Climate change is the “tragedy of the horizon”, warned Mark Carney, then governor of the Bank of England, in a 2015 speech to the insurance market Lloyd’s of London.

By that he meant that the current generation has no direct incentive to fix the catastrophic impacts of climate change that will be felt by future generations beyond the horizon of business, political cycles and “technocratic authorities, like central banks…. bound by their mandates”. 

Joseph Mariathasan

Joseph Mariathasan

Carney proved to be a powerful advocate for a radical change in thinking, which played an important role in the creation of the International Sustainability Standards Board (ISSB) in 2021, according to Ravi Abeywardana, technical director of the Climate Disclosure Standards Board (CDSB). 

The objectives of the ISSB will be transformational for investors examining sustainability-related issues. The ISSB was set up by the IFRS Foundation as an addition to the well-established International Accounting Standards Board (IASB) to develop a single set of high-quality, understandable, enforceable and globally accepted sustainability disclosure standards focused on enterprise value. It has become clear that sustainability information in its various guises, not only climate, but also covering areas such as water consumption, biodiversity, health and safety, is critical for assessing a company’s financial health. 

“This sort of thinking was really propelled into the public domain by the Task Force on Climate-related Financial Disclosures (TCFD) recommendations, which is a genesis of what CDSB had created back in 2007. That was followed by the International Integrated Reporting Council (IIRC) in 2010, and the Sustainability Accounting Standards Board in 2011,” explains Abeywardana. 

Sense of urgency

COP26, the global climate change conference in Glasgow last year, saw the publication of two prototypes on climate and general requirements. The IFRS Foundation has indicated that the ISSB is likely to release consultative documents into the public domain as early as the first quarter of this year. There is a sense of urgency, he says, with some ambitious timeframes for delivery outlined by the foundation, to create a comprehensive global baseline of high-quality sustainability disclosure standards that meets investors’ information needs, which jurisdictions can pick up, build upon and mandate. This will give investors access to decision-useful information on sustainability-related factors that may impact a company’s future cash flows, its financial performance, position and ability to execute its strategy. That can raise some delicate issues for an international set of guidelines and ISSB has to produce impartial standards that can be picked up by all jurisdictions.

The work of the CDSB itself, since it was set up in 2007, had an initial focus on a climate-related framework to support preparers in disclosing material information to investors about financial risks and opportunities. CDSB’s framework and associated materials have grown to include not only all environmental considerations like water and biodiversity but also social issues such as diversity-related matters that can have an impact on a company’s future cash flows. 

Message from the market

The key to company disclosures is to allow investors to examine sustainability factors that can reasonably be expected to pose a risk to a company’s enterprise value and assess plans to manage and mitigate the risks. It will require the disclosure of all material information about sustainability risks that impact an entity’s enterprise value.

It raises challenges for companies, investors, and rule setters. Wide-scale capacity building will be required to meet expectations. The problem is that merely disclosing tonnages of carbon emissions, tonnages of toxic wastes, cubic litres of water consumed and wastewater produced does not translate into an understanding of the significance of the impact on the organisation and society, nor does it allow comparisons between different types of impact. 

“The total impacts of companies on the world need to be measured, monitored and managed”

A cement company, for example, emitting differing levels of pollutants from a number of sites, will have more negative adverse outcomes to human wellbeing if the sites are close to towns than if they are in isolated locations. Management itself may not even be aware of the differences and certainly will not be quantifying the difference. There is a need to understand the significance of external sustainability trends and impacts. 

“That is why the valuation of impacts is a very useful tool that could be used by investors to ascertain the potential impacts on a company and the impact of those emissions on the communities in which companies operate,” says Abeywardana, who previously led impact valuation efforts for food and agricultural business Olam International.

Valuations of impacts, which include qualitative, quantitative and monetary methods, are being advocated by academics such as George Serafeim at Harvard Business School and by sustainability focused analytics firms.  Abeywardana says there are currently no impact valuation metrics within the IFRS’s Technical Readiness Working Group metrics, “but that’s no reason to say that shouldn’t change if there’s a real demand from the market as a means of communicating enterprise value”. 

Sustainable companies have to be able to prove that they are able to make profits for investors, lenders and other creditors and prove they are able to operate in an environment that is changing due to climate change, biodiversity and social issues. 

That is certainly not the case now. The majority of listed companies produce negative impacts on the environment and society which are not accounted for at all, while generating profits for their shareholders that may be at risk over the short, medium and long term from significant sustainability risks that have not been measured and managed. 

What is interesting about the IFRS Foundation, says Abeywardana, is the power of connectivity between IASB and ISSB. This enables the creation of coherent standards for the disclosure of material sustainability information which affects enterprise value. This can be both through financial disclosures and also via management commentary. Incorporating the thinking of CDSB on connected disclosures allows investors to see one coherent message on enterprise value.

Abeywardana, who is also a member of the sustainability committee and council member of the Institute of Chartered Accountants of England and Wales, is excited about the opportunity to help create standards that can shift the world’s capital markets towards valuing more highly those companies that are more sustainable. The creation of the ISSB is a vehicle for moving towards that goal. Key functions of the ISSB will be hosted in Frankfurt – where the chair’s office will be – and Montreal, with technical hubs in London and San Francisco, as well as Asia. 

Sensible strategy

As the world still reels from the COVID pandemic, a risk that was never factored into any company or government planning scenarios, one lesson has become clear: ignoring sustainability risks such as climate, biodiversity and human rights is not a sensible strategy. The total impacts of companies on the world need to be measured, monitored and managed. Only then can potential future risks of corporate strategies, and the impact on enterprise value, be assessed and change enforced. The creation of the ISSB reflects that fact.

Joseph Mariathasan is a contributing editor to IPE and a director of GIST Advisory