On July 29, 2022, the International Financial Reporting Standards (IFRS), issued a draft report on Climate Related Financial Reporting. This piece looks at the draft and its relationship to Enterprise Risk Management (ERM).

IFRS

IFRS is a not-for-profit, public interest organization. It was established to develop high-quality, understandable enforceable and globally accepted accounting and sustainability disclosure standards. The standards are developed by two standard setting boards. These are the International Accounting Standards Board (IASB) and the International Sustainability Standards Board (ISSB). Both boards are part of the IFRS foundation.

On July 29, 2022, a draft “IFRS S2 Climate-related Disclosure” was released.

Purpose of Draft

The purpose of the draft is to establish requirements for “identifying, measuring and disclosing climate-related risks and opportunities,” (1) The draft is a response to requests by users of general financial information for more “consistent and complete” information including metrics on how climate-related issues and associated risks can affect an organization.

“In assessing an entity’s financial and operating results and future cash flows, users of general purpose financial reporting want insight into the governance, risk management and strategic context in which such results are derived. Users also want to understand an entity’s targets for managing climate-related risks and opportunities and the metric the entity uses to measure progress towards meeting the targets.” (2)

The standards proposed in the draft are consistent with the Sustainability Accounting Standards Board guidelines. The guidelines cover four main sections.

Guidelines

The guidelines are designed to enable the user of general financial information to understand an organization’s actions for the following sections.

1. Governance – the processes, controls and procedures the organization uses to monitor and manage climate-related risks and opportunities.
2. Strategy – the climate-related risks and opportunities that could enhance, threaten or change an organizations business model and strategy over the short-term and long-term including:

• Whether and how information about climate-related risks and opportunities informs management’s strategy and decision-making.
• The current and anticipated effects of climate-related risks and opportunities on the business model.
• The effects of climate-related risks and opportunities that could reasonably be expected to affect the entity’s business model, strategy and cash flows, its access to finance and its cost of capital, over the short, medium, and long-term.

3. Risk management – how climate-related risks and opportunities are identified, assessed, managed, and mitigated by an organization.
4. Metrics and targets – the metrics and targets used to manage and monitor and entity’s performance in relation to climate-related by the organization.

• Performance and outcome measures that support the qualitative disclosures across governance, risk management and strategy disclosures requirements.
• Targets that an entity uses to measure its performance goals related to significant climate-related risks and opportunities. (3)

For each section the guidelines provide details on the types of information that an organization should provide. Below are selected examples from the Risk Management section.

Risk Management

The objective of climate-related financial disclosures on risk management is to enable the users to understand the process by which climate-related risks and opportunities are identified, assessed, and managed.

1. To achieve this objective, an entity shall disclose:
   1. The process or processes it uses to identify climate-related: Risks and opportunities
2. The process or processes it uses to identify climate-related risks for management purposes, including when applicable:
   1. How it assesses the likelihood and effect associated with and effects associated with such risks (such as qualitative factors, quantitative thresholds and other criteria used).
   2. How it prioritizes climate-related risks relative to other types of risks, including its use of risk assessment tools (for example science bases risk-assessment tools).
3. The extent to which and how climate-related risk identification, assessment and management process, or processes, are integrated into the entity’s overall risk management process. (4)

Discussion

Climate-related risk is an issue which is receiving a lot of attention. As noted in CERM Insights #404, #382, #378 #372 and # 367 the U.S. federal government is heavily involved in pushing climate- related regulations and reporting requirements. To date, except for cyber-security, the major emphasis of these regulations has been on Environment, Societal, and Governance (ESG) related risks.

The IFRS S2 Climate-related Disclosure draft is an attempt to create a global standard which accountants, auditors, C-suite members, and the public can use to evaluate the anticipated environmental risks identified by an organization and its risk mitigative efforts. This standard is more specific than ESG risks.  This is because it focuses solely on climate-related risks and how that information can be incorporated into the organization’s financial statement. Even so, it would provide a standard format by which investors, regulators and the public could evaluate an organization’s ESG risk identification and mitigation efforts.

While the emphasis of the standard is on climate-related risks, there is a recognition that these risks can impact the entire organization. Therefore, it is expected that a comprehensive approach to risk management will be taken by the organization. Such a comprehensive approach is Enterprise Risk Management (ERM). In short, the push toward climate-related risk identification and mitigation standards will ultimately result in the organization adopting ERM.

Endnotes

1. IFRS, 2022, Exposure Draft IFRS Sustainability Disclosure Standard: IRFTS S2 Climate-related Disclosures, July 2022, page 5, https://www.ifrs.org/content/dam/ifrs/project/climate-related-disclosures-issb-exposure-draft-2022-2-climate-related-disclosure.pdf
2. Ibid page 5.
3. Ibid page 6.
4. Ibid page 39-40.

BIO

James J. Kline, Ph.D., CERM, He has worked in federal, state, and local government. He has authored numerous articles on quality in government and risk analysis. His book Enterprise Risk Management in Government: Implementing ISO 31000:2018 is available on Amazon. He is also the editor of Quality Disrupted. It is also available on Amazon. He can be reached at jamesjk1236@outlook.com.