The release of the International Sustainability Standards Board (ISSB) IFRS S1 and IFRS S2 standards marks a significant milestone in sustainability-related disclosures.
Both IFRS S1 and IFRS S2 are built on the principles that underpin the IFRS Accounting Standards. These accounting standards are already widely adopted across more than 140 jurisdictions. With this new package, the ISSB aim to provide a global baseline for sustainability reporting, ensuring consistency and comparability of information by harmonizing existing sustainability standards and frameworks.
Whilst directed at Capital Markets, Private Equity firms (PE) will be affected by this new wave of standardization in sustainability reporting both directly and indirectly. Therefore, PE firms should understand their requirements, assess gaps in current processes and prepare for disclosure.
This article explores the potential impact of these standards on the private equity sector, provides suggestions on how funds can prepare for the upcoming changes and how firms can derive value from them.
First up, it is helpful to assess the key features of IFRS S1 & S2:
- Disclosure of Sustainability-Related Risks and Opportunities:
IFRS S1 requires companies to provide a comprehensive disclosure of sustainability-related risks and opportunities they face in the short, medium, and long term. This includes disclosing information on environmental, social, and governance (ESG) factors that impact the company's prospects. This can be identified through materiality assessments, either at the fund level, or even more precisely at the PC level. The standard emphasizes transparency and provides investors with decision-useful information.
- Integration of Sustainability Information with Financial Statements:
Companies need to integrate sustainability-related information alongside their financial statements, all within a single reporting package. This requirement ensures that sustainability reporting is not treated as a separate entity but is presented in conjunction with financial disclosures. The aim is to provide a holistic view of a company's performance, considering both financial and non-financial aspects.
- Specific Climate-Related Disclosures:
IFRS S2 focuses specifically on climate-related disclosures. It sets out detailed requirements for companies to disclose information related to climate risks and opportunities. This includes disclosing the impact of climate change on a company's strategy, governance, and financial performance. The standard aims to enhance transparency and enable investors to make informed decisions considering climate-related factors.
- Integration with IFRS S1:
IFRS S2 is designed to be used in conjunction with IFRS S1. It complements the broader sustainability disclosures required by IFRS S1 by providing specific guidance on climate-related information. Companies need to ensure that their climate-related disclosures are consistent with the broader sustainability disclosures outlined in IFRS S1.
- Adoption of Task Force on Climate-related Financial Disclosures (TCFD) Recommendations:
Both IFRS S1 & S2 fully align to the recommendations of the TCFD. By aligning with the TCFD framework, the standard promotes consistent disclosures of climate-related information, allowing investors to assess a company's exposure to climate risks and evaluate its resilience and adaptability in a standardized manner. For publicly traded U.S. PE firms and their PCs, adopting reporting to follow the IFRS frameworks will also inevitably prepare them for SEC climate disclosure once that rule is finalized.
IFRS S1 and IFRS S2 will become effective for annual reporting periods beginning on or after 1 January 2024. However, mandatory application will depend on each jurisdiction’s endorsement or regulatory processes. Earlier application of the Standards is permitted, provided an entity applies both Standards at the same time and discloses that it has applied the Standard early.
Figure 1: The ISSB’s collaboration with other frameworks, such as the Global Reporting Initiative (GRI), enables the ISSB to build its requirements to be interoperable, helping to reduce the disclosure burden.
How IFRS S1 & S2 Impact Private Equity Firms:
Enhanced Reporting and Transparency:
The standards introduce a common disclosure language for sustainability-related risks and opportunities. Whilst there is not yet specific sectoral guidance, affected private equity firms will be required to communicate sustainability-related information alongside financial statements, providing a more comprehensive view of their investments' environmental and social impacts. All PE firms however may be indirectly impacted through requests made by LPs. A good starting point would understand fund level requirements, considering both geography and industry, before cascading to PC level disclosures. Increased transparency and integration with financial reporting can advantage PE firms in their Due Diligence processes to assess the risk and opportunity of investments more holistically. Further, it can attract more sustainability minded LPs.
- Alignment with a Global Baseline:
Private equity funds operating internationally will benefit from the ISSB standards' harmonization efforts. These standards are designed to align with existing accounting requirements and the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). With over 140 jurisdictions already requiring IFRS Accounting Standards, the ISSB standards create a global baseline for sustainability reporting. This alignment facilitates consistent understanding and evaluation of sustainability factors across borders. PE funds can benefit from companies being evaluated under a homogenous standard, which will streamline reporting processes, reduce duplication and improve comparability.
- Preparation and Timelines:
While the Standards are not yet mandatory, private equity funds should proactively prepare for their adoption. Funds can start by assessing their current sustainability reporting practices and identifying gaps in their ability to meet the new requirements. Getting ahead can provide a competitive advantage.
Call to Action:
- Understand requirements of the fund and of portfolio companies by keeping abreast of updates within your jurisdiction.
- Stay updated on the ISSB's implementation guidance and timelines to ensure a smooth transition.
- Assess current sustainability reporting practices and identify areas for improvement.
- Consider early adoption of the standards to gain a competitive edge and showcase commitment to sustainability.
By adopting the ISSB standards, PE firms can strengthen their integration of ESG factors into investment decision-making processes. This enables a more comprehensive assessment of risks and opportunities associated with sustainability factors. Effective ESG integration leads to the improvement of risk management strategies, identification of value-creation opportunities, and ultimately, better investment outcomes.
For more information on Schneider Electric’s Sustainability team’s approach to ESG reporting, visit: https://perspectives.se.com/sustainability-reporting-toolbox
Tomi Greene, Client Development Manager, Schneider Electric
Tomi helps global organizations develop responsible investment strategies and decarbonization pathways, and helps create go-to-market sustainability strategies.