United States: Tannenbaum Helpern ESG Advisor: New ISSB Global Sustainability Standards – A Q&A Guide To Private Fund Advisers

Sustainability factors have become an increasingly important element in investment decision-making. While certain portfolio companies of private funds and some private fund advisers themselves are already providing sustainability reports, almost all remain troubled by overlapping and inconsistent ESG metrics and standards and disparate jurisdictional requirements.

To address this fragmented landscape, on November 3, 2021, the IFRS Foundation created the International Sustainability Standards Board ("ISSB") as a sister board to the International Accounting Standards Board, the organization that issued IFRS accounting standards. On June 26, 2023, ISSB published the long-awaited global sustainability reporting standards (the "ISSB Standards") to help establish a global baseline for sustainability reporting so that investors can compare businesses across jurisdictions on a like-by-like basis.

The ISSB Standards focus on financial materiality and aim to meet the information needs of global investors. The ISSB Standards stand to impact private fund advisers in many ways as regulators in a number of jurisdictions have already indicated a willingness to make the ISSB Standards mandatory. Therefore, investees of private funds that are public companies, megacorporations and multinational corporations, as well as funds that market to multiple jurisdictions, make offshore investments or structure cross-border transactions, should be familiar with the ISSB Standards and actively consider whether to incorporate them in their reporting and investment due diligence processes.

One direct requirement in the ISSB Standards with respect to the asset management industry is that an entity that engages in asset management (like a private fund adviser) is required to disclose specific information about its Scope 3 "financed emissions" in connection with its portfolio companies and counterparties, that is, the portion of gross greenhouse gas ("GHG") emissions of an investee or counterparty attributed to the loans and investments made by the asset manager to the investee or counterparty.

In addition, private fund advisers typically rely on their portfolio companies' financial statements in connection with both their due diligence and valuation of portfolio companies, as well as when providing interim and annual reporting to fund investors. The ISSB Standards broaden the concept of "general purpose financial reports" to include at least general purpose financial statements and sustainability-related financial disclosures. This change enables fund advisers to see a more complete picture of an investee's business, have a better understanding of an investee's strategies, and analyze more accurately risks and opportunities related to climate and other sustainability factors in an investee's value chain. This should not only improve coverage and effectiveness of due diligence, but also help fund advisers formulate and calibrate investment modeling and asset valuation.

Furthermore, in order to satisfy their own sustainability mandates, investors in private funds (especially institutional investors seeking long-term growth) may begin to request funds to provide ISSB Standards-aligned reporting in parallel with financial statements in their periodical and annual reports to investors. Anchor investors, strategic investors and GP-stake investors are also increasingly likely to require ISSB Standards-aligned sustainability reporting in connection with their due diligence of advisory firms and their affiliates.

How the ISSB Standards may impact the businesses of private fund advisers remain being tested in global capital markets and various jurisdictions. It is important to stay informed of these standards. To help private fund advisers digest the new ISSB Standards, the following answers ten frequently asked questions.

Q1. What are the ISSB Standards?

A: The ISSB Standards include IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information ("IFRS S1") and IFRS S2 Climate-related Disclosures ("IFRS S2"). Each contains main contents, appendices and accompanying resources.

Q2: How does IFRS S1 and IFRS S2 differ from and relate to each other?

A: IFRS S1 sets out the overall requirements on a complete set of sustainability-related financial disclosures. IFRS S2 relates specifically to climate-related financial disclosures and complements the overarching requirements in IFRS S1. A reporting entity is required to apply IFRS S1 in preparing IFRS S2. However, to avoid unnecessary duplication with IFRS S1, if an entity's oversight of sustainability-related risks and opportunities is managed on an integrated basis, the entity may provide integrated governance disclosures and integrated risk management disclosures in its IFRS S1 report and add corresponding cross-references in its IFRS S2 report.

Q3: Are the ISSB Standards mandatory?

A: The ISSB Standards are a voluntary framework. Business entities may choose to voluntarily apply the ISSB Standards. It would be up to individual jurisdictions to decide whether to make these standards mandatory. Canada, Britain, Japan, Singapore and some other jurisdictions have reportedly expressed their willingness to incorporate the ISSB Standards into their respective regulatory regimes.

Q4: What entities are covered by the ISSB Standards?

A: The ISSB Standards are intended for entities world-wide that are required or choose to prepare general purpose financial statements, regardless of their size, location or industry, whether such entities apply IFRS accounting standards, US GAAP or otherwise.

Q5: What information is required to be disclosed under the ISSB Standards?

A: The ISSB Standards require a reporting entity to disclose sustainability-related and climate-related risks and opportunities that could reasonably be expected to affect an entity's cash flows, its access to finance or cost of capital over the short, medium or long term (referred to in the ISSB Standards as the entity's "prospects"). Information about commercially sensitive sustainability-related opportunities and climate-related opportunities is exempted.

The core content required under both IFRS S1 and IFRS S2 includes four aspects: governance, strategy, risk management, and metrics and targets. This aligns with the disclosure structure required under the Taskforce on Climate-related Financial Disclosures (TCFD) recommendations.

Q6: How may an entity identify its sustainability-related risks and opportunities required to be disclosed under the ISSB Standards?

A: In identifying sustainability-related risks and opportunities to be disclosed under IFRS S1, entities are required to apply IFRS sustainability disclosure standards and SASB Standards, and allowed to consider CDSB Framework Application Guidance (for water-related and biodiversity-related disclosures), the Global Reporting Initiative Standard, the European Sustainability Reporting Standards, the most recent pronouncements of other standard-setters, and regional and industry practice.

In identifying sustainability-related risks and opportunities to be disclosed under IFRS S2, entities are required to apply IFRS S2 and refer to the Industry-based Guidance on Implementing IFRS S2 (which is published in 68 separate volumes and is derived from SASB Standards).

Q7: Where to report the sustainability-related information required under the ISSB Standards? To whom will the sustainability-related information be disclosed?

A: Sustainability disclosures are required to be prepared for the same reporting entity and reporting period as the related financial statements, as part of such entity's general purpose financial reports. To facilitate application in different jurisdictions, the ISSB Standards do not specify or require where in the financial reports such sustainability-related disclosures may be placed. For example, they could be included in an entity's management commentary or a similar report.

The ISSB Standards are intended to meet information needs of primary users of general purpose financial reports, including an entity's existing and potential investors, lenders and other creditors.

Q8: What information related to "financed emissions" is an entity that participates in asset management activities required to disclose under IFRS S2?

A: Four aspects: (i) its absolute gross financed emissions, disaggregated by Scope 1, Scope 2 and Scope 3 GHG emissions; (ii) for each disaggregated item, the total amount of assets under management ("AUM") that is included in the financed emissions disclosure; (iii) the percentage of the entity's total AUM included in the financed emissions calculation (if less than 100%, also disclose types of assets and associated amount of AUM excluded from the calculation); and (iv) the methodology used to calculate the financed emissions.

Q9: When will the ISSB Standards become effective?

A: Both ISSB Standards will become effective for annual reporting periods beginning on January 1, 2024, but allow voluntary earlier application. For the first annual reporting period, non-climate disclosure, Scope 3 emission disclosure, and if conditions met, application of Greenhouse Gas Protocol are not required.

An entity needs to publish financial statements and sustainability disclosures at the same time, with certain transitional relief in the first year of reporting.

Q10: How are the ISSB Standards intended to interoperate with jurisdictional regulations?

A: The ISSB Standards are intended to be compatible with laws and regulations in various jurisdictions all over the world. To facilitate interoperability, the ISSB Standards used the TCFD architecture as their core content and require industry-specific disclosures aligned with SASB Standards. Both TCFD and SASB approaches have already been adopted in some jurisdictions. Therefore, some jurisdictions may adopt the ISSB Standards outright. Other jurisdictions may want to add additional building blocks to meet broader multi-stakeholders' needs, considering the ISSB Standards are mainly investor-focused. Still other jurisdictions may require sustainability disclosures separate from financial reports.

To the extent a jurisdictional regulation also requires an entity to disclose sustainability-related information in its financial reports, according to IFRS S1, the entity is permitted to include non-material information (as long as material information is not obscured) if required under jurisdictional regulation, is required to disclose material information even if not required under jurisdictional regulation, and is allowed not to disclose material information if prohibited under jurisdictional regulation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.