New illustrative examples aim to boost transparency and consistency in financial reporting of climate-related uncertainties.
Banks and companies worldwide face a stark choice: disclose climate risks clearly or risk losing investor confidence.
That’s the message from the International Accounting Standards Board (IASB) as it launches a new consultation to improve how climate-related and other uncertainties are reported in financial statements.
On July 31, 2024, the IASB published a set of proposed illustrative examples to guide companies in applying IFRS Accounting Standards to capture climate-related risks and other uncertainties in their financial reporting. The move comes in response to growing investor concerns that climate risk information in financial statements needs to be more consistent with other company disclosures.
“If we think about the last ten years, there’s been much more disclosure generally about climate-related risks,” IASB board member Nick Anderson said, according to The Banker. “Much of that would be outside the financial statements, [in] transition plans, commitments to net zero. But equally, one would expect there to be some more disclosure in the financial statements.”
The IASB’s proposed examples focus on critical areas, including:
- How materiality judgments around climate-related transition plans impact financial position and performance
- Disclosures about assumptions and estimation uncertainties
- Disaggregation of information
While primarily addressing climate risks, the principles illustrated apply equally to other types of uncertainties facing businesses.
The consultation stems from a collaborative effort between the IASB and the International Sustainability Standards Board (ISSB) to strengthen the connection between financial statements and other parts of a company’s sustainability reporting.
IASB chair Andreas Barckow emphasised the importance of the initiative: “Investors have clearly communicated that they factor climate-related risks into their decision-making process. Although our Accounting Standards already address such risks, we have identified a need for illustrative examples to improve the application of these requirements.”
The proposed examples do not add new requirements to existing IFRS Accounting Standards. Instead, they guide the application of current standards to offer investors better information about climate-related risks and other uncertainties.
One example for financial institutions outlines how climate-related risks could impact credit risk exposure and risk management practices. It describes a bank with loans to agricultural customers susceptible to droughts and loans for properties in flood-risk areas. The example details what information banks should consider disclosing, such as collateral held as security and how climate risks are incorporated into assumptions and estimation techniques.
Anderson noted that while some of this information is quantitative, such as portfolio sizes and exposure significance, qualitative factors like market, economic, regulatory, and legal developments also play a crucial role.
The IASB’s move aligns with recent regulatory actions in Europe. In January, the European Central Bank published a critical assessment of European banks’ credit portfolio alignment with the Paris Climate Agreement, finding that 90% of 95 “significant institutions'” portfolios were misaligned. The ECB has even threatened unprecedented daily penalty payments for banks failing to assess climate and environmental risks adequately.
The IASB calls on regulators, financial institutions, auditors, and other companies to provide feedback on the proposed illustrative examples by November 28, 2024. This input will help determine whether additional standard-setting is needed to enhance climate risk disclosure requirements.
As climate change increasingly impacts global economies, the financial sector’s role in managing and disclosing these risks becomes more critical. The IASB’s latest initiative represents a significant step towards ensuring investors receive the clear, consistent, and decision-useful information they need to navigate the challenges and opportunities of a changing climate.
