How Australian small caps are likely to be impacted by the new ISSB sustainability disclosure standards

Capital markets worldwide are talking about the release of two new sustainability disclosure standards by the International Sustainability Standards Board (ISSB).

The ISSB is formed under the same organisation that develops the accounting rules for public companies (the International Financial Reporting Standards Foundation), so its sustainability disclosure standards have been highly anticipated by the investment community as finally enabling the more uniform and comparable corporate sustainability information investors have looking for.

The two standards, called IFRS S1 and IFRS S2, are based on accounting concepts and they were developed specifically to meet the needs of investors.

IFRS S1 and S2 require companies to provide their sustainability disclosures in a standardised format, alongside their financial statements, making it easier to assess risks and opportunities across companies.

IFRS S1 prescribes how an entity is to prepare and report its sustainability-related financial disclosures. IFRS S2 is designed to be used with IFRS S1, and it focuses on climate-related disclosures such as greenhouse gas emissions, low carbon economy transition risks, and resilience against extreme weather events. The ISSB is expected to expand its sets of sustainability disclosure standards to include other sustainability topics in future.

The two new standards fully incorporate the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD), an organisation that has, up until now, prescribed best practice for disclosures related to climate change. The standards were developed in collaboration with Global Reporting Index (GRI), another leading sustainability standard-setter.

The ‘so what’ for small caps

The arrival of the IFRS S1 and S2 frameworks is different to that of other ESG frameworks, and ASX listed companies of all size are likely to be impacted in several inter-related ways.

For one, while the adoption of IFRS S1 and S2 is voluntary, governments around the world including Australia and the US are enshrining standards aligned with IFRS S1 and S2 into legislation, making it mandatory for organisations that meet certain thresholds to provide sustainability-related information with a key emphasis on climate-related risks.

Under Australia’s current proposed progressive roll-out plan, large entities will start reporting from 1 July 2024, and, by the 2027/28 financial year, reporting will apply to all entities required to lodge financial reports under Chapter 2M of the Corporations Act 2001 (Cth) (Corporations Act), and who meet two of the following criteria:  

• the consolidated revenue for the financial year of the company and any entities it controls is $50 million or more;
• the value of the consolidated gross assets at the end of the financial year of the company and any entities it controls is $25 million or more;
• the company and any entities it controls have 100 or more employees at the end of the financial year.

Although micro caps and many small caps may fall below mandatory reporting thresholds set by governments, we expect investors to increasingly want to see companies disclose key data required of IFRS S1 and S2 alongside financial reports, as it starts to become the norm.

Many micro and small cap companies today already gather and provide the data required of IFRS S1 and S2, such as energy use and emissions, to appeal to investors who adopt Responsible Investing principles. As funds available through impact and Responsible Investing grow, the number of companies voluntarily reporting climate-related information is also expected to rise.

It’s difficult to say at this point how investor decisions will impact companies who choose not to provide key sustainability-related information, regardless of whether or not the company is required by legislation to report it.

Varying mandatory reporting thresholds around the globe mean that investors in some parts of the world may be more lenient on small caps than those in other parts.

The thresholds for mandatory reporting proposed by the Australian and US governments are higher than those set by the UK and EU.

The EU’s roll-out plan will see reporting made mandatory from January 2029 (for FY 2028) for SME with balance sheet equity exceeding 350,000 euro, net turnover of more than 700,000 euro, and as little as 10 or more employees.

As they grapple with how to respond to ESG, small caps may wish to consider how the jurisdictions in which they deal and operate are rolling out mandatory sustainability disclosures and applying thresholds.

IFRS S1 and S2 could become the ASX’s recommended ESG disclosure standards for all listed companies, regardless of their size or market cap, replacing the multitude of frameworks the ASX currently guides companies towards.

Recommendation 7.4 of the ASX Corporate Governance Council’s Principles and Recommendations states that “a listed entity should disclose whether it has any material exposure to economic, environmental and social sustainability risks and, if it does, how it manages or intends to manage those risks”.

For guidance on how to disclose ESG information, the ASX points to a multitude of standards and frameworks that have either been incorporated into IFRS S1 and S2 or consolidated into the IFRS since the ASX published its Corporate Governance Council’s Principles and Recommendations in February 2019.

It will be interesting to see whether the next update to the ASX’s Corporate Governance Council’s Principles and Recommendations simply refers companies to IFRS S1 and IFRS S2, especially with the Australian Government expected to align its reporting standards to those of the IFRS.

Small caps will benefit from IFRS S1 and S2 if they embrace the standards for their intended purpose; as a tool for communicating with investors.

The new standards have been welcomed by investors and asset managers because they speak their language. We recommend small caps might familiarising themselves with terms contained in IFRS S1 and S2 and considering how confidently they might be able to talk to them – even if reactively, as part of investor Q+A.

Finally, and perhaps most importantly, by gathering the data necessary to adopt the new disclosure standards, companies may be able to demonstrate a more attractive risk-return profile to investors. For example, investors seeking to minimise risk exposure will be actively seeking companies able to evidence low physical risk in relation to climate change and low carbon transition risk. Companies that can talk confidently to investors on these points, and other sustainability-related risks and opportunities, are more likely to be able to have a seat at the table with responsible investors.

Photo by Appolinary Kalashnikova on Unsplash