Navigating the Alphabet Soup of Sustainability Reporting: The IFRS S1 & S2, and ESRS
Explore the IFRS S1, S2 & ESRS. Learn how the frameworks impact disclosure requirements & prepare your organization for a more transparent, sustainable future.
The landscape of sustainability reporting has long been a complex and confusing web of overlapping frameworks and disclosure requirements. Companies have often found themselves navigating an alphabet soup of disclosure standards, with new frameworks emerging seemingly every year. As sustainability disclosure has become a central focus for investors, regulators, and stakeholders, the need for a unified reporting standard has become increasingly clear.
A Step Toward Convergence: IFRS S1 and S2
The International Sustainability Standards Board (ISSB) has made a significant move in this direction with the introduction of the new International Financial Reporting Standards, IFRS S1 and IFRS S2, launched on June 26th, 2023. IFRS S2 focuses on climate-related disclosures, while IFRS S1 encompasses all other ESG (Environmental, Social, Governance) disclosures. Together, these standards aim to streamline and unify the sustainability reporting process.
The ISSB has worked collaboratively with the FSB Task Force on Climate-Related Financial Disclosures (TCFD) to ensure a smooth transition of stewardship for sustainability reporting. The TCFD has formally requested that the ISSB take over the monitoring of sustainability standards for reporting and disclosure. Importantly, IFRS S1 does not attempt to redefine the sustainability issues and metrics suitable for each industry. Instead, it refers to existing frameworks, such as the Sustainability Accounting Standards Board (SASB) and Climate Disclosure Standards Board (CDSB), for guidance in defining what is relevant for each sector and topic. Both SASB and CDSB now fall under the stewardship of the ISSB.
Climate Risk Assessment and Scenario Analysis
A crucial aspect of IFRS S2 is its emphasis on climate-related scenario analysis to assess an entity’s resilience to climate-related risks and opportunities. Entities are required to disclose the methodology they use for scenario analysis, including key assumptions, time horizons, and the range of scenarios considered. This approach ensures that organizations assess their exposure to climate risks—both physical and transition risks—by evaluating different climate pathways and their potential financial impacts.
The IFRS S2 standard mandates that companies conduct climate resilience assessments at least in line with their strategic planning cycles and disclose any material financial effects of climate risks. This means that organizations must evaluate their ability to adjust their business models in response to evolving climate-related challenges, including regulatory changes, technological advancements, and market shifts. Furthermore, the standard encourages a progressive approach where entities refine their scenario analysis over time as methodologies, data, and climate models improve.
To provide measurable and comparable insights into their exposure to climate-related risks, IFRS S2 also requires entities to disclose specific metrics and targets related to their risk assessment. In particular, entities must report on:
- Climate-related transition risks, including the amount and percentage of assets or business activities vulnerable to such risks.
- Climate-related physical risks, identifying financial exposure to acute (e.g., extreme weather events) and chronic (e.g., rising sea levels) physical risks.
- Climate-related opportunities, assessing the extent to which an entity’s activities are aligned with opportunities arising from the transition to a low-carbon economy.
These metrics strengthen the connection between scenario analysis and financial risk assessment, allowing companies to translate climate-related risks and opportunities into tangible, trackable data points. Furthermore, by requiring disclosures on both physical and transition risks, IFRS S2 ensures that organizations provide stakeholders with a comprehensive view of their climate resilience strategies.
By integrating scenario analysis with clear metrics and targets, IFRS S2 promotes transparent, forward-looking climate risk management, helping investors and stakeholders understand the financial and strategic implications of climate change on an organization’s business model.
Another Layer: European Sustainability Reporting Standards (ESRS)
However, there is an additional layer of complexity in the European Union. While the IFRS S1 and S2 are reporting frameworks, the EU’s Corporate Sustainability Reporting Directive (CSRD) is a law scheduled to come into effect in 2024, which mandates reporting based on a new set of standards known as the European Sustainability Reporting Standards (ESRS). The European Commission adopted the ESRS on July 31st, 2023, with an effective date of January 1st, 2024.
The ESRS is made up of 12 standards, divided into four reporting categories: general, environmental, social, and governance. The environment category receives significant attention with five standards: Climate Change, Pollution, Water & Marine Resources, Biodiversity & Ecosystems, and Resource Use & Circular Economy. The social category encompasses four standards: Own Workforce, Workers in the Value Chain, Affected Communities, and Consumers & End-users. Finally, the governance category consists of a single standard on corporate ethics.
Key distinctions between the ESRS and IFRS S1 & S2
Despite the high level of convergence between the ESRS and IFRS S1 and S2, there are some key differences that will continue to require that companies monitor both frameworks and optimize their approaches accordingly. The main differences are:
- Definition of materiality: In the ESRS, materiality is based on the concept of double materiality, which considers both the company’s financial performance and its impact on people and nature. The IFRS S1 and S2 focus solely on financial materiality, which makes it easier for companies to disclose but does not consider the full impact of the enterprise.
- Reporting on non-material issues: The IFRS S1 and S2 allow companies to omit reporting on topics not deemed material. The initial draft ESRS required certain disclosures of all companies, regardless of materiality. However, the finalized version has dropped most of these mandatory reporting requirements, making the two frameworks more similar.
Preparing for the New Requirements
Given the new convergence and ongoing changes in sustainability reporting standards, companies may find themselves asking how to best prepare for the new requirements. Both the IFRS and ESRS require companies to gather new levels of information about their own operations and value chains. Lessons learned from the implementation of the German Supply Chain Act (LkSG) have shown that early preparation is crucial. Companies that proactively prepared for compliance had a smoother transition than those who delayed.
Despite the convergence, reporting remains a complex process. Companies must conduct materiality assessments, collect data, and report on the metrics relevant to their organization. Sphera has over a decade of experience in assisting companies in collecting data from their supply chains for both voluntary and compliance reporting. Our standard assessments continuously evolve to align with existing and emerging reporting frameworks and legislation.
Each company’s reporting process is unique, depending on factors such as industry, materiality considerations, and organizational maturity. That’s why the Sphera platform offers flexibility, allowing companies to customize assessments to suit their specific needs. From Climate Change solutions like the Scope 3 Emissions Calculator, to the Human Rights Compliance Assessment, Sphera provides valuable tools for navigating the complexities of sustainability reporting.
The introduction of the IFRS S1 and S2, and ESRS marks a significant transformation in the world of sustainability reporting. Despite this much-needed consolidation of frameworks, organizations must remain proactive, informed, and agile in understanding the nuances and requirements of each one. As the alphabet soup of reporting standards starts to clear, one message remains evident: sustainability, transparency, and diligence are more than just buzzwords – they are the foundation for future-proofing businesses in a rapidly evolving corporate landscape.
SupplyShift was acquired by Sphera in January 2024. This content originally appeared on the SupplyShift website and was slightly modified for sphera.com.
