Sustainability reporting and the end of the black box

Are you reporting numbers which are based off of assumptions, because of incomplete data or otherwise?

The last few years have seen rapid development and convergence of reporting standards for climate and other sustainability risks and opportunities.

The International Sustainability Standards Board (ISSB) has introduced the IFRS Sustainability Standards to enhance trust and confidence in company disclosures regarding sustainability, aiding investment decisions. These standards aim to ensure that companies provide consistent, complete, comparable and verifiable information on their sustainability-related risks and opportunities, allowing stakeholders to better assess the entity’s enterprise value. So far, the ISSB has published two standards: IFRS S1, General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2, Climate-related Disclosures.

These standards require adherence to a principle which may have a profound impact on an organisation’s sustainability reporting by affecting which metrics are reported and how they are determined, validated and disclosed.

To comply with the standards, organisations must disclose metrics on each sustainability-related risk and opportunity that could reasonably be expected to affect its prospects. This includes metrics on its performance in relation to these risks and opportunities, along with comparisons to any targets set by the organisation or its regulator. Where not already defined by an existing standard, organisations must also disclose:

• How each metric is defined;
• The method used to calculate the metric and the inputs to the calculation, including the limitations of the method used and the significant assumptions made;
• For metrics with a high level of measurement uncertainty, information regarding the sources of uncertainty in the measurement; and
• Whether the metric is validated by a third party and, if so, which party.

Metrics with a high level of measurement uncertainty are those that involve the most difficult, subjective or complex judgements. Examples of information which may need to be disclosed include:

• Sensitivities of the amounts disclosed to the assumptions made.
• Reasons for the sensitivities.
• A range of reasonably possible outcomes.
• Explanations of changes made to past assumptions.

Any redefinition or replacement of a previously disclosed metric also requires explanation, including the reasons for the change and comparative figures for the revised metric if not impracticable.

While adhering to the standards offers clear benefits, such as improving transparency and trust and avoiding perceptions of green- or blue-washing, the additional disclosure requirements can present several challenges, even for existing metrics disclosed.

Sustainability-related reports (or sections of reports) currently tell a story in a neat way; however, preparers of these reports will need to consider the impact of the additional explanations required by the new standards. In some cases, the space needed for just one metric may be a multiple of what is currently used.

Existing processes may not be set up to produce the new information required, such as sensitivities or analyses of changes in results which separate changes occurring over time from changes in methods and assumptions.

Management may not currently have a full understanding of which metrics are impacted by the new requirements. This includes knowing where explicit and implicit assumptions have been made, which assumptions significantly impact the results, the limitations of the methods used and the full set of inputs into the calculations. Some calculations may be a “black box”, where these factors are not known or understood for the relevant metrics. Explicit assumptions are usually numerical inputs into a calculation, whereas implicit assumptions relate to the methodology used and are more “hidden”.

The production of sustainability metrics is often hampered by data challenges. This means that some metrics, which ideally should be based on straightforward data summarisation, are actually based on numerous assumptions that may not be visible even to management.

With the challenges, however, also come opportunities:

What can reporters do now to take advantage of the opportunities, meet the expectations of stakeholders created by the new standards and ultimately achieve compliance?

• Identify the existing metrics which are impacted by the new requirements. Consider where data challenges may have resulted in the use of assumptions, judgements or proxies.
• Obtain an independent review and challenge of the calculations from an expert who is experienced in unpacking black box or complex calculations, identifying all the explicit and implicit assumptions, assessing their robustness, explaining their impact on the results, and helping to clearly articulate the methods and assumptions used.
• Consider the impact of the new requirements when developing new metrics. Will we be able to simply and clearly articulate the methodology and assumptions? Can the new metric be assured? Outside help might also ensure that new metrics developed are sufficiently robust.
• Consider the impacts of the requirements on both reports and processes.

These steps may also help kickstart your development of a roadmap for assurance-readiness.

Our sustainability team has model validation, reporting and assurance experts who are uniquely placed to assist you to meet the new challenges.

In each of these examples, currently only the final metric is disclosed and there is no insight provided as to how the values were determined and the uncertainties around them. Management may not have a full understanding of the assumptions and uncertainties either—the calculation could be a black-box and/or they could arise from externally-sourced information used in the calculation.