The Financial Conduct Authority (FCA) is consulting on this at the moment. One of the people behind the international standards joins us and ICAEW’s Sustainability Reporting and Assurance Director to discuss the implications of this.
Host
- Philippa Lamb
Guests
- Ravi Abeywardana
- Richard Barker
Producer
- Natalie Chisholm
Transcript
Philippa Lamb: Welcome to Behind the Numbers, 30 minutes of expert discussion on a fresh subject every month. And of course, it's CPD. I'm Philippa Lamb, and today we're looking at the introduction of UK sustainability reporting standards, or UK SRS. Now this is all part of the ongoing process to align reporting standards globally. Right now, the Financial Conduct Authority is consulting on what those standards might look like, and, crucially, exactly which businesses will have to adhere to them. So what does the FCA have in mind, and how can you have your say in that consultation?
[Teaser audio] Richard Barker: If you're an investor in this business, what do you need to know about the exposure of the business to sustainability related risks and or opportunities? Well, what information is there that the business has or ought to have that you would welcome having, as an investor that affects the financial prospects of the entity over the short term, medium term, long term?
[Teaser audio] Ravi Abeywardana: What we're seeing here is the mainstreaming of sustainability related financial information, so that it's on a par with the traditional financials, which accountants across the world labour over every month, every quarter, every year.
PL: To shed light, we have Richard Barker joining us remotely. He's one of the architects of the international standards and a board member on the international sustainability standards board, or ISSB and full disclosure, this episode will be a sea of acronyms, so I apologise for that. Here in the studio, we have Ravi Abeywardana, Director of Sustainability Reporting and Assurance for ICAEW. Welcome to both of you.
RB: Thank you.
RA: Thank you.
PL: Ravi, we know sustainability is a very fragmented landscape right now. What standards are people in the UK largely using right now?
RA: They're very much using a framework called the Task Force on Climate Related Financial Disclosures. And I'm going to bring in an acronym here called also known as TCFD, and that's particularly pertinent for a certain slice of the economy, the listed entities under the FCA rules, or a particular component of listed entities. And what's required there is a disclosure of climate related financial disclosures. Or if an entity isn't able to do that, they would need to explain why, outside of those organisations who are captured by those FCA rules, you do have a bit of a smorgasbord of disclosures across different regimes.
PL: So what sort of problems is that causing, then?
RA: In a nutshell, fragmentation. And investors have noted this, that there's fragmentation in the actual information which has been disclosed. And from their perspective, investors are ultimately global. They're International. And when they want to compare one entity to another across different jurisdictions, that becomes a bit of an issue for them comparability, and it's also complex for preparers as well. And overall, this just leads to costs within the actual ecosystem itself.
PL: So Richard, what is the plan now? ISSB, you've created new standards...
RB: You called me an architect before, which is a new one for me. I've never been an architect before, so thank you for that.
PL: Not at all!
RB: So the ISSB is the sister board of the IASB, right? So everyone listening to this, I think, will be familiar with International Accounting Standards, IFRS. And the IFRS foundation now has two boards setting two sets of standards, accounting and sustainability and the ISSB standards really come in response to investor demand, as Ravi was just describing, investor demand for better sustainability related disclosure. So as investors have become increasingly aware of the opportunities and the risks to their investments associated with all aspects of climate and so they want more information. They want it in a standardised way, in a comparable way, in a high quality way, and so on. So same underlying criteria as applied to accounting standards. And if you're global, you want the information globally, right? So it made sense for the IFRS foundation to step in and provide those standards.
PL: Now, as I said, the FCA, it's consulting right now as we're recording this, what questions are they asking?
RB: The process the UK has been through... every jurisdiction constructs its own process. And the UK process has been one of the... FRC, the financial reporting Council, first of all, doing a sort of kicking of the tires of the standards, as it were. So they went through an extensive, really high quality process of rigorously going through all aspects of both standards to determine whether or not they were appropriate for use in the UK essentially. They determined that they were, then the critical next stage in that process, especially for listed entities, is the FCA consultation for then requiring those for listing rules in the UK.
PL: So they're looking at the costs, the benefits for listed entities?
RB: Sure, as we are required to as well. So all standard setting and regulation in this space always looks at both cost and benefit.
PL: So assurance as well?
RB: And assurance, yeah. So again, a part of bringing in standards and mandatory standards is you bring in assurance with them as well. But also, again, different jurisdictions are making different levels of requirement about the assurance that's required. So the UK, not pushing into the FCA proposal is not to push ahead with mandatory assurance at this stage.
PL: There's a novel point here. Well, novel to the UK, at least. This ‘comply and explain’ idea. Can you just talk us through what that is and what that will mean in practice?
RB: So Ravi has mentioned ‘comply or explain’ that applies to TCFD, and in the FCA proposals, comply or explain applies to specific parts of the ISSB standards. So if you split the standards between climate and everything else sustainability related, then the standards would require... so mandatory disclosure of scope one and scope two emissions. So scope one is emissions from your own operations, directly controlled within your own operations. So you know... whatever fuel burned in your own furnace or something. And scope two is emissions, is emissions from electricity, basically. So relatively straightforward category to measure. Scope three is everything else – is emissions upstream and downstream of your business. And those are required by the IFRS standard, S2 the FCA proposal, is to have comply or explain. In other words, either tell us what your scope three emissions are and comply with the standard or explain why you haven't. And that would apply under the proposal both to scope three emissions and to all other sustainability related disclosures. So very broad, actually.
PL: Ravi?
RA: I guess, the question is: What could this look like in practice, under a comply and explain regime? Assuming these proposals became mandatory and regulatory ultimately. Perhaps a good explanation is setting out, if you can't do scope three, what's missing? Why? What's being done to improve the data and the direction of travel. But we also have to take a step back with regards to what Richard and the other board members have done, from an ISSB perspective, is to say you don't necessarily need to boil the ocean to get this information out to investors. So that investors ultimately have the information to inform their decisions and get a sense of direction when it comes to scope three emissions. And I think that's a particularly important component. You know, this is relatively achievable, you can use estimates. And what an investor, I assume they would do with such information, is understand the potential risk of a particular entity against, for example, a possible carbon tax on emissions, for example. So what is the risk of a particular entity to such matters, and how could it affect future cash flows over the foreseeable future.
PL: Okay, so it's looking ahead. So if you're a business selling into the EU and as you say, if there's a thought that there may be a carbon tax at the border, what is that going to mean in terms of the investors' approach to it? That's the idea. Now, this is obviously an attempt to create global standards. How many jurisdictions, Ravi, have adopted the ISSB standards so far?
RA: Richard, you're gonna have to correct me here, but I was trawling through your website over the weekend, and based upon the information which I was able to gather, it's pretty phenomenal. You know, it's just over two and a half years ago that the ISSB had released their inaugural standards, and it's around 40 jurisdictions who are adopting or moving towards ISSB standards. That is really phenomenal. Of those 40 jurisdictions, there are 17 published ISSB jurisdictional profiles. What does that mean? This is a bilateral dialogue between the IFRS foundation and the regulators within these particular jurisdictions, about their mandatory adoption pathways and I can go into a little bit more detail, because this is fascinating. So it spans Africa, so Ghana, Kenya, Nigeria, Tanzania, Zambia, Asia, Pacific. So Australia, Bangladesh, Hong Kong, Malaysia, Pakistan, Sri Lanka, Chinese Taipei, the Americas... so we're across the pond now, over to Brazil, Chile and Mexico, but also other parts of Europe in the Middle East, such as Turkey and Jordan. So it really shows that adoption is global, not confined to one particular region or level of economic development. It's really, really encouraging from a UK perspective, these discussions. There are FCA proposals out in the public domain on the future direction of sustainability disclosures within the UK, which is really pleasing to see.
PL: I mean, Richard, you must be pleased with that level of adoption. Is it more than you thought in the timeframe?
RB: Yes, I think it's fair to say. It's also... the number 40 is about right. But Ravi didn't give you the 40 names. So there's more names. There's more jurisdictions...
PL: Let's read them all out!
RB: Yeah (laughs). And I think very pleasing is both the geographic spread and the size spread as well. You know, jurisdictions like China and Japan, for example, Brazil, sort of large jurisdictions in a global economic context, but also medium sized ones and smaller ones. And across the Americas and Europe, Middle East, Africa and Asia.
PL: Is the UK a bit late to this party, Richard?
RB: It's interesting. The UK is kind of coming at a pivotal moment, I would say, because it certainly wasn't a first mover in terms of adopting. But there's 140 countries or more using IFRS accounting standards. So in that sense, it's still in an early wave, as it were. But I think it's more important than just a jurisdiction, because it's such an important capital market and also an important jurisdiction in terms of sending signals to others as well. So I think the UK adoption is for us a really important milestone.
PL: I mean, conversely, are there lessons the UK can learn from previous adoptions?
RB: Well, this is all happening very quickly. The only country that has adopted and required and mandated and assured and so on, and the reports are already out, is Turkey. So that Turkey was the very first mover in that sense.
PL: And when did that happen?
RB: Last year. So there are audited reports from that jurisdiction already available. But then in the current year, there will be many more. So it's a bit early to learn from practice, in that sense. That said, back to where Ravi started – the UK experience is extensive already in this space. So if you're applying our climate standard, our climate standard is built on TCFD. It's basically TCFD with a few additions. And so UK companies are already doing this to a large degree, and already very well placed to do it. So it's important, I think, not to see adoption as some sort of binary, different world or something. It's very much an evolution from existing practice.
PL: So Ravi, is that how practitioners are seeing is it? I mean, this is sitting with the finance team, right? Largely?
RA: One can say there's been a maturity in thinking with regards to how an entity takes such thinking forward. So it's bit of a change management exercise initially. And I for one, would say this would be a stepping stone, rather than something completely new. TCFD and its thinking is not new to the UK market, and building upon that which the FCA proposals have articulated, there is a real opportunity for UK listed entities in particular, to really build upon that knowledge and top it up to actually meet requirements from an international perspective, by the ISSB standards.
RA: And Richard, as you say, a lot of this will feel familiar to a degree, but S1 is different, isn't it? It involves new requirements?
RB: Yeah, it extends beyond climate, essentially, is the difference. There's something else to add though, I think, which is really important here, which is, for many people, the notion of sustainability reporting. And one reason why S1 feels different to your question, is a perception that sustainability reporting is about corporate social responsibility or corporate impact, or doing the right thing, or not core to business or something. And in an IFRS context, it's not that right? In an IFRS context, it's providing decision useful information to investors to make investment decisions in exactly the same way, in principle that accounting standards are written. So we have the same target audience as it were, which is investors, the same criterion of providing material information for investment decisions. And therefore this is sustainability related information, which is it might not be about the company's own impact. So we've talked about greenhouse gas emissions, and it may be that those are relevant because, and Ravi gave the example, you may have the carbon adjustment, border adjustment mechanism, or you may have a high carbon intensity product or supply chain, which means that your market is becoming increasingly untenable over time, and your investors need to understand that. So that's why scope three matters, right? So you can understand the exposure of the business to its emissions. But it's not just its emissions. You know, businesses might be exposed to extreme weather events, for example, which has got nothing to do with the business itself, but it's climate related, right? So understanding how the business is exposed to climate and what opportunities it has for, let's say, the EV market or something, is what our standards are all about, rather than making the business responsible or accountable in some in some narrower sense. So again, that mindset should be more than familiar. That's what the finance team, the investigations team, has always done... is report information in that way, sustainability reporting, I think historically, has been owned by the sustainability teams. And so we're starting to see a move from the sustainability team into the finance team. So the fact that it's labelled sustainability is kind of unfamiliar to the finance team, but the fact that it's all about reporting material information for investors is bread and butter to a finance team.
PL: Yeah, Ravi...
RA: And just building upon that, what the ISSB has ultimately done is take that very the same focus that the accounting standards have done, but what it's asking for is for a finance team to open up its blinkers and take into consideration a wider pool of information which could have an impact on a company's financial position and its financial performance. Now? So are there any particular matters which should be reflected In your existing financial statements and the connectivity between both, but also, are there any particular effects on cash future, cash flows, access to capital, and the cost of capital over the foreseeable future, which could call into question the strategic direction, the very strategic direction of a corporate? And really what we're talking about, this is very much the bread and butter of a finance team, but it's just bringing together this information in a clear and concise way. And if it is material, actually disclose it to your investors so you can have that communication where necessary.
PL: It's a big change management project, this. And actual organisational design terms because, as Richard says, "This has been the sustainability team". You know, kind of... those guys over there, and now it's not.
RB: It is and it isn't, right? It isn't because it is for the reasons you described, but it isn't in the sense that the requirement to provide material information is a requirement to explain to investors things that are of economic significance to the entity, essentially. And a board already has a fiduciary duty to be taken care of such things, right? And so for most businesses, sustainability is going to be a few key issues for any given business. It might be water, it might be human rights, it might be emissions or something. But if you view it through a business lens, most businesses will realise they are already looking at these things. They may not be describing it as a sustainability issue or thinking about sustainability reporting, but it's already there. So if it feels dramatically new, then either the requirements of the reporting are not well understood, or the business is not managing what it should be managing, one or the other.
PL: It's an understanding exercise?
RB: Yeah, I think so. Yeah.
PL: That brings us neatly to what businesses should do now?
RB: Now, again, I would look through an investor lens. If you're an investor in this business, what do you need to know about the exposure of the business to sustainability related risks and our opportunities? Well, what information is there that the business has or ought to have that you would welcome having as an investor that affects the financial prospects of the entity over the short term, medium term, long term? So again, notice the difference with accounting information. Accounting information is about historical performance and current financial position, whereas this is about looking ahead. Things like your transition to net zero is the obvious example. How are you going to do that? Are you going to do that? Do you have a target to do that? What capital expenditure is associated with that? What revenue is at risk? Is it possible to grow in the course of that transition and so on? So it's the financial effects the investor is interested in. So if you view through those lens, of what the investor is interested in, you won't go far wrong.
RA: Ravi, your thoughts on how entities should actually operationalize that?
RA: First of all, they should do some form of assessment of the potential sustainability related risks and opportunities. There are sources of guidance, via the ISSB standards, that help an entity identify particular risks or opportunities that may be pertinent to a particular sector. If you're starting on this exercise, I would go down that road. Understand what could be those written opportunities, and then have a discussion internally with regards to all these matters which we should be looking into a little bit more closely. But building upon what Richard had mentioned, a business should already have a feel of what those risks and opportunities are. Financial numbers are so closely monitored, entities will be very... they will have a good understanding of why particular numbers are down. It could have been a water scarcity issue. Or cost might have gone up because of an energy crisis. So it really is doubling down and perhaps expanding upon that as well. A company should really understand what its supply chain is as well. So if they have quite a deep supply chain, are there any risks associated with the suppliers in which they're interacting with? That could have, as Richard had articulated, a financial effect on the entity's prospects over the foreseeable future.
PL: So this is core to proper governance?
RA: Absolutely. And it needs to be led from the top ultimately, and systems and processes and controls and the monitoring of all of this needs to be done alongside your financials. What we're seeing here is the mainstreaming of sustainability related financial information so that it's on a par with the traditional financials, which accountants across the world labour over every month, every quarter, every year.
PL: It's happening. Do we have any sort of sense of time frame for adoption?
PL: These standards, they're available to review, aren't they? Through the ISSB, right now. So how can people get involved in the consultation if they want to.
RB: It depends what kind of entity you are, whether you're a listed entity, and therefore covered by the FCA rules or not. And there'll be a consultation also... well, it's already done a consultation. There'll be an announcement by the DBT, by the government, for entities that are not listed.
RB: The FCA consultation... the documents are on the FCA website. I'm not sure if you can find a link via this...
PL: We'll put it in the show notes, yeah. Absolutely.
RB: And the deadline is.. is it the 10th of March? Maybe I'm making it up, it's something like that.
PL: Can we get clarity on this? Because I do think it does matter what the deadline is (laughs). March 20th is the deadline. Are we sure about this?
PL: Yeah, I think it's 20th of March.
RA: We are, yeah. I've got it on my notes!
PL: And as I say, we will put links to all of this in the show notes, so you'll be able to see what the ISSB does. See how you get involved with the consultation.
RA: And because it's such an important consultation for the UK market, but also the significance from a global perspective, ICAEW will be responding as well. So if there are any particular questions or thoughts from our members, please do reach out.
PL: That's great. Thank you both. Very much indeed.
RA: Pleasure. Thank you.
RB: Thank you very much.
PL: As I said, we'll put links in the show notes to both that consultation and the original standards. And when the consultation is resolved and finished, we'll be talking to CFOs about how they plan to work with the new standards. Next month on Behind the Numbers, we'll be looking at AI and what it might mean for accountancy careers. How is the technology reshaping the skills makeup of firms and finance teams, and what does it mean for the talent pipeline for career progression and succession planning? Now you've listened to this podcast, do remember to log it as CPD on the ICAEW website. You need to do that every time you listen to an episode, but as you will see, if you haven't done it before, it is very quick to do. Thanks for being with us.