IFRS S2 requirements relative to TCFD recommendations. How will climate disclosures change?

Authored by Dr Mary Stewart, Olivia Kember, John Evans, Stephen Catchpole and Dr Nick Wood

Key takeaways

• While the overall requirements of both IFRS S2 and TCFD are aligned for the most part, IFRS S2 will require climate-related information to be incorporated into financial reports and it will be legislated.
• IFRS S2 is not about reporting on emissions, it’s about your company’s path to 2050, and the impact climate risk will have on financial performance.
• It’s not just about compliance. There is real value in understanding how climate will impact company value.
• Companies are encouraged to use the next eight months to build out their capacity and capability to report in line with IFRS S2, to understand any gaps and to work out pragmatic approaches to address these.

In July the Financial Stability Board announced that the Taskforce for Climate-related Financial Disclosures (TCFD) will sunset in 2024, with its monitoring role to be taken over by the International Financial Reporting Standards (IFRS) Foundation. The IFRS Foundation has already convened the International Sustainability Standards Board (ISSB), which has overseen the development of a new voluntary baseline standard based on the TCFD’s recommendations. This standard, called IFRS S2 Climate-related Disclosures, was also released in July[1] . The IFRS Foundation acknowledged the ground-breaking work of the TCFD, stating, “The TCFD has been a trailblazer in raising the practice and quality of climate-related disclosures, providing much-needed information to investors about climate-related risks and opportunities[2] .”

IFRS strongly recommends that companies continue to disclose in line with TCFD recommendations until the 2024 handover. This will help prepare them for the IFRS S2 disclosure requirements.

In this article Energetics explores the areas of overlap with TCFD and some of the differences, noting that the requirements of IFRS S2 reporting are much broader than those of TCFD. We also recommend areas for review and where additional capability will be needed.

Comparing IFRS S2 and TCFD2

Before discussing the differences between IFRS S2 and TCFD it needs to be stressed that the overall recommendations of both frameworks are aligned. The most significant differences between the two programs are:

• IFRS S2 requires climate-related information to be included in your annual financial statements, which has significant implications for the timing of reports. It will take a while for the extent of this impact to be understood. We note the potential for some climate-related information to be out of step with financial information supplied.
• Disclosure based on ISSB Standards will be legislated. In Australia it will become part of the Corporation Act.

IFRS S2 presents its reporting requirements across the following four areas.

Governance

More detailed information is required. Significant changes that companies should note are the need to develop and report on climate risk management skills/competencies at executive and board level (for which we are not yet sure what a satisfactory response looks like), and the linking of climate-related targets to remuneration.

Strategy

The TCFD recommendations on strategy disclosure seem more comprehensive than those of IFRS S2, which only require an understanding of these aspects. However, there are many layers to ISSB which need to be unpacked. IFRS S2 does not necessarily allow companies to determine whether climate-related risks are material, and there are minimum disclosure requirements on an industry basis.

Differences between TCFD and IFRS S2 relate to four main aspects of reporting:

1. Disclosure of climate-related risks and opportunities over the short, medium and long term. IFRS S2, in addition to industry-specific disclosure requirements which need more detailed information to be supplied around both risks and opportunities, also has a focus on broader impacts to the business model and its value chain. This is a significant change.

• From an Australian perspective it is not clear yet whether Treasury is going to require any of the industry-specific information contained in IFRS S2. However, other jurisdictions and/or sources of capital may seek this information. Our initial summary is available in our article, Part 2: What will the ISSB requirements mean for Australian companies experienced in NGER reporting? | Energetics . Industry specific requirements could include some surprises. Companies are encouraged to review the requirements of their industry.

2. Descriptions of the impact of climate-related risks and opportunities on strategy and financial planning. IFRS S2 requires disclosure of transition plans in some detail. Further, IFRS S2 is focussed on the quantification of climate-related risks, and while qualitative assessment is possible, companies will need to identify their reasons for undertaking this level of reporting based on their inability to separate risk from opportunity, or because the measurement uncertainty is too high. The ISSB wording relating to these disclosures should be noted “When preparing disclosures on the anticipated financial effects, IFRS S2 requires a company to use all?reasonable and supportable information that is available at the reporting date without undue cost or effort and requires the use of an approach that is commensurate with the company’s circumstances.”

• We note that both the ISSB and, from an Australian perspective, Treasury, expect companies to face a learning curve when it comes to quantifying climate-related risks. Companies will need to make best endeavours within reason (cost of assessments is considered) when disclosing this aspect.

3. In their resilience assessment, TCFD requires companies to include a 2oC or lower future temperature scenario. IFRS S2 is not prescriptive about the scenarios to be included. However, it does require additional information on resilience where it relates to:

• Areas of uncertainty in the assessment
• Whether the company has the ability to adjust and adapt its business model over time
• A description of the climate-related scenario analysis. IFRS requires scenario analysis to be in line with the company’s circumstances and to consider all reasonable and supportable information that is available at the reporting date without being too expensive. We note at this point that Treasury requirements in Australia are more prescriptive of scenario requirements. Energetics will discuss this topic in another article.

4. The inclusion of the disclosure of transition plans is a significant and challenging additional requirement of IFRS S2.

Risk management

The TCFD primarily focused on climate risks. IFRS S2 requires companies to review and disclose the opportunities as well as the risks highlighted by the breadth of their assessments. Further, IFRS S2 places additional emphasis on the processes that companies use to identify climate-related risks, particularly with reference to how they are integrated into the company’s overall risk management processes and structures.

IFRS S2 requires more detailed information than TCFD with respect to:

• The input parameters used in identifying risks, for example data sources, operations covered, and assumptions made
• How climate-related scenarios are used in the identification of risks
• Whether risk processes have changed with time.

IFRS S2 requires additional information on:

• The processes used to identify, assess, prioritise and monitor opportunities highlighted by the risk assessments
• How the processes used to raise these opportunities are integrated into the company’s overall risk management approach.

Metrics and targets

IFRS S2 and TCFD are aligned on the goals of reporting against metrics and targets, however the IFRS S2 has additional requirements.

For metrics, IFRS S2 asks for more information on:

• A company’s business model and activities using ISSB defined industry-based metrics
• Disclosure of scope 1 and scope 2 emissions in line with different structures and ownership models
• Scope 2 emissions as reported on a location-based approach. This is how NGER companies typically report their emissions
• Scope 3 emissions, including information on the measurement approach, inputs and assumptions
• Additional information on financed emissions if applicable.

In the case of targets and how companies are performing against them, more information is needed on:

• How international agreements and their conclusions have informed targets, and whether the targets have been verified
• The use of carbon credits and the reporting of gross (excluding the impact of carbon credits) and net (including the effect of these credits) emissions
• How the company monitors performance over time
• Whether the target is derived using a sectoral decarbonisation approach.

IFRS S2 builds on the disclosure recommendations of TCFD – review and address new and expanded elements now

Companies are encouraged to continue to report following the TCFD recommendations, and use this next year to build out their capacity and capability to report in line with IFRS S2. Now is the time for companies to identify and address gaps in skills and data, build the necessary internal processes, and even conduct trials to assess how well placed they are to meet the IFRS S2 reporting requirements.

IFRS S2 is not about reporting an energy and greenhouse gas inventory. It is about reporting on your transition to the company you plan to be in 2050, and the impact that this transition, and physical climate risk, will have on the financial performance of your company. It requires you to assess not only the risks but also the opportunities that actively managing the impact of climate change will represent to your business.

Getting the reporting right isn’t just about compliance or coming up with numbers. This is about corporate strategy and value.

References

[1] IFRS | IFRS Foundation welcomes culmination of TCFD work and transfer of TCFD monitoring responsibilities to ISSB from 2024

[2] IFRS | Comparison: IFRS S2 Climate-related Disclosures with the TCFD Recommendations (July 2023)