IFRS S2 climate-related disclosure requirements

Many organisations have managed to implement their Taskforce for Climate-related Financial Disclosures (TCFD) climate reporting requirements without a significant impact on their sustainability or finance teams. However, we believe this is about to change with the introduction of International Sustainability Standard Board (ISSB) new reporting standards. The new standards will mean it is going to be a busy period for many organisations in the run up to their formal adoption for large and listed companies.

The recent and final publication of ISSB IFRS standard S2 related to climate-related disclosures may appear to a casual reader to be a minor re-tread of the pre-existing TCFD guidelines. This, however, misses some material changes — in particular, for insurance companies and asset managers.

Internationally the new standard is effective for reporting periods ending on or after 1 January 2024, although local adoption is required in each jurisdiction. The UK government, for example, is aiming to endorse these standards by July 2024, by incorporating them into their new Sustainability Disclosure Standards (SDS). It is expected to come into force during 2025.

What is staying the same compared to TCFD?

For organisations currently producing a TCFD report, the first observation is that the four key pillars of disclosure will remain the same as outlined below in Figure 1. Although what requires to be disclosed under each section is generally more detailed or prescriptive, adopting the same basic framework is helpful in enabling organisations to evolve their reporting processes.

The governance section is least impactful, with just a requirement to provide more evidence of how climate risk matters are addressed, for instance, the charters of committees and policy documents.

The risk management pillar is also relatively unchanged, although there is an expectation that climate opportunities, as well as threats, are to be considered when reporting on the risks being identified, assessed, and managed. More detail is required on how the organisation implements its risk management processes, including sources of information, use of scenario analysis, and whether the process itself has been revisited and changed.

Figure 1 – Overview of IFRS S2 guidance

What is changing compared to TCFD?

IFRS have helpfully produced a comparison document to highlight the key differences. However, for insurance and asset management organisations, some of the more challenging and resource intensive requirements occur from the Industry-based Guidance on Implementing IFRS S2. This has largely adopted the expectations previously laid out in the Sustainability Accounting Standards Boards (SASB) sector-based disclosure expectations.

We would group the significant implications into three areas for careful consideration:

• Strategy – additional disclosure expectations

Transition plans. There is a requirement to disclose a transition plan (if the organisation has one in place) and provide explanation on how targets will be met. Although not having a transition plan is currently possible, this is unlikely to remain, given that the Transition Plan Taskforce final recommendations are due shortly and are anticipated to be backed by the UK government and regulators.

Quantitative disclosures. There is also expectation that all organisations will need to provide quantitative disclosures on financial impacts of climate change, subject to a test that the ‘approach is commensurate to their circumstances.’ Although this reads like a proportionality tests, it is unlikely to apply to financial services, given the extensive quantified information available to most insurers and asset managers.

• Core metrics and targets

The most interesting disclosure requirements that apply to all organisations relate to exposure and remuneration.

• Exposure and opportunities. There is expectation that the percentage of an organisation’s assets or activities exposed to transition or physical risk be disclosed, as well as the level of investment in climate transition-related new solutions.

• Remuneration. Disclosure is required as to whether executive’s remuneration is aligned to climate factors and the level of long-term incentives involved. Again, although it is possible not to create this link, it is likely that peer pressure will increase over time to align with the ‘developing norm’.

Additionally and specific to insurance and asset managers, there is a requirement that Scope 3 greenhouse gas emissions clearly address financed emissions under Category 15 of GHG Protocol Corporate Value Chain (Scope 3) Standard. The implication being that insurance-associated emissions according to the Partnership for Carbon Accounting Financials (PCAF) would need to be followed.

Finally, there is a requirement to disclose whether a third party has validated emission reduction targets. Again, there is an implication here that this will over time become standard.

Sector-specific metrics and targets

Most of the additional sector-specific requirements are derived from the SASB standards and are not necessarily new but have not been widely adopted by a sector reluctant to disclose what some see to be commercially sensitive information.

Although at high-level, only six additional disclosures are listed. They break down quickly into some quite detailed and specific requirements.

Catastrophe exposures. The most significant for property and casualty insurers will relate to catastrophe exposures. There is a specific requirement to disclosure Probable Maximum Loss (PML) values for weather related natural catastrophes on an annual aggregate exceedance probability-basis (AEP), at a minimum of three return periods. These values are expected to be broken down by peril type (e.g., wind, flood, drought, or winter weather) and region, showing the exposures gross and net of reinsurance recoveries. Information on measures being taken to adapt their catastrophe modelling to account for climate change is also expected, as well as the approach to risk selection and pricing. These types of disclosures may be currently considered confidential by many insurers.

Interestingly there is an option for organisations to describe how sustainability risks have been integrated into their enterprise risk management frameworks.

Policies designed to incentivise responsible behaviour: There is an expectation that insurers disclose detailed quantitative information and narrative describing their approach to encouraging resilience to climate effects and encouraging transition to cleaner technologies, including new products and policy wording changes. The accurate data capture of a number of these factors may take some time for organisations to establish.

With many of these disclosures, there are two additional layers of challenge in managing the change.

1. The first is communicating the change internally and gaining buy-in from senior management to a significant change in disclosure behaviours. Much of the information required, has until recently been considered proprietary and linked to the insurer’s underwriting ‘secret sauce’, particularly details related to risk appetite, exposure profiles and reinsurance protections.
2. The second is being able to put in place internal controls and procedures, capable of supporting the reporting of the information to the standard consistent with external disclosure. There remains a significant gap between financial and non-financial reporting, in terms of level of testing and assurance in place to protect the organisation against the risks of misstatement.

The wider implications of IFRS S2

We observe that many sustainability teams are struggling to deliver what they are currently being asked to do, due to twin process-related challenges:

1. Complexity: insurance organisations are often faced with multiple reporting expectations, for instance, an international re/insurer might be regulated by over ten supervisors with varying reporting requirements. Being listed on a major stock exchange also brings additional requirements, as do any voluntary commitments the organisation has chosen to make.
2. Speed of change: the rapid evolution of requirements places significant burden on climate teams, forced to focus on short-term deadlines. Teams have in some cases been moving from reporting deadline to deadline, without any time to step back and think about how best to be organised.

These pressures tend to establish inefficient processes, and resource utilisation. The long-term answer is clearly not to continue to expand the resources required to manage external reporting, but to better define an internal framework capable of being adapted to new and emerging requirements and establishing strong data architecture, capable of reliably and efficiently managing the data flows required to support the preparation, sign-off and reporting of disclosures. Perhaps now is the time to think more broadly about how to organise matters around sustainability strategy delivery.

Figure 2 outlines an example where an organisation firstly puts in place its own sustainability strategy, driven by its strategic context, related to stakeholder and business model. This defines what external commitments and targets are felt to be appropriate. As requirements are modified or added to, the framework is simply adapted and expanded to cope. Now is the time for organisations to step back and think about how best to be organised to manage these requirements.

Figure 2 – Crowe’s approach to addressing rapidly changing sustainability reporting expectations

Our advice is that if you currently have a TCFD reporting process in place, use the time before the formal adoption of IFRS S2 standard, to prepare the ground for your additional disclosures. This is vital because these changes will impact several teams and not just the climate and financial reporting functions. Therefore, a ‘dry run’ exercise is highly advised, to confirm that you can reliably report against the new requirements.

This time also provides you with opportunity to take stock and think about how you are currently organised to deliver on your external reporting commitments. IFRS S2 follows the same basic pillars as TCFD, but this does not help unless you have taken the opportunity to consider whether it has the right capabilities in place and efficient processes to deliver on its commitments.

Please contact Alex Hindson or your usual Crowe contact for more information.

Please find our insight on the IFRS S1 sustainability-related disclosure requirements here.