12 Climate-Related Matters Summary of Connectivity Research – Update

22 June 2023 Agenda Paper 12 UKEB UK Endorsement Board

Executive Summary

Purpose of the paper

This paper presents a summary of recent research undertaken by third parties, relating to the connectivity between reporting of climate-related matters in the financial statements and the sustainability disclosures in the narrative reporting sections of the Annual Report.

This paper will enable the UKEB to be aware of relevant recent research findings, concerning UK reporting; to identify key themes; and, to identify potential areas of further research.

A draft of the summary report was reviewed by the Board at the April 2023 Board meeting. This is an updated version reflecting the feedback from that meeting.

Summary of the Issue

This represents the first deliverable per the Climate-related Matters Research Project Initiation Plan (PIP).

The paper has been prepared to support the UKEB responses to the ISSB Request for Information (RFI) on its workplan, and the IASB's project regarding Climate-related Risks in Financial Statements.

The paper contains a summary of the three key themes found from analysing 24 research reports and articles which commented on issues related to connectivity between climate-related risks as described in narrative reporting and the financial statements. The three key themes are:

• Connectivity—Approximately 80% of the reports found an overall lack of connectivity between climate-related narrative disclosures and disclosures in the financial statements.
• Occurrence and quality—Approximately 50% of the reports found an increase in the occurrence of climate-related disclosures over time but the quality of disclosures remains low.
• Estimates and judgments—Approximately 50% of the reports found that estimates and judgements relating to climate-related disclosures is a critical area of poor connectivity.

The summary does not comment on the causes or potential solutions to issues identified. These will be considered by other deliverables in the PIP.

The main changes, to the draft presented at the April 2023 Board meeting, are:

1. the tone has been changed to make it clear that we are supportive of the work of preparers in this fast moving area;
2. the Executive Summary includes information from the introduction sections of each topic;
3. section 1 'Approach' has been reduced and is more focussed;
4. the 'membership organisations' stakeholder group has been renamed to 'International Regulators' to better reflect its members (IOSCO and ESMA);
5. the 'Next Steps' section has been deleted;
6. an additional appendix (Appendix B) has been inserted to include further background, taken from Section 1;
7. information under the heading 'A new sister board to the IASB' in Appendix B includes quotes from the IFRS Foundation's Feedback Statement to its 2020 consultation paper on sustainability reporting; and,
8. a Glossary has been added to make the document more accessible to an international audience.

Decisions for the Board

1Does the Board approve the publication of the report on the UKEB website, subject to any amendments requested by the Members?

Recommendation

N/A

Appendices

Appendix A: Climate-Related Matters: Summary of Connectivity Research

The UKEB does not accept any liability to any party for any loss, damage or costs howsoever arising, whether directly or indirectly, whether in contract, tort or otherwise from any action or decision taken (or not taken) as a result of any person relying on or otherwise using this document or arising from any omission from it.

© (2023) All Rights Reserved

Executive Summary

Key connectivity themes identified by stakeholders

1The UK Endorsement Board (UKEB) conducted a desktop review of 24 research reports and articles published, during the period February 2020 to April 2023, by both UK and global organisations. The documents reviewed comment on climate-related disclosures and their connection with financial statements.

2The UKEB recognises that the information being reported in this area is new to preparers and that, therefore, best practice is emerging. This exercise identified three broad themes which are set out below in order of prevalence. The issues are expected to be resolved going forward as entities become more experienced at making climate-related disclosures and at connecting them to the financial information.

An overall lack of connectivity between climate-related narrative disclosures and their associated disclosures in the financial statements

3Approximately 80% the reports and articles reviewed noted concerns with a lack of connectivity within Annual Reports. This was generally manifested as frustration from stakeholders presented with an abundance of narrative climate-related commentary but with very limited means to link the effect to the financial statements.

Summary of highlighted issues and observations

• the importance of connectivity between climate-related disclosures and the financial statement to stakeholders.
• a common challenge of over-disclosure in the front half of Annual Reports and under-disclosure in the financial statements.
• a lack of medium- and longer-term considerations or use of voluntary disclosure to support users understand the differences between sustainability information and financial information.

While there has been an increase in the occurrence of climate-related disclosures the quality of disclosures remains low

4Approximately, 50% of the research reviewed noted a significant, and encouraging, increase in the frequency of climate reporting in annual reports over the past two years. However, they also noted that the quality of the disclosures was low and, therefore, not yet decision-useful for users. Examples of ‘low-quality' disclosures include limited evidence that climate-change issues have been considered in financial statements, a lack of quantified information and generic, rather than company-specific, information on connectivity. Such issues are to be expected as reporting is still at a nascent stage but these are areas entities can look to improve in future reports.

Summary of highlighted issues and observations

• poor connectivity between various elements of report.
• improvements on prior period disclosures but a lack of useful information.
• increased, but generally brief, disclosures, rarely inclusive of financial quantification.
• a lack of preparedness by entities and continued disconnects with financial reporting.
• limited evidence that climate change issues were being considered in the preparation of financial statements.
• insufficient decision-useful climate-related financial information, which may hinder investors, lenders, and insurance underwriters' efforts to appropriately assess and price climate-related risks.

More transparency is required regarding climate-related estimates and judgements used to prepare financial statements

5Approximately 50% of the reports reviewed mention estimates and judgements being a critical area of low connectivity. Common areas related to overall inconsistency between the reporting in the front and back halves of the annual report, a lack of disclosures relating to how (or if) climate-related risks had been reflected and whether (or not) Net Zero commitments were aligned with the estimates, judgements and assumptions used in the financial statements.

Summary of highlighted issues and observations

• while some entities had made appropriate disclosures, investors continued to call for better information in financial statements, including connecting net zero targets to relevant disclosures.
• the importance of this information to investors.
• the low levels of disclosure, in 2019, had not improved dramatically, in 2020.
• entities with significant GHG emissions provided limited evidence to confirm that climate change issues were considered in the preparation of financial statements.

Disclaimer

6Please note that the content of this report does not represent a UKEB policy position.

7The report does not attempt to comment on any particular causes or solutions to issues identified. This is a changing area of reporting and the landscape is developing at pace. The report summarises themes found in existing research papers on climate-related disclosures in an effort to highlight areas of difficulty being experienced by preparers. Accordingly, the report should not be taken as criticism of the work preparers are doing in this area.

1. Approach

The UK Endorsement Board (UKEB)

1.1The UKEB adopts and endorses IFRS Accounting Standards for use in the UK. It is an independent body, with specific delegated powers: to adopt international accounting standards for use within the UK, when they meet the statutory criteria; and, to influence the development of a single set of global international financial reporting standards.

Connectivity between the ISSB and IASB

1.2The objectives of the IFRS Foundation, as set out in its Constitution, are to develop, in the public interest, through both its boards, high quality, understandable, enforceable, and globally accepted standards for general purpose financial reporting, based on clearly articulated principles.

1.3The International Accounting Standards Board (IASB) is responsible for developing accounting standards. Its sister board, the International Sustainability Standards Board (ISSB) is responsible for developing sustainability disclosure standards. These complementary sets of IFRS Standards are intended to result in the provision of high-quality, transparent, and comparable information in financial statements and in sustainability disclosures that are useful to investors and other participants in the world's capital markets in making economic decisions.

1.4IFRS Accounting Standards require companies to consider all risks in their financial statements, including climate related risks, when their effect may be considered material to investors.

1.5The ISSB's first draft standard, IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information (General Requirements Exposure Draft)¹, requires entities to disclose information about all their significant sustainability-related risks and opportunities. The second, IFRS S2 Climate-related Disclosures (Climate Exposure Draft)² focusses on climate-related risks and opportunities. The IASB Chair, Andreas Barckow, and ISSB Chair, Emmanuel Faber, co-authored an article³ explaining how the two boards will work together to produce holistic, comprehensive and coherent general purpose financial reports.

UKEB project background and methodology

Background

1.6The aim of the UKEB report is to build awareness of connectivity matters by reviewing recent research, with a focus on climate-related disclosures and their connectivity to the financial statements of UK listed entities.

1.7This research is consistent with the UKEB's statutory functions, as well as the request from the UK Government for the UKEB to carry out additional work regarding the connectivity between the [draft] IFRS Sustainability Disclosure Standards and the IFRS Accounting Standards (see Appendix B).

1.8UK entities are required to include disclosures relating to climate-related matters, under the Taskforce for Climate-related Financial Disclosures (TCFD) requirements, and their energy use and greenhouse gas emissions under the Streamlined Energy and Carbon Reporting (SECR) requirements, in their annual reports.

1.9The evidence gathered from this research will help the UKEB to obtain insight into UK entities' existing experience of reporting on climate-related matters, by using TCFD and SECR reporting as a proxy for [draft] IFRS S2 Climate-related Disclosures.

1.10This approach has some limitations, as [draft] IFRS S1 and IFRS S2 have specific connectivity requirements, and this is a fast-moving area. However, the research will support the UKEB to provide evidence-based responses to both the IASB, on its project on climate-related Risks in Financial Statements, and to the ISSB, on its Request for Information (RFI) on its future work plan.

1.11The report does not attempt to comment on any particular causes or solutions to issues identified. This is a changing area of reporting and the landscape is developing at pace. The report summarises themes found in existing research papers on climate-related disclosures in an effort to highlight areas of difficulty being experienced by preparers. Accordingly, the report should not be taken as criticism of the work preparers are doing in this area.

1.12The outcome of the research is to develop a body of evidence which identifies potential disconnects between TCFD and SECR narrative disclosures and the disclosure of the associated financial effects, as appropriate, in the financial statements with a focus on UK Annual Reports.

Methodology

1.13This report is a summary of connectivity themes identified in, predominantly UK, reports and articles published since 2020, which included consideration of connectivity between climate-related disclosures and financial statements.

1.14In addition to literature searches, several academics (including members of the UKEB Academic Advisory Group) were contacted directly to assist in identifying relevant academic research. Only a limited number of academic papers were identified. This was consistent with the expectations of the academics we spoke with, who highlighted that this is still a relatively new research topic.

1.15The diagram below illustrates the reports and articles reviewed, by type of author. Appendix A provides the names of the author(s) and the report, as well as links to the documents.

24 Research reports and articles - by type of organisation

2. UK context

Current UK Reporting Framework

IFRS Accounting Standards requirements

2.1The Companies Act 2006 sets out the duty for UK registered entities to produce individual and group accounts, and the applicable accounting framework to be used.

2.2Public companies listed on a regulated market in the UK must use UK-adopted international accounting standards for their group accounts. Private companies, above the small company threshold, may also choose to produce their accounts using international standards. Around 14,000 UK registered private companies report under these standards on a voluntary basis.

2.3The UK Endorsement Board (UKEB) adopts and endorses IFRS accounting standards for use in the UK.

Narrative reporting requirements

2.4In the UK, the reporting requirements for registered entities are set out in Company Law. Since 2013, the Companies Act 2006 has required all large and medium-sized UK registered entities to file a Strategic Report as part of their publicly available Annual Report. Quoted companies are additionally required to include information about environmental matters (including the impact of their business on the environment), their employees and social community and human rights issues.

2.5In 2018, legislation⁴ came into force which implemented the Government's policy on SECR. The legislation requires all UK quoted, large unquoted and large limited liability partnerships (LLPs) to report on their energy use and greenhouse gas emissions.

2.6Under its Listing Rules, the Financial Conduct Authority (FCA) mandated climate reporting for, the nearly 900, premium listed companies, for accounting periods beginning on or after 1 January 2021. These initial requirements to report against the recommendations of the TCFD were introduced on a comply or explain basis.

2.7In January 2022, The Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2022⁵ extended the requirement to provide TCFD disclosures to all large companies & LLPs, of which there are over 1,300 for financial years starting on or after 6 April 2022.

2.8To help ensure that UK and global investors, and other stakeholders have access to consistent, relevant and reliable information on how companies are addressing sustainability matters, the UK remains committed to an international approach to sustainability reporting.

3. Key connectivity themes

3.1The desktop review of twenty-four recent research reports and articles commenting on climate-related risks and their connections with financial statements indicated four broad themes. In order of prevalence, these were:

1. Connectivity: the level of connectivity between climate-related narrative disclosures and the disclosures in the financial statements.
2. Occurrence and quality: an increase in the frequency but not quality of climate-related disclosures.
3. Estimates and judgements: a lack of transparency regarding the use or impact of climate-related matters in the estimates and judgements used to prepare financial statements.

3.2These three areas are discussed in more detail in the section below. Due to the range of reports and articles published by stakeholders, for ease of reference, each section includes an overall high-level summary and then comments on relevant research from stakeholders in the following order:

1. Standard Setters
2. UK Regulators
3. International regulators (IOSCO & ESMA)
4. Accounting firms
5. Academics
6. Not for Profit
7. Other

1. Connectivity

3.3This section notes comments made in relation to the connectivity between climate-related disclosures and TCFD, and the financial statements prepared under IFRS Accounting Standards. The box below summarises the feedback noted at an overall and stakeholder level.

Connectivity section summary

Approximately 80% of the reports and articles reviewed noted concerns with a lack of connectivity within Annual Reports. This generally arose as stakeholders found an abundance of narrative climate-related commentary but had very limited means to link this to the financial statements.

• Standard Setters noted the importance of connectivity between climate-related disclosures and the financial statement and recognised that it was a topic of interest to their stakeholders.
• Regulators noted a common challenge of over-disclosure in the front half of Annual Reports and under-disclosure in the financial statements.
• Accounting firms shared this observation, as well as noting a lack of medium- and longer-term considerations or use of voluntary disclosure to support users understand the differences between sustainability information and financial information.
• Academics noted poor disclosure behaviours and an inherent lack of connectivity between climate-related disclosures with information in company financial statements. The overall conclusion was that, due to this lack of connectivity, the TCFD may not be a useful proxy for firms' climate commitments.
• Not for profit research indicated that there was a poor level of connectivity with the financial statements as most climate-related assumptions and estimates were not visible in the financial statements.
• Other no specific observations noted.

Standard Setters

3.4The Chairs of the IASB and ISSB published an article⁶ noting the importance of connectivity between the IASB and ISSB products and processes.

3.5In addition, the IASB staff paper⁷ noted that stakeholders have been asking for greater clarity about how sustainability-related risks and opportunities disclosed in applying IFRS Sustainability Disclosure Standards would connect with and interact with the financial statements.

UK Regulators

3.6In November 2020, the Financial Reporting Council (FRC) published a Climate thematic⁸ which noted an increase in the number of companies providing a minimum level of narrative reporting on climate-related issues. Whilst acknowledging that the report was looking at earlier annual reports, it noted that:

1. Entities should consider whether the 'annual report and accounts, taken as a whole, presents a consistent message about the most significant risks presented by climate change, and includes all information that may be material for decision making'.
2. Only a quarter of companies sampled had made any reference to climate change in their financial statements, although almost all had addressed climate change in their narrative reporting.
3. It was generally unclear how forward-looking assumptions and judgements applied in preparation of the financial statements were consistent with narrative discussion of climate change in the strategic report.
4. There were apparent inconsistencies where uncertainties associated with climate change could reasonably have been expected to have had a significant impact on the financial statements but had not been disclosed.

3.7The report concluded that consideration and disclosure of climate change in financial statements was lagging narrative reporting and that users expected to see disclosures regarding the financial implications of climate change.

3.8In July 2022, the FRC published a second Thematic review of Task Force on Climate-related Financial Disclosures (TCFD) and climate in the financial statements⁹ and found mixed results. For example, in relation to impairment reviews, the FRC report noted that, while several entities had disclosed when climate change had not impacted certain assets' useful economic lives, others had only provided generic statements regarding impairment impacts. This made it unclear if, or how, climate risk had been reflected in cash flow projections or discount rates.

3.9In other instances, some entities had provided insufficient detail in their financial statements when compared to extensive disclosures about climate-related risks and opportunities in their Strategic Reports. A key example was that of an entity that referred to climate change over 100 times in the front half of its Annual Report but then made no reference to it within the financial statements.

3.10The FRC advised that it expected preparers to consider if narrative reporting disclosures were consistent with the judgements and estimates in the financial statements. It further clarified that it would challenge entities disclosing significant climate risks or net zero transition plans with no explanation of how that had been considered when preparing their financial statements.

3.11In March 2023, the FRC Corporate Reporting Review (CRR) team published their public case summaries¹⁰ noting four cases where the regulator had raised queries regarding climate-related risk disclosures. These cases referred to disclosures concerning the following topics:

1. significant sources of climate-related estimation uncertainty and in relation to the impairment of assets;
2. the relative impact and uncertainty of disclosed climate-related risks and opportunities;
3. climate targets and ambitions; and
4. statement of consistency with the TCFD Recommendations.

3.12All cases (since closed) referred to 2021-year end reporting and involved an exchange of substantive correspondence between the regulator and the entity.

International regulators

3.13IOSCO's Sustainable Finance Taskforce (SFT)¹¹ concluded that investor demand for sustainability-related information was not being properly met. In relation to connectivity issues, the report noted:

1. There was often a disconnect between sustainability information, either in the narrative sections of companies' annual reports, or separate publications, and the companies' financial statements.
2. Financial Statements often failed to reflect material sustainability information due to a lack of consistency in content and a mismatch in timing between the separate publications.

3.14The ESMA statement¹² communicated that consistency between IFRS financial statements and non-financial information is a priority area for 2022 Annual Financial Reports.

Accounting Firms

3.15PwC research observed¹³ that the front half of Annual Reports often included significant content on climate change but then there was often little or no mention of this in the financial statements. Recognising that there can be valid reasons for this apparent disconnect, they also noted that entities do not often provide this type of explanation to their investors.

3.16The research found a lack of quantified financial impact disclosures from climate-related matters. Only 8% of companies in the sample had quantified the financial impact of physical and transitional risks. It also found that while climate change was particularly relevant to impairment reviews, especially in high carbon emitting sectors, little information was generally provided regarding any climate-related risk assumptions used in the financial statements.

3.17PwC research also noted that TCFD financial disclosures tended to focus on the materiality of climate change related to the current balance sheet. It emphasised that the TCFD framework actually requires entities to consider the potential impact of climate-related issues on future financial performance and position but found little evidence of this in the sample.

3.18In an earlier report¹⁴, PwC noted that investors look to entities to explain the meaning, relevance, and effect of ESG issues on their business. However, the quality of information, regarding plans for reaching environmental and social commitments, as well as progress towards ESG targets, was lacking. The report also commented that, while investors have high expectations of sustainability-related reporting, their information needs are not currently being met, as one-third of investors classed the current quality of ESG reporting as poor.

3.19A Deloitte report¹⁵ observed that there can be an actual or perceived lack of connectivity between published climate commitments, such as TCFD disclosures, and the financial statements. In some circumstances, this can contribute to a perception that ‘words are hollow' until they change the numbers. The conceptual difference was highlighted between the narrative disclosures, which communicate an entity's future intentions, and historic financial reporting, which was designed to primarily show the effects of past transactions and events.

3.20This report suggested that additional voluntary disclosures could be considered by preparers to help users understand why stated or expected actions are, validly, not yet reflected in the financial statements.

Academics

3.21A KPMG report¹⁶ noted that when climate change or climate-related risks were mentioned in the financial statements, it was mostly included in significant estimates and judgements in relation to the impairment of plant, property and equipment and goodwill. However, based on the limited level of disclosure in the financial statements, they concluded that ‘for many UK reporters their Annual Reports have net zero in the front, but zero detailed climate disclosures in the financial statements'.

3.22A joint report by ACCA and University of Glasgow Adam Smith Business School¹⁷ compared climate-related and financial disclosures between 2019 to 2020 reports for a sample of entities in the construction materials and chemical industries. It noted that, overall, entities' poor disclosure behaviour had not changed dramatically.

3.23The ACCA and University of Glasgow Adam Smith Business School¹⁸ conducted further research on these industries and identified they were least prepared for the financial statement disclosures and noted the importance of these disclosures as a connection between the 'front and back' of an entity's annual reports. The analysis noted that the entities ‘appear not to inherently connect climate-related disclosures with information in their financial statements.'

3.24Brendan O'Dwyer & Jeffrey Unerman¹⁹ noted that there are currently significant discrepancies in the way in which material issues are identified and disclosed in mainstream corporate financial reports and in sustainability reports. They note that a key issue underlying materiality is how climate-related financial disclosures can be integrated into a mainstream corporate reporting model that might insufficiently cater for them. They note the risk that the TCFD's advice to adopt the approach to materiality applied to a corporation's mainstream financial reporting might result in limitations being transferred to the TCFD reporting. The Swiss Finance Institute²⁰ research noted that there was a current lack of standardisation and precision in climate risk disclosures, resulting in concerns that entities were not providing sufficiently granular and decision-useful information in their climate-related reporting. It noted that investors, financiers, and societal stakeholders considered that the available climate-related disclosures were not decision-useful, comparable, nor complete. It concluded that currently the TCFD framework was not a useful proxy for firms' climate commitments.

Not for profit

3.25Carbon Tracker²¹ published a research report in 2021, regarding the extent to which entities had disclosed climate risks within their financial statements and reached similar conclusions finding:

1. little evidence that companies had incorporated material climate-related matters into their financial statements;
2. that most climate-related assumptions and estimates were not visible in the financial statements; and
3. that most companies did not tell a consistent story across their reporting.

3.26The Climate Action 100+²² report found that the quality and quantity of entities' decarbonisation strategies and plans remained 'alarmingly low' and that there continues to be widespread failure to integrate climate risks into accounting practices.

2. Occurrence and quality

3.27This section notes comments made in relation to the occurrence and quality of climate-related disclosures and their connection with financial statements. The box below summarises the feedback noted at an overall and stakeholder level.

Occurrence and quality section summary

Approximately, 50% of the research reviewed noted a significant, and encouraging, increase in the frequency of climate reporting in annual reports, over the past two years. However, the research also highlighted that quality of the disclosures was low and, therefore, not yet decision-useful for users.

• Standard Setters found poor connectivity in relation to connections between various elements of report.
• UK Regulators noted improvements on prior period disclosures but a lack of useful information. The lack of connectivity is an active area of investigation.
• Accounting firms found disclosures had increased but were generally brief and rarely included financial quantification.
• Academics noted poor quality disclosures, a lack of preparedness by entities and continued disconnects with financial reporting.
• Not for profit identified incremental progress but found that there was limited evidence that climate change issues were being considered in the preparation of financial statements.
• Other (TCFD) found that not enough companies were disclosing decision-useful climate-related financial information, which may hinder investors, lenders, and insurance underwriters' efforts to appropriately assess and price climate-related risks.

Standard Setters

3.28The European Reporting Lab²³ review of climate-related disclosures found poor connectivity in relation to connections between various elements of report and references to supporting information elsewhere (such as a sustainability report, or greenhouse gas report).

UK Regulators

3.29The Financial Conduct Authority (FCA) found an overall improvement in the completeness and consistency of disclosures with the TCFD framework following their regulatory intervention²⁴. That is, more companies since 2020 were making disclosures that were either partially or mostly consistent with the TCFD framework. Reporting gaps were in respect to quantitative elements e.g., scenario analysis and metrics and targets.

3.30The FRC's initial Climate thematic²⁵ noted an increase in the number of companies providing narrative reporting on climate-related issues and their follow up thematic noted that significant progress had been made on climate reporting²⁶. However, the second thematic concluded that connectivity between TCFD and financial statements disclosures was generic in nature, tended not to be company specific, and that only a small proportion of companies had disclosed the impact of climate change on amounts recognised in the financial statements.

Accounting Firms

3.31A KPMG report²⁷ noted that more companies were including relevant climate information in their financial statements, but that the disclosures were generally brief and rarely included any financial quantification.

3.32A PwC report²⁸ found that, while 78% of companies referred to climate change in their financial statements (also noting a significant increase from only 22% observed in the FTSE 350 by PwC in the prior year), disclosures were often brief and high level.

3.33A Deloitte report²⁹ found that 90% of their sample of premium listed commercial companies had clearly identified statements of compliance with TCFD but that there was a 'spectrum' of approaches taken.

Academics

3.34Joint research by ACCA and Glasgow University Adam Smith Business School³⁰ noted that almost 80% of their sample of extractive entities identified climate change as an important issue to be considered within their 2020 business model disclosures.

3.35However, in a later report³¹ it was found that most entities in their construction materials and chemicals sample fell short of the type and level of disclosure that the ISSB has proposed.

Not for Profit

3.36A Climate Action 100+³² report found that companies had exceeded their sustainability disclosure expectations by presenting further incremental progress since their March 2022 Benchmark assessments. However, it also noted that the near-term accountability mechanisms and robust plans required to achieve the entities' stated climate goals, remained lacking.

3.37A Carbon Tracker³³ report also concluded that there was still limited evidence that climate change issues were being considered by entities with the most significant greenhouse gas (GHG) emissions when preparing their financial statements. The report found that while companies were setting net zero targets, these were not being reflected in the assumptions or estimates used to prepare entities financial statements.

Other

3.38The TCFD status report³⁴ provided an overview of current disclosure practices, in terms of their alignment with the TCFD recommendations. The research indicated that users still required disclosure of the actual and potential financial impacts of climate-related issues.

3.39It also noted that users were using climate-related financial disclosures in their decision-making (90%) and to price assets or determine rates (66%).

3.40However, the Task Force also highlighted concerns from stakeholders that not enough companies were disclosing decision-useful climate-related financial information, which may hinder investors, lenders, and insurance underwriters' efforts to appropriately assess and price climate-related risks.

3. Estimates and judgements

3.41This section notes comments made in relation to the estimates and judgements used in climate-related disclosures and their connection with financial statements. The box below summarises the feedback noted at an overall and stakeholder level.

Estimates and judgements section summary

Approximately 50% of the reports reviewed mention estimates and judgements relating to climate-related disclosures as a critical area of poor connectivity. Common areas related to overall inconsistency, failure to disclose how (or if) climate-related risks had been reflected and whether (or not) Net Zero commitments were aligned with estimates, judgements, assumptions used in the financial statements.

• Standard Setters the IASB staff paper noted that for their project Climate-related Risks in the Financial Statements they will leverage the work of the ISSB.
• Regulators noted that while some entities had made appropriate disclosures, investors continued to call for better information in financial statements, including connecting net zero targets to relevant disclosures. The ESMA statement advised that consistency between IFRS financial statements and non-financial information would be a priority area for 2022 annual reports.
• Accounting firms noted the lack of disclosure and emphasised the importance of this information to investors.
• Academics noted that overall entities low level of disclosure in 2019 had not improved dramatically in 2020.
• Not for profit concluded that for entities with significant GHG emissions there remained limited evidence to confirm that climate change issues were considered in the preparation of financial statements.
• Other no specific observations noted.

Standard Setters

3.42In an article³⁵ published by the IASB Chair, Andreas Barckow, he explained how the IASB's project on Climate-related Risks in the Financial Statements will relate to the work of the ISSB. He noted that the IASB could leverage the ISSB's work and consider questions such as how companies use assumptions consistent with the financial statements when applicable and to disclose information about the current and anticipated effects of sustainability-related risks and opportunities on the financial statements.

UK Regulators

3.43The FRC Lab³⁶ report noted that investors continued to call for better information in financial statements, including connecting net zero targets to relevant disclosures. That research found that investors valued information on the uncertainties and assumptions that impact a company's ability to reach net zero emissions, as well as factors that may cause companies to change plans. However, current reporting was not always clear or transparent in this area.

3.44The FRC Lab findings highlighted the need for companies to disclose specific estimates leading to material adjustment and to quantify key assumptions. The importance of sensitivity disclosures was also highlighted, and the Lab noted that IAS 1 Presentation of Financial Statements (paragraphs 122, 125, 129) and IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors (paragraph 39) provide requirements for these disclosures.

3.45The initial FRC Climate Thematic³⁷ noted that climate change was not generally addressed in disclosures of significant judgements, or about sources of estimation uncertainty which have a significant risk of resulting in a material adjustment within the next financial year. The report recognised that while uncertainties associated with climate change can often be resolved over a timeframe greater than 12 months, this was not always the case.

3.46The FRC CRR³⁸ team raised two queries with a listed company in relation to climate-related estimate and judgements. The first related to the relative impact and uncertainty of disclosed climate-related risks and opportunities. The FRC asked the entity to clarify the relative impact of the disclosed climate related risks and opportunities on gross margin. The second related to climate targets and ambitions where the FRC noted that the entity's climate transition plan in the annual report included large number of targets and aspirations, but that it was unclear if these are incorporated into budgets, business plans and accounting assumptions.

International regulators

3.47ESMA³⁹ communication emphasised that issuers should specifically consider judgements and estimates, provisions, contingent liabilities and contingent assets, and the impairment of non-financial assets when preparing their financial statements.

3.48IOSCO's Sustainable Finance Taskforce (SFT)⁴⁰ also noted similar concerns regarding investor requirements for clarity with the assumptions used to prepare financial statements.

Accounting firms

3.49A PwC report⁴¹ noted that climate change was particularly relevant to impairment reviews, especially in sectors with high GHG emissions but that little information was provided about the assumptions used relating to climate risk.

3.50A Deloitte report⁴² found that only one entity in its sample of 30 UK listed entities had connected the TCFD scenario disclosure with the relevant judgements and estimates used in the financial statements. It was noted that while this link is not a requirement of TCFD, investors have highlighted the importance of being able to understand the connection to the financial statements.

Academics

3.51While the joint research by ACCA and Glasgow University Adam Smith Business School⁴³ noted that a significant proportion of the sample had identified climate change as an important issue there was no significant improvement, since the previous year, in recognising climate change as an important factor in judgements and sources of estimation uncertainty, accounting policies on provisions and contingent liabilities, exploration and evaluation assets, tangible and intangible assets, or financial instruments.

3.52The research did identify a significant increase, from the previous year, in the number of entities recognising climate change as a key factor in their policies on impairment testing but only a minority recognised impairment losses where climate change was disclosed as an influential factor. As noted in the authors' 2019 research, none of the sampled entities identified climate-related risks as an important factor in determining the useful lives of its assets in 2020.

3.53In provisions and contingent liabilities notes, only marginal differences were identified. The authors concluded that, overall, entities' disclosure behaviour did not change dramatically from 2019 to 2020.

Not for profit

3.54Carbon Tracker's⁴⁴ initial report was followed up with a second in 2022. The report found that there remained limited evidence to confirm that climate change issues were considered in the preparation of financial statements of the entities with significant GHG emissions. That is, while companies were setting net zero targets, they were not factoring these into the assumptions and estimates used in preparing their financial statements. The key findings in relation to connectivity with financial statements were:

1. nearly all entities assessed provided insufficient information regarding whether climate-related matters were considered in the preparation of financial statements;
2. despite noting that climate risks may impact significant assumptions and estimates, nearly all of the entities assessed did not disclose relevant assumptions and estimates used in the preparation of financial statements;
3. while many entities recognised climate risks as material and indicated that they were taking steps to meet emission targets, climate considerations were not fully reflected in the financial statements; and
4. entities that had set net zero targets did not factor these into assumptions and estimates used in preparing financial statements. Out of 137, only 3 companies provided sensitivities to net zero aligned inputs.

Appendix A: Research reports and articles reviewed

Appendix B: Background

The UK Endorsement Board (UKEB)

B1The UKEB adopts and endorses IFRS Accounting Standards for use in the UK. Before the UK's exit from the EU, the EU Commission was responsible for IFRS Accounting Standards being adopted for use by companies in all Member States.

B2After EU Exit, the Government set up the UKEB, an independent body, with specific delegated powers: to adopt international accounting standards for use within the UK, when they meet the statutory criteria; and, to influence the development of a single set of global international financial reporting standards.

B3The memorandum of Understanding between the UKEB, the Secretary of State for Business, Energy and Industrial Strategy (BEIS)⁴⁵ and the FRC requires the UKEB to consider additional areas of work when requested to do so by the Secretary of State. Accordingly, the UKEB has also been tasked with considering the overlap between the proposed IFRS Sustainability Disclosure Standards and IFRS Accounting Standards⁴⁶.

B4The UKEB reports annually to Parliament on how it has performed its delegated statutory functions, as set out in Companies Act legislation⁴⁷.

International Sustainability Standards Board (ISSB)

A new sister board to the IASB

B5At the twenty sixth Conference of the Parties (COP 26), the IFRS Foundation announced⁴⁸ the establishment of the ISSB, as a 'sister' board to the IASB. The purpose of the ISSB is to develop a comprehensive global baseline of high-quality sustainability disclosure standards to meet users' information needs.

B6The IFRS Foundation had consulted on the ISSB's establishment and found strong support for the proposals from stakeholders. Responses to the Foundations' 2020 Consultation Paper on Sustainability Reporting⁴⁹ “illustrated widespread support for the IFRS Foundation to play a role in global sustainability reporting".

B7Respondents cited “the Foundation's relationships with global governance bodies and industries, its expertise in international standard-setting and its rigorous due process." Some respondents went further and "noted the potential value of having two boards setting international standards for both financial reporting and sustainability reporting working within one organisation (IFRS Foundation)" but noted that "the IASB and the new board would need to build effective synergies between sustainability reporting and financial reporting".

B8The objectives of the IFRS Foundation, as set out in its Constitution, are to develop, in the public interest, through both its boards, high quality, understandable, enforceable, and globally accepted standards for general purpose financial reporting, based on clearly articulated principles.

B9The IASB is responsible for developing accounting standards and the ISSB is responsible for developing sustainability disclosure standards. These complementary sets of IFRS Standards are intended to result in the provision of high-quality, transparent, and comparable information in financial statements and in sustainability disclosures that are useful to investors and other participants in the world's capital markets in making economic decisions.

IFRS Sustainability Disclosures Standards

B10Since COP 26, the ISSB has developed and issued two Exposure Drafts (ED):

1. IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information (General Requirements Exposure Draft) requires entities to disclose information about all their significant sustainability-related risks and opportunities; and
2. climate-related risks and opportunities.

B11While the ISSB incorporated the recommendations of the TCFD into both standards, the requirements of [draft] IFRS S2 are more granular than the TCFD recommendations. In March 2022, the ISSB published a comparison of the key differences between the requirements in the EDs and the TCFD's recommendations⁵⁰. The draft standards also include metrics, tailored to industry classifications, derived from the industry based SASB Standards.

B12Following the issue of the two EDs, the ISSB redeliberated comments received and made several tentative decisions to amend the proposals⁵¹. The ISSB has indicated that it intends to finalise both standards in the first half of 2023 and that their effective date will be 1 January 2024.

B13The ISSB made a tentative decision⁵² to enable entities to focus their efforts on ensuring they can meet investor information needs regarding [draft] IFRS S2 in their first year of reporting using the ISSB standards. Entities will only be required to provide full reporting on sustainability-related risks and opportunities, beyond climate, from their second year of reporting.

ISSB Agenda Priorities

B14The ISSB's first consultation on its agenda priorities was published on 4 May 2023, and the consultation period closes for comments on 1 September 2023. The Request for Information (RFI) Consultation on Agenda Priorities⁵³ seeks feedback on the ISSB's priorities for its next two-year work plan.

B15The RFI identifies four potential projects: three sustainability-related research projects:

1. biodiversity, ecosystems and ecosystem services;
2. human capital; and
3. human rights,

and a fourth project researching integration in reporting, which would look at "reporting on interdependencies, synergies and trade-offs between a company's own resources and relationships" in order to progress “integrating reporting via the connection of sustainability-related disclosures with the financial statements”.

B16The ISSB encourages stakeholder feedback primarily via electronic survey, rather than following the IASB approach of inviting open comment letters, to facilitate analysis of feedback. The ISSB staff intend to present an analysis of the RFI feedback in the fourth quarter of 2023.

International Accounting Standards Board (IASB)

IASB and climate-related matters

B17IFRS Accounting Standards require companies to consider all risks in their financial statements, including climate related risks, when their effect may be considered material to investors. This was initially clarified in the article 'IFRS Standards and climate-related disclosures'⁵⁴, and later, through educational material 'Effects of climate-related matters on financial statements' (November 2020)⁵⁵.

B18However, based on the feedback to the Third Agenda Consultation⁵⁶ in July 2022, the IASB established a maintenance pipeline project entitled ‘Climate-related Risks in Financial Statements'. This project is intended to consider stakeholder concerns from the consultation such as:

1. why companies that are expected to be impacted by climate related risks do not disclose information about the effects in their financial statements;
2. why companies that make net zero commitments do not recognise liabilities or impairments; and
3. how companies can factor long-term uncertainties into the measurement of amounts in the financial statements.

B19At the IASB's March 2023 meeting⁵⁷ it agreed to activate this project now that the ISSB has finished its redeliberations on draft IFRS S1 and S2, so there is a stable platform for the IASB to use. The IASB project will explore whether and, if so, how financial statements can better communicate information about climate-related risks. As a maintenance project, the project outcome will be narrow in scope i.e., any amendments to IASB Standards will be minor.

B20The project is currently researching the potential causes of stakeholder concerns relating to climate-related risks in the financial statements. These include:

1. unclear or insufficient requirements in IASB Standards;
2. lack of compliance with current requirements by companies; and
3. investor information needs that go beyond the objective of financial statements.

B21The IASB intends to leverage the work of the ISSB and consider questions such as:

1. whether to cover climate-related opportunities, as well as risks;
2. whether the IASB should cover all sustainability risks or only climate;
3. how scenario analysis could be considered when measuring assets and liabilities in the financial statements; and
4. whether connectivity mechanisms⁵⁸ used in the ISSB Standards could be mirrored in IASB Standards. For example, using consistent assumptions and explaining connections between the sustainability information and financial statements.

Connectivity between the IFRS boards

B22The IASB Chair, Andreas Barckow, and ISSB Chair, Emmanuel Faber, co-authored an article⁵⁹ explaining how the two boards will work together to produce holistic, comprehensive and coherent general purpose financial reports.

B23They note that investors are interested to see how matters reported in financial statements and sustainability financial disclosures are connected. Examples provided of tangible connectivity products include:

1. The many concepts and terms used in IASB and ISSB standards.
2. The requirement, in [draft] S1, to provide sustainability related financial disclosures as part of the financial report.
3. The requirement, in [draft] S1 and S2 for companies to explain how sustainability and climate related risks and opportunities are reflected in financial statements and use assumptions consistent with the financial statements.
4. The IASB new project on Climate-related Risk in the Financial Statements, that will use learnings from the ISSB's work in S1 and S2.

B24The article explains that, to achieve connectivity in products, the IASB and ISSB are building connectivity into their processes. Engagement between the boards will enable them to identify and address common issues and to identify opportunities to use common language and concepts.

Appendix C: Glossary

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