of any implications of the examples in terms of their reporting. It's to try and buy a bit more time for companies.
It's a bit unusual, though, right? Because usually the IASB's message to its stakeholders is 'don't focus on the draft, focus on the final document'...
It's not unprecedented, we have done this before. It's healthy that we can demonstrate pragmatism in this respect, and to ensure that we get the outcome that everyone is looking for. This helps by buying a little bit more time for companies, rather than providing these to companies just a few months and weeks before their year-end.
One of the reasons for starting the project was investors' concerns over inconsistent information being disclosed around climate related risk, how will these examples address those concerns?
We've sought to focus on the biggest areas of concern for investors. They are around three areas in particular: one is materiality; the second is around the disclosure of assumptions and adjustments; and the third is around what we describe as disaggregation, breaking down the information further.
We could have had further examples but these, we think, are the most pressing areas from an investor perspective.
To your question, if we take the example of materiality and think about the apparent inconsistencies in the reporting that investors are perceiving. Our definition of materiality includes both quantitative and qualitative elements. For example, investors might think from reading a company’s transition plan that it may be facing a climate risk, given perhaps the industry or market it operates in, but the company makes no mention of climate-related risk in its financial statements. Disclosing that there are no impacts on its assets for their remaining life could be material information for investors in the context of the financial statements.
An example could be a production line for internal combustion engines. Given investor expectations, the company stating: ‘these assets only have a five-year life, they will be fully depreciated, we won't need to write them off’ could be material information for investors, given the company’s specific circumstances.
By portraying a coherent story, both inside the financial statements and outside the financial statements, helps investors build trust in management, in the company and ultimately their own investment case.
Maybe taking the question from the other way around, how does the IASB expect these examples to influence reporting practice by company?
We've all become specialists to some extent, and actually, if I'm an investor, I'm looking at a company holistically: i'm looking at what the company is telling me, and I want to see this coherent story. Where I don't see that, it starts to erode my trust in a company.
So within a company, you may be in the financial reporting team but you need to speak to others who have a sense of what the capital markets are worried about.
Go and have a coffee with investor relations, because those professionals in that team, will know the pulse of the market.
This is about trying to tie that information together, which already exists within many companies today, and ensuring you provide that coherent story. You remove apparent inconsistencies just by saying 'actually this inconsistency that you're worried about is fine, it doesn't exist, this is the reason why it doesn't exist'.
How do the illustrative examples align with the Board's broader goal of enhancing 'connectivity' between financial and sustainability reporting?
They play an important role because at the moment part of the feedback is that investors are seeing a disconnect. They see a lot of information which could be in sustainability-related disclosures or elsewhere, but they're still not seeing so much within the financial statements. Now within the financial statements, this could only relate to the elements recognised in the financial statements, that's our boundary: assets, liabilities, income, expenses and equity.
But investors believe that they should be seeing some information in relation to those elements, particularly in terms of what it means for the company's assets.
These examples really help to tie these pieces of information together and build that connection.
What should be in the financial reports and what's provided within sustainability reporting are the same topics but looked through a different prism. It's complimentary. You first need the information: If you don't have the information, you can't make the connection.
Indeed, that is the perennial question: what should be in the financial statement and what shouldn't be? In that sense, how do you see the future of the financial statements with regards to sustainability reporting?
I see it in an optimistic fashion. My last role was as a global equity sustainable fund manager, it was tough because there weren't standards for sustainability-related factors, and we had to contend with different sources of information.
Now we're getting into place where we are starting to actually have information provided on a consistent and comparable basis, ran in parallel with financial statements, and that helps me, as an investor, build my picture and my understanding of a company.
It helps me because I have the numbers which provide me not just with the historic record but a lot of historic information, and then I have sustainability related disclosures which tend to be more forward looking because they're looking at risks and opportunities.
As an investor, I'm making forward looking decisions with historical numbers from the financial statements that I need to model and I have some further information about risks and opportunities in terms of sustainability-related disclosures. So I have a higher quality of information all round - it's a huge step forward.
Of the examples that are being released do you have a favourite?
I do like the first example which is around materiality, because that's an issue that we've been confronted with on many occasions, in terms of thinking beyond just quantitative materiality and also thinking qualitatively as well.
I always liked the last example, because it's disaggregating between where your assets may be or your revenues may be in terms of those that are particularly exposed to climate-related risk, and those which are less exposed. I think it's really helpful information for investors. But they're all good, of course!
Given the decision to exclude non-climate examples, does the IASB anticipate expanding this project or issuing a second phase focused on other types of uncertainty?
We've renamed the output, which will be 'disclosures about uncertainties in the financial statements, using climate-related examples', just to try and underline that you can analogise from these examples to other uncertainties. That's the nature of principle-based standards which goes right back to the 2019 article which was saying these are principles based standards, you can use those principles across all kinds of emerging risks.
We're always driven by stakeholders in terms of what our work plan is and our future agenda, we don't have any initiative to do further examples in this space in our plan today, but it's not to say I can't rule it out either. Everything remains on the table. Next time we go out and consult in terms of what we should be doing, we'll listen to that feedback.
At your last meeting there was a mention of an 'identity crisis', whereby this is not standards setting work, but it feels and sounds like it. As you continue along that path from educational materials to illustrative examples and perhaps standards setting in the future, do you feel some sort of identity crisis?
There's no identity crisis.
We are very clear on what our boundaries are. We have to have an anchor, and the anchor is those elements of the financial statements that I talked about earlier.
There are numbers that might inform about future revenues or customer retention that don't belong to the financial statement because they don't have that linkage to the financial statement elements. Don't forget the market is very capable of finding routes to provide some of that information elsewhere, so we will stick to our clear mandate. Having sustainability-related information alongside that is very often complementary and provides a richer data set to investors. But there is no identity crisis.
But in that journey that started with educational material, the question is 'if and when' the IASB will cross the Rubicon of standards setting on these issues.
We were very careful at the start of this project to examine what's the best route to go. In terms of the issues that were presented to us, we found that the standards were sufficient and it was the implementation of those requirements that sometimes was lacking. It was identifying the problem and finding the best tool to help solve that problem.
Now, this is a dynamic world, things change. We may find a different set of circumstances in the future. Again, we don't rule anything out or say that we have a propensity to go in any particular direction from here. To me, it's always about thinking like an investor: what information do I know today, and then how do I base my decisions on that going forward?