Series 8 Episode 4: Rethinking sustainability reporting - exploring the final UK SRS

Transcript

Andrew Strange: Welcome to this episode of Risk & Regulation Rundown, the podcast where we share perspectives on the latest issues shaping the financial services risk and regulatory agenda. I'm Andrew Strange, and today I'm switching hats to be your host as we talk about the UK Sustainability Reporting Standards - the UK's adoption of the ISSB Standards. We'll cover what's changed now that the UK SRS are final, what the FCA's recently closed consultation could mean for listed firms, and what firms should be doing now to prepare.

Now I'm not an expert on this; however, I am delighted to be joined by two people that I hope are. We have Richard Barker, a Board Member of the International Sustainability Standards Board, and Gemma Jones, Sustainability Director in our Insurance and Asset & Wealth Management team, who works with financial services clients on sustainability.

So welcome Gemma; welcome Richard.

Why don't we start off with a bit of a recap. What are the UK Sustainability Reporting standards (the UK SRS), and where do they sit in the wider UK landscape for sustainability reporting? Richard, maybe you could start.

Richard Barker: Thank you. It was nice to hear you in your introduction talking about the UK's adoption of ISSB standards - we've reached that milestone in this process. So, the process in effect started at COP26 in Glasgow when the IFRS Foundation announced that it would create a sister board to the IASB, the ISSB. And the ISSB created two standards, S1 and S2, S1 - general disclosure requirements, and S2 for climate, building on TCFD. And there has been a global process of adoption of those standards. This is the UK taking part in that process, essentially. So S1 and S2 are the foundation standards for the UK SRS.

Gemma Jones: I echo it's exciting to see that this has finally come to fruition. I guess they matter because they moved the UK from a TCFD, which is Task Force for Climate-related Financial Disclosures, climate reporting towards a broader sustainability reporting model. And it's focused on material information for investors. I think you asked the question there around where do they sit in the wider UK landscape - this is not a brand new subject for many of our clients, and essentially they sit alongside the FCA's consultation for listed issuers and wider UK reform on corporate reporting. For banks and insurers who we work with, they're also thinking about this and how it interacts with the PRA's recent Supervisory Statement 5/25 and required implementation plans. And that is about embedding climate risk inside your organisation. And one of the requirements of that is to report in line with UK SRS as and when adopted. Asset managers will also need to think about how this fits in with their wider sustainability reporting requirements around things like SDR as well. There’s still lots going on, but absolutely for me this is a very welcome evolution of what has gone before and great to see.

Andrew: Excellent. I'm beginning to see why our regular host asked me to step into this. The number of acronyms is staggering. In practice, what changes now the UK SRS are final, and why does this moment matter for UK markets?

Richard: I think it's not so different from when accounting standards first came in. It wasn't that we didn't have practice in some form or another, but having a global standard for sustainability-related financial disclosure ups the game, it increases the quality of information. This is the UK taking part in this global movement. Investors have been demanding sustainability-related information for some time. Now, the IFRS Foundation is all about providing material information to investors. And the world is in transition, in the sense that we have a climate transition taking place and other environmental and social demands on business and the future of business that will change business models in one way or another. We're seeing that all around us now. And business explaining how it's resilient in the face of those changes and how it sees opportunities in the face of those changes, and doing so in a way that's standardised and comparable across entities, nationally and globally, that's what it's all about.

Gemma: I couldn’t agree more. And I think that point around comparability has been an issue for a number of years across the piece, and this really helps to provide some of that standardisation. And I think as well, what's important to note, is that this really takes us into a place where we have a more integrated finance connected disclosure model. And probably there has been disclosure for many years and lots of information, but it hasn't necessarily brought the insight that the market and investors are looking for. This really does help move us into a new space. And as Richard mentioned there, the world is changing pretty rapidly. There's lots for people to think about. And this really helps organisations understand if they’re 'future fit’ in a way that helps them compare with how other people are dealing with some of these topics. And there are risks, but there are definitely opportunities too, so leaning into it really helps identify some of them as well.

Andrew: Great. Let's zoom out a bit on this. What are the key foundations underpinning the ISSB standards, and how are those principles being carried forward as jurisdictions begin to implement them?

Richard: So, a little bit of an aside first of all - you say you're not an expert. I think it's really important to say, I don't think anybody's an expert in this. I think it's inherent in the nature of sustainability-related financial disclosure that we're bringing together a range of different disciplines and understandings and so on, in a practice that's evolving very quickly. So, you're more of an expert than you realise. Sustainability reporting is relatively speaking new and so we are all learning, systems are developing and so on as time progresses. It's important to not to think there are lots of experts out there and I'm not one of them kind of thing. What was the question again?

Andrew: It was more of the key foundations underpinning the standards – and how those principles are being carried forward towards as other jurisdictions implement.

Richard: I think an important aspect of the IFRS Foundation taking on this work is that it's investor oriented. This is capital market stuff. For us, we don't use expressions like non-financial. For us, this is a part of financial reporting. This is about providing material information to investors. So, the financial statement is a subset of useful information that investors might want to receive. This is expanding the basic set of information that's provided to investors. I think that's the really core point to understand through a business lens what this is all about. This is not the UK introducing some sort of compliance exercise or do the right thing exercise or a regulatory checklist or something. This is about core communication to investors.

Andrew: Okay, and you did mention materiality just then and previously as well actually. What does that mean in practice for firms and how should they approach this if they also need to do double materiality in Europe?

Richard: So, materiality for us, is essentially the same for ISSB, is essentially the same as it is for IASB. The only difference is the information to which the concept is applied. Materiality is a property of information; so information is material if it can reasonably be expected to affect an investment decision. So, it's a really high bar. This is information that is important, investors really need to know it. And that concept applies to the financial statements in determining what to include in the financial statements. And it applies to sustainability-related financial disclosures.

So, to illustrate a difference, we might ask for prospective financial effects, anticipated financial effects. We might ask for information on entities, targets, and transition plans if it has them. Those are the kinds of things you don't get in financial statements which are grounded in past events and transactions. The information set is different, but the concept is the same.

Now, materiality in a double materiality sense means that you are providing information to one set of stakeholders, your investors, and you're providing information to a different set of stakeholders who have an interest in the entity which is not an investing interest. Now, the two concepts are closely related. So, we require in the climate standard S2 the disclosure of greenhouse gas emissions. Greenhouse gas emissions have an impact on people, including future generations. It's certainly not just an impact that's restricted to current investors. But the impact is broader than just investors. But if you're an investor, it helps you to know what an entity's greenhouse gas emissions are in order that you understand the transition risks and opportunities faced by that entity. If you've got a large footprint, the question becomes, what are you doing about it? Or if you're the kind of business that can benefit from lowering the footprints of others, what's your business opportunity? You see what I mean? It's indirectly relevant, a company's impacts, but all from an ISSB point of view, entirely through the lens of materiality for investors.

Andrew: Brilliant. Thank you. Gemma, can I turn to you now and think a bit more about the UK market perspective. What are you seeing in terms of firms’ readiness for this, because it's been a while in the making? And are firms treating this as a big strategic reporting reset, or is this a compliance exercise, or are they thinking about it differently?

Gemma: A great question, and I think the honest answer is that we’ve seen varying approaches across the market. A lot of that depends on where firms have come from and what they’ve been having to deal with in the last 12 to 18 months. You made the point that this has been coming for a while, and it has. And most people broadly are very welcoming of it coming in. It is an opportunity to reset for most firms but to do that, you really need to lean in. Richard made the point there that this is an evolution in terms of process and it will take everybody across the organisation leaning in and everybody learning from each other. It took decades for financial reporting to stabilise and go through various iterations; this will be exactly the same. And those working in the sustainability space want to lean in and learn from people who have gone before.

I think if we step back and think about that point of really trying to define who are the stakeholders and what are you trying to satisfy, to then think about the strategy. And one of the areas where - whether you're thinking about standards or those different expectations - being able to really think about what is genuinely material to our business and our business model and how then are we thinking about that, so that you can start to make sure that you can separate almost what needs to go in the strategic report versus what needs to go elsewhere.

Materiality will be critical as part of this exercise, and we do see people looking at that at the moment. We also get quite a lot of feedback around there is broader stakeholder pressure in the UK that exists beyond the annual report. So, to go back to that point, it really does take thinking about what messaging should sit elsewhere for other stakeholders. And then how do you really think about bringing that story to life as Richard mentioned for investors about what do you see as being the risks and opportunities part of some of these absolutely massive issues that organisations face at the moment.

Andrew: Turning to the FCA's consultation around bringing UK SRS into the listings rules, what's been proposed there and what does that mean for UK listed companies?

Gemma: Yes, so the standards are available for voluntary use at the moment. We haven't necessarily seen a huge amount of take up of that as of yet, although we have had some conversations with clients because a lot of our clients are global and of course are caught in other jurisdictions as well. So sometimes depending on how you organise your company, you pool this information centrally rather than by jurisdiction.

In terms of listed firms, the FCA is consulting at the moment, or the consultation is closed, apologies, and we're expecting an update in the autumn. But fundamentally in the UK, essentially what we're looking at here is largely adopted in line with ISSB but with a couple of tweaks. So, the notable exceptions are SASB, so a switch from ‘shall’ to ‘may’ in terms of the wording of referring to SASB, and then the ‘comply or explain’. So that applies to certain parts of the standards. So, under climate, so S2, as Richard mentioned, you have Scopes 1 and 2 are mandatory. So, Scope 1 being direct, so your company facilities and vehicles and Scope 2 being purchased electricity, steam, heating for your own use. Scope 3 is ‘comply or explain’. So, comply or explain why not. Scope 3 is essentially everything else in your value chain. It will be interesting to see how that plays out, particularly for financial services firms in the coming years.

Andrew: Richard, any views on how those proposals compare to things we've seen in other jurisdictions as they adopt ISSB standards?

Richard: There are 40 jurisdictions so far globally that have either already put ISSB standards into law and regulation and so on, and those that are in a similar stage to the UK of nearing the end of that process. Those 40 are pretty well spread geographically and in terms of size and jurisdiction and so on, there's no particular pattern I would say. And the UK is in a similar place, in many ways. The critical difference in terms of the way the FCA proposal has been set out is the ‘comply or explain’ that Gemma has described.

The UK's practice in this space is good, and I think it's fair to say I probably shouldn't be making those sorts of judgments, but I think it is, and I think the UK has been doing this again, TCFD and so on for a long time. And so practices, especially the larger, more sophisticated entities, are good already. It would be very surprising if those entities were to step backwards and say, ‘we don’t need to do this and so we’re not going to’. So, I think the balance of voluntary and mandatory has always been important in this space and will continue to be important. And for those entities that really understand the point of doing this, there’s precious little difference between voluntary and mandatory I think actually, because those who really understand it will do it well and want it to be assured as well, because that’s the way to signal quality and that’s the way to communicate with your investors in such a way that they have trust in your business and in your disclosures that encourages investment and lowers the cost of capital. So, if you understand what this is about, then the quality of disclosure will continue to grow in the UK.

Gemma: Can I just jump in there because I couldn’t agree more and when we look at the years gone by and the evolution of this and the desire and the application in the UK to talk about this and to disclose on this, and when I think back, often the question would be, what must we do? What must we put in? And when you say what you must put in, at that point it was about two sentences. We didn't get here from a compliance perspective. Largely for me we got here because investors were looking further ahead and saying, ‘we are stepping into a big problem here and people need to think about that’.

So to Richard's point, I do not think, and certainly the discussions that we've had today are not about ‘can we go backwards?’, it is about how do we make sure that we set ourselves up for success so that we can be compared in the right way based on the standards which help us get to that level of maturity that we've all been crying out for. And actually, that real positivity is starting to flow through some of the training of others who are coming into the field as well through the accountancy bodies.

Richard: And to draw a parallel with accounting here, imagine a situation in which there are no requirements to produce financial statements and an entity has an internal discussion which says, ‘what do we have to do?’ Well, you don't have to do anything. Let's not tell anybody anything then, and so no one's going to invest in your business if you don't explain how much debt you're carrying, and how profitable you are. And in the same way, we've got a business which is exposed to flood risk or extreme weather events or whatever it happens to be. But let's just not tell anybody about it because we don't have to. It doesn't make any sense. There isn't self-interest in that.

Andrew: Agreed. And you referenced the current TCFD style reporting. Is there a risk that firms over focus on S2 and don't focus enough on the broader S1 disclosures?

Richard: The reason we did S2 first was that that was our mandate. Go and get on with climate first, build on TCFD. Climate is the big issue. I think there's no question about that. I also think that climate is a really good space for developing the skill set to do good reporting, because you're thinking that all the kind of stuff we've just been talking about in terms of what's material, what do people want to know and in what form is it useful to them. You're having to think about governance, strategy, risk management, metrics and targets, disclosures, and that framework applies across all non-climate issues as well as to climate. Of course, there's huge overlaps, your greenhouse gas emissions is one thing, but your exposure to climate is going to come through a whole series of different routes, whether that's regulatory or tax or extreme weather or disruptions to your supply chain or higher commodity prices, you name it, there's all kinds of ways it can affect your business. So, when you're reporting on climate, you're reporting on broader than just emissions. And also, the level of preparedness and understanding of climate-related disclosure is that much higher globally as well. I think for all kinds of reasons, it is the right place to start and the right place to build out from.

Andrew: Do you agree with that, Gemma?

Gemma: A hundred per cent. And I think practically this is an idiom that is more mature. And if we're thinking about how you set up and scale inside your organisation and have the infrastructure, some of these foundations have already been laid. So that's going to be infinitely easier. And moving that into a space where there's a lot of numbers involved and therefore people will more easily be able to get their head around that, get that right, get it moving, and then you can move into that S1 space. We do see quite a lot of questions on S1 at the moment in terms of how to deal with some of those issues. But I do think in a working principle, and for me, one of the areas where it feels very pragmatic and sensible that's come from the ISSB is that climate first, get up and running, get moving and the recognition that it would be very difficult for firms to do everything at once, which definitely we've seen pushback on in some other ways of being able to just get your head around it as an organisation.

Richard: Let me just pick up on something you described earlier Gemma, on Scope 1 and Scope 3 because it illustrates two different types of learning in this space. One is having to have data systems and so on to collect Scope 3 data in the first place. That's the kind of challenge that people are not used to. The other issue is why would you want that information anyway. A typical financial accountant's view of the world is you report on what you control, that's what accounting does. All of a sudden, we're saying, no, report on the whole of your value chain. Why would I do that? Well, it's because you're exposed to risks and opportunities throughout your value chain. And it may be that you can't decarbonise your products, to give an example, unless your supply chain is decarbonised. And it may be that's where your greatest risk is. Or it may be that you have a product that's very carbon intensive in use. And there's a competitor out there that has one that's not. So that's what you're exposed to. So, thinking about value chain and reporting on value chain is not naturally within the domain of the accounting function, but it's a different way of thinking.

Andrew: I suppose there's a practical side to this, isn't there, Gemma? The FCA's consultation closed at the end of March, and there's obviously final laws later this year and the government's wider reforms. What should firms be doing now on things like the governance, skills, data, and reporting design elements of this?

Gemma: Yes, so that's a lot. Let's start with governance. What I still find interesting is we are a number of years into climate and we still have experiences of asking ‘who's accountable for the oversight of climate?’. And that's not always clear inside an organisation. And if you create that in parallel to saying, who's in charge of finance or who's in charge of HR, you will get a very clear answer. Of course, there will be delegated authorities and people will have different responsibilities within that. But I do think that really going back to basics of who owns, and it will be different parts are owned by different people, but getting some clarity around that is really important to help with that upskilling and accountability piece inside an organisation and recognising you will need expertise across the firm.

The other obvious one is gap assessment against what you already do. But I definitely think that is aligned with materiality, because materiality is important. And being able to define that is quite a difficult exercise. You might not call it sustainability, or you might have things that are aligned in different places, but being really clear on that and documenting the rationale will be a very important step for people because it allows you to be super clear, back to that point of ‘what are the bits that are genuinely going to affect our prospects’ versus the parts that are important. It's not saying other things are not material, it's just trying to make that distinction, which sounds simple on paper, but it's quite difficult to do.

I think in terms of skills, Richard touched on it earlier, everybody's learning, it will take lots of people to lean in. There is definitely a transition happening from the sustainability team into finance for the reporting side, but equally we do see more step in from the risk teams, the legal teams, because fundamentally the main outcome here is how it's better integrated across the piece. So, you shouldn't really have a strategy and a sustainability strategy. You should be able to talk about your strategy and the sustainability risks and opportunities that settle inside that strategy, because it will help inform your strategy for the better or the worse, depending on the situation.

Data is a challenge. I am in the camp of ‘don't let perfect be the enemy of the good’. The data is not necessarily where we need it to be yet, but it's improving all the time. And I would also challenge that not all data is perfect anyway. Some of it has to be human judgement and overlay to drive forward some of that.

And then on the last point, which is the design and operating reporting design, I think this is a really important point. Many of our clients, particularly global ones, have lots of different expectations because they operate in lots of different jurisdictions. So, going back to being clear on what is our strategy and the policies for us from a sustainability perspective, what is the delivery model? Who is delivering it? Where is the data? Does it back up our strategy and our delivery evidence? And then how are we reporting on it? And how are we collecting all of that reporting data? Because it will start to feed into lots of different places to make sure we're comfortable with that. And wrapped around that is culture and remuneration to make sure that people are all aligned on the same page.

I do think it's important to try and not necessarily just think about what are all the boxes we need to tick here to see what really matters to us. Because if you do that well, you will tick all the boxes. I think sometimes we see people jump into that end point rather than starting at this point. Because if you start at that end point all the time, you will get a little bit lost because it won't always feel that aligned. And fundamentally, everybody's just asking you to articulate, 'do you understand what you need to be ready for as an organisation?’

Andrew: Yes, agreed. And Richard, do you have any particular views on some of those people that need to be around the table - the skills challenge that this presents?

Richard: I think it's a really important thing to say that these sustainability-related issues for any given business are issues that it almost certainly has a good sense of already. Because we're talking about information about activities that is so important that it could affect a decision on whether to invest in an entity or not. And so that's only going to be a small number of issues for any given entity.

But if your business is one that depends upon water and water-stressed areas, or your business is one that produces a lot of single use plastic or a high level of greenhouse gas emissions or that has challenges of human rights in its supply chain or whatever it happens to be, you're going to know that already. And there will be experts in your business who are dealing with those issues already. And if there aren't, the directors of the business are not doing their legal duties as directors of the business. It's really important not to be put off by this.

This is core business activity that is being explained and communicated in a standardised way in the way that we've always explained and communicated financial statements. So, it may be the case that there are people that need bringing together that haven't previously worked together, your finance function and your sustainability team might be an example of that. So, you would expect, as these standards are increasingly central in the UK, you would expect the finance team to play an increasingly important role because it forms part of the financial control, financial reporting, investor relations kind of domain, more so than the sustainability reporting team domain. That's no different from any other business activity. If you look at, R&D and marketing or something, the R&D team doesn't speak to the investment community, they talk through the finance function and the investor relations team. So, if it feels unfamiliar, you're not doing it right. I think that's another way of saying it.

Andrew: That's interesting. I have to reflect on PwC, our audit practice and our sustainability practice have worked together a lot over the last few years as they've evolved their own thinking. I guess it's exactly the same kind of dynamic.

Gemma, just picking up on another practical point from something you said earlier and linked to that reporting piece, where or how should firms begin to rethink what belongs in the annual report under SRS versus what’s important to disclose elsewhere?

Gemma: I think that this is a great opportunity to refocus. We're not starting from scratch, but using this as the point at which, because I think I mentioned earlier, over the years we've seen more and more information go into the strategic report on sustainability. And there has been lots of information, but perhaps not as much insight as we would hope that information would lead us to. I think there really is that point of trying to segment your stakeholders and what it is that you're trying to get across. And I think that's why it's welcome. This is also coming with a bit of a corporate modernisation agenda. For most, being able to kind of strip back some of that, but focus into Richard's point, that does not mean that you're going to stop talking, that your customers are still going to want to hear about this. There is a difference between ESG factors, corporate social responsibility and sustainability. That's probably a whole other podcast. But they are different things and they mean different things to different people. And therefore, trying to use that framework to say, ‘where are the areas that as a business are going to be the most financially material and how do we talk about that?’ And then ‘how do we help, how do we communicate with our customers, clients and colleagues?’ Colleagues are another big audience here who hold their organisations to account. But that does not mean that it needs to go in the strategic report. So really trying to think through some of that, I think is really important. But just to be clear, saying ‘less but better’ is not saying say nothing. You still have to have to think about that.

Andrew: And obviously, many of our clients are multi-jurisdictional. How should firms build a UK programme that also works globally?

Gemma: Yes, so this is something our clients have been grappling with for a while because they are thematically consistent, the requirements, but often there's those slight incremental changes that can make it difficult. I personally would say that that is often the case for other parts of your business as well. I don't think it's a lone sustainability challenge, as sustainability often gets held to a higher standard.

Andrew: During Brexit, I think the phrase was ‘broadly equivalent but awkwardly different’.

Gemma: Yes, Thank you. Great phrase. So, I think that, but it's back to that point of being really clear on what it is you're trying to solve as a business and then how do you fix for that in aggregate and think about the systems and the infrastructure that needs to come. And also, just have a view that it is going to need to be flexible. Things are going to change. All things change all the time. So back to that point of learning the lessons of other types of programmes or different skills that you've had to phase into your organisation, I think are very important to consider.

Andrew: Great. Richard, any views from you?

Richard: Yes, I'd say two things here. One which echoes with what Gemma just said is ‘be authentic’. Focus on issues that matter to your business and that you understand your investors need to understand, and you won't go far wrong, I think that is the most important message. And the other thing to say is that, if you compare IFRS accounting with IFRS sustainability, IFRS accounting is a big book at this point. And if you're adopting those standards, that's a big lift in terms of the granularity of requirements. The UK SRS are not that. And to a very large degree, they require the answer to be complete in its disclosure, but there's huge judgement in terms of what is material information in the context of your business. There's also built into those standards concepts of proportionality. What you're expected to provide is information that is reasonable to expect you to provide. The standard doesn't say you must give a precise number on X or value emissions in your value chain, for example. On the contrary, it says you must provide reasonable and supportable information without undue costs and effort. In other words, ‘don't give us a number of 0, but give us what's a reasonable estimate and explain your estimate’. So don’t be shy of judgement and uncertainty and estimation as long as the information is clarified. Again, that speaks to authenticity, I would say.

Andrew: Thank you. And as a final question, when we're talking about the evolution and the fact that these rules are fluid and will develop, where do you both see this agenda going next? And what is the one thing firms should keep in mind over the next 12 months? Richard, I'm going to start with you on that.

Richard: I'm going to go back to what I just described, and maybe my favourite word in this context is ‘authentic’. So, I would say, don't think compliance, don't think rules, Think, what does my investor need to understand about my business? Oh, it turns out it's the things I'm managing and now I need to communicate them in a standardised way so that they can understand and compare my business against others, so they understand the risks and opportunities that I'm facing. So, if it makes sense to you from a business case, business lens perspective, and you're talking about sustainability-related risk and opportunity, then you're doing the right thing.

Gemma: I completely agree with all of that. And I think, fundamentally, please do not treat this as a tick box exercise. If you do that, you will not gain the value from it, and there really is a lot of value to be had if you use this as a reset opportunity. And, crossing back over into that last question as well, absolutely join the dots. When it comes to thinking about this globally, what we do often see is firms treating each requirement individually in different parts of the organisation. That will be inefficient and it will cost you more money. In the shorter term, it is harder to try and consolidate this. But really kind of mapping out what will be required over the next 12 to 36 months will stand you in good stead and help you think about getting people around the table. Use this as the opportunity to build the foundations early and a chance to improve the quality of your reporting.

Andrew: Brilliant. Thank you both very much. And thank you to our listeners for tuning in too. One of the key takeaways for me is around the UK SRS not being about producing more sustainability disclosures, but it's about authenticity. And it should lead, I hope, to better quality information for investors across a wider range of topics and clearly it's going to evolve over time.

To our listeners, if you would like to find out more about UK SRS and what they may mean for your reporting programme, please do feel to reach out to any of us to talk further about this conversation. And if you've enjoyed this episode, do subscribe to the series and consider rating or reviewing this as it helps other listeners to find us. We look forward to speaking to you again next month.