Ambition, passion and a sense of urgency often characterise discussions around sustainability. And that still holds true when you get into the weeds of the standard-setting processes for sustainability reporting and disclosures, and the best way to move forward, as mandatory sustainability reporting enters the mainstream in jurisdictions across the world. 

The recent arrival of inaugural mandatory European Sustainability Reporting Standards (ESRS) and global IFRS Sustainability Disclosure Standards (S1 and S2), on which many national jurisdictions plan to base their standards, has highlighted significant challenges, not least a lack of consensus among standard-setters on some fundamental matters.

What comprises sustainability-related information? Who is it for? What information is considered material? These are just some of the fundamentals that must be widely agreed on if the future development, usability and implementation of sustainability reporting and disclosure standards are to mirror the success of global standards for financial reporting. The aim of achieving better standard setting and ultimately a global baseline for sustainability reporting requires consensus on key sustainability-related concepts and decisions. Should these standards be principles- or rules-based? Can reporting on sustainability and finance be more meaningfully connected? Is a combined conceptual framework for financial reporting and sustainability needed? 

More questions than answers?

In considering such questions and ways to address them, much may be learned from the accounting standard-setting model. The approach of the International Accounting Standards Board (IASB) and its Conceptual Framework for Financial Reporting have enabled the development of globally agreed standards that have been adopted in more than 140 jurisdictions.

Could this be a template for sustainability standards from the International Sustainability Standards Board (ISSB) and others? “My personal view was always that the IASB Conceptual Framework would make a great starting point for the work of the ISSB,” says Jeremy Nicholls, an academic and ‘lapsed accountant’, who has spent decades as Chief Executive of Social Value International alongside advising other organisations and lecturing at several universities.

Nicholls is clearly a fan. “You need to be quite geeky to appreciate how rarefied its beauty is, but I think the IASB’s Conceptual Framework is an astounding document,” says Nicholls, who is not its only admirer. ICAEW’s 2024 report on Shaping sustainability standard setting describes it as “one of the more significant features of the IASB’s standard setting”. 

This conceptual framework provides high-level, overarching principles for key aspects of general-purpose financial reporting. Its objective and intended audience are explained as: “providing financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions relating to providing resources to the entity”. 

Recognising the need to provide information that this audience will find useful for a particular purpose is, says Nicholls, one of the key things that sustainability standard-setters can learn from the IASB’s Conceptual Framework. Clearly defining purpose and users helps to prevent a deluge of information that is not material to the decisions that users will be making on providing resources in the expectation of financial returns.

The IASB’s Conceptual Framework also recognises that for this purpose, these primary users of general-purpose financial reports will need two types of information, Nicholls explains. Information on resources a reporting entity has at its disposal, and information on how effectively management has used those resources to meet the expected interest in financial returns. And those different types of information, broadly, give you a balance sheet and a profit and loss account.

Different types of uncertainty

“Among its most impressive features are ways the conceptual framework deals with uncertainty and levels of uncertainty that are inherently unmeasurable and unquantifiable,” says Nicholls. “It is brilliant,” he says, in how it teases out different types of uncertainty and how much of these uncertainties the primary users are prepared to live with – “one of the most amazing things is that this includes unknown unknowns”.

Uncertainties translate into risk. The IASB’s Conceptual Framework has enabled the development of financial reporting standards that acknowledge different types of uncertainty and risks that don’t easily fall into measurable buckets. By putting boundaries around them and using a structure (including audit) that can assess risks, this framework helps to keep risk at levels that are acceptable for a very tightly defined group of primary users.

“There is a lot within the IASB Conceptual Framework that would have made a very useful starting point for the ISSB. It could have helped with reflections on what ‘useful’ information on sustainability is and for whom,” says Nicholls. After all, primary users of general purpose financial reports and sustainability-related financial disclosures are the same people, making the same decisions around providing resources to a reporting entity in the expectation of financial returns.

The ISSB and IASB are both part of the IFRS Foundation, so the new standard-setter is well placed to stand on the shoulders of its more experienced stablemate. Some aspects of the Conceptual Framework for Financial Reporting can be found in IFRS S1, the ISSB standard on general requirements for disclosure of sustainability-related financial information. However, says Nicholls, a lot of what’s good about the framework is not in IFRS S1, which could create challenges for users.

Potential for confusion

Users of financial reports know that a reporting entity has prepared these based on information about past events. “It’s very clear, for example, that financial reports reflect decisions that managers have made in the past and should not be confused with anything they might do in the future,” says Nicholls. Users may find less clarity around sustainability-related information as this may relate to past events and what might happen in the future.

The IASB and ISSB take different approaches to uncertainty and what’s considered ‘useful’, he adds. For a past event that potentially meets the definition of, for example, an asset or a liability, and merits disclosure in general-purpose financial reports, it must reach a particular level of certainty. When it comes to sustainability-related financial disclosures the thresholds are less clear.

This logical disconnect and its potential to create confusion extends to materiality – a tricky concept at the best of times. “Users of sustainability-related financial disclosures are being given information they didn’t have before and that is financially material, but the context in which the ISSB is applying materiality is not the same as IASB.” This has prompted a great deal of debate among standard-setters and other stakeholders. “There’ve been some big arguments,” says Nicholls.

There’s certainly potential for some thoughtful discussions about which are the most significant differences between financial reporting standards from the IASB and sustainability disclosure standards from the ISSB. And to carefully consider how (at least some of these) might, potentially, be addressed in a way that will make general-purpose and sustainability-related financial information that is reported and disclosed more useful, comparable and transparent.

For Nicholls, what is missing from sustainability-related financial information is also significant. “There are many arguments around materiality, but the big issue for me is that sustainability-related financial information does not convey how effectively management has been making decisions in order to reduce bad sustainability consequences or increase positive ones.” As a subset of financial information, some of this seems likely to be financially material.

A framework for progress

Complex matters such as these can end up in a metaphorical box marked ‘too difficult’. But Nicholls sees the IASB Conceptual Framework for Financial Reporting as a vehicle for the ISSB to consider difficult issues around sustainability standard-setting and how these might be addressed. “It would really flag up some of the big issues and force us to grapple with what we are going to do about addressing some of the challenges.”

It may help sustainability standard-setters and stakeholders to see that users of sustainability-related financial disclosures need two types of information on which to base their decisions, just like users of general-purpose financial reports. “I think we are on a journey towards providing the equivalent of a sustainability profit and loss account relating to past events or an impact profit and loss account, with a number of corporates working on the development of an integrated profit and loss.”

At least the challenges and the direction of travel might become more clearly articulated. Given the amount of recent and planned mandatory standard-setting, it seems improbable that a solution can be found immediately that will provide the primary users of general-purpose and sustainability-related financial information the holistic, connected, comprehensive, internally coherent and transparent picture of a company they deserve.

As ICAEW observes in its report, a combined Conceptual Framework to address sustainability and financial reporting matters would be a long-term project for the IASB and ISSB. Meanwhile, a conceptual framework specifically designed to set out key concepts relevant to sustainability reporting could provide some much-needed clarity. Could this be removed from the ‘too difficult’ box with relative ease?

Taking the Conceptual Framework for Financial Reporting and replacing ‘financial’ with ‘social and environmental’ quickly shows what might be kept and what might need to be tweaked, suggests Nicholls. “It should not be beyond our ability to create an equivalent form of useful information that meets users’ requirements,” he says, and there’s an urgent need for a Conceptual Framework to guide standard setting for sustainability. “Change will be much harder when everyone around the world is busily reporting on it.”