The ecosystem that shapes and supports voluntary and mandatory reporting of sustainability-related information has changed a lot over recent years – and it is going to change even more. There are thorny challenges ahead for standard-setters and other stakeholders, including regulators, reporters, investors and auditors – to name but a few. 

During 2023 and 2024, difficult issues have been highlighted by significant developments, including the 12 inaugural European Standards for Sustainability Reporting (ESRS) and two inaugural IFRS Sustainability Disclosure Standards, IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information (IFRS S1) and IFRS S2 Climate-related Disclosures (IFRS S2). 

Elephants in the room

The issues relate to the lack of consensus on the purpose and audience of these standards; managing expectations among stakeholders that may not have previously engaged with standard-setters; decision making on future projects and direction of travel; interoperability matters such as materiality and the prospects for a globally agreed baseline for sustainability-related reporting. 

ESRS drafted by the European Financial Reporting Advisory Group (EFRAG) and IFRS S1 and S2 from the IFRS Foundation’s International Sustainability Standards Board (ISSB) don’t just come from different places, they are trying to achieve different things. “Put simply, standards from the ISSB and ESRS share one purpose, but the Europeans also have a second purpose in mind,” says Chris Nobes, Professor of Accounting at Royal Holloway, University of London, and a member of the steering group that oversaw the production of the ICAEW thought leadership report, Shaping sustainability standard setting. As a former member of the International Accounting Standards Committee, which developed International Accounting Standards, Nobes can also offer insights into some of the underlying complexities and practical challenges these differences can create. 

Taking a large UK listed company with hundreds of non-UK subsidiaries applying locally endorsed IFRS as an example, he explains, UK law tells the company to comply with UK-endorsed IFRS which, for most practical purposes, means that one set of rules is used for consolidated group reporting. Reporting is trickier if that large UK company is one of those that must also apply the rules of Europe’s ESRS.

Attempts have been made to smooth the way with interoperability guidance from EFRAG and the IFRS Foundation, but differences between Europe’s ESRS and the IFRS Sustainability Disclosure Standards (which a number of jurisdictions have committed to) still present problems, for example, in relation to some of the concepts that shape what’s needed in sustainability-related disclosures. 

Nobes explains that the ESRS and ISSB standards are carefully worded to achieve some alignment on what they mean by “financial materiality”, but that ESRS also require disclosures if there is “impact materiality”, creating the two-dimensional “double materiality”. By comparison with the narrowly defined scope of financial materiality, the scope of impact materiality is much more open-ended.

What is material?

On sustainability-related financial disclosures, IFRS S1 echoes other IFRS Accounting Standards on information being material if it could “reasonably be expected to influence decisions that primary users of general-purpose financial reports make” and “reasonably be expected to affect the entity’s cash flows, its access to finance or cost of capital over the short, medium or long term”. 

Also, says Nobes, IFRS S1 sensibly points out that if some ‘nasty thing’ is not expected to happen until many years into the future, that thing is less likely to affect decisions now by primary users. “A reporting entity may not need to worry about disclosing it because it is not material for today’s decisions by today’s users. There’s a sort of discounting going on,” he explains.

By contrast, ESRS impact materiality encompasses “actual or potential, positive or negative impacts on people or the environment over the short, medium or long term” and an amorphous “upstream and downstream value chain” where impact materiality assessment due diligence is informed by, among other things, the UN Guiding Principles on Business and Human Rights. 

“The ESRS include thousands of words, but no definition of impact materiality,” says Nobes, and they span a wide range of sustainability-related topics and sectors. “I would be very alarmed if I were a CFO or the auditor of a corporation having to comply with these ESRS rules.” Almost anything could, potentially, have an impact that is considered material by an ESRS stakeholder.

Perspective is everything

IFRS S1 offers some guardrails for financial materiality by referring to “primary users”. However, because ESRS encompass many disparate and ill-defined stakeholders with competing priorities, the political pressures they exert could be unprecedented in scope and scale, and ESRS disclosures could become a deluge that obscures sustainability-related information that some stakeholders consider material.

“The longer the annual report, the fewer people will read all of it,” says Nobes. This would not satisfy stakeholders such as the International Organization of Securities Commissions, G20, the Financial Stability Board and others that want to build on existing reporting with a cohesive global baseline of sustainability disclosures focused on the needs of investors and financial markets. 

That is unless some gaps can be closed between existing and emerging standards from Europe and the ISSB. In theory, either set of standards could become more like the other, but Nobes sees this as unlikely. “While standards from Europe and the ISSB have a fundamentally different purpose and fundamentally different set of users in mind, I don’t see this happening,” he says.

The reality of ESRS and/or the ISSB’s standards could create pressures that change the direction of either or both camps. Over past decades, efforts in some jurisdictions have focused on concise, usable, transparent and understandable reporting and disclosures. Nobes says: “It will be interesting to see what emerges when the ESRS and ISSB standards are both applied.”