Podcast

What must you disclose in mandatory climate reporting? What is ‘material’?

Our podcast series has returned. We have a new name, the ERM Energetics Exchange and, with ERM’s international footprint, the ability to bring a wealth of local and global insights to our discussions. To follow is an article based on the first podcast of a new series talking about the requirements of the Australian Sustainability Reporting Standards or the ASRS as they are widely known - once positioned by ASIC’s Chair as the biggest change to financial reporting in Australia since the introduction of the GST[1]. In this first episode, we'll speak to the crucial topic of materiality and the challenge of determining the climate impacts that are, and are not, financially material to ASRS disclosures.

The participants are Dr Mary Stewart, CEO of Energetics who facilitated the discussion, ERM’s Victoria Cross who is a partner in corporate sustainability and climate change, and Matty Lunn who is a partner and Asia Pacific lead for assurance and certification at ERM Certification and Verification Services or ERM CVS.

New to Australia, Victoria is from the UK. Her expertise and experiences are grounded in the disclosure regime in Europe, the Corporate Sustainability Reporting Directive (CSRD), under which an estimated 50,000 companies worldwide will have to report on their ESG activities. Matty joined ERM CVS after a 30 year career with one of the Big 4 accounting firms.

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The following is based on the transcript of the podcast episode.

(Mary) Why does the ASRS present such a significant change?

With the introduction of mandatory climate reporting in Australia, we know we need transparent and assured ESG data and, throughout reporting organisations, a commitment to clear and accountable sustainability practices. It is therefore important to remember:

• These reports are included in your financial reports, which are due within 3 months of your financial year end. You don’t have the luxury of time to prepare these disclosures
• You need to speak to how climate change, and addressing emissions reduction, will impact the financial performance of your company. You need to articulate these impacts in dollar terms
• This is a whole of business effort. You will not be able to deliver even adequate disclosures without the input of the entire management team, and the board. This is not something that you can leave to the sustainability department to deliver.

Remember, the origin of the ASRS is the ISSB. The precursor to a fair amount of the ISSB disclosures is the TCFD which came from an initiative of the Financial Stability Board. These reporting standards reflect calls from investors for greater clarity on the sustainability of the companies they invest in so that they can better measure how risky their investments are. Sustainability is all about how well a company’s business model and corporate strategy will perform as the natural environment changes and the economy decarbonises.

This is about building the company you need to be to take best advantage of the changes we see coming.

Victoria, like ASRS here in Australia, reporting under the CSRD is rigorous, in fact even more so. From your experience of implementing CSRD for some of the UK’s largest FMCG clients, what are the non-negotiable first steps for companies to take? What do you have to do to ensure success?   

Right now, an organisation needs to think about their disclosure appetite. Not every company has the same appetite. Some clients are saying, “please help us to nudge our chin over the bar”. Other organisations want to be a leader in sustainability disclosures. Each organisation needs that level-setting conversation to understand how they wish to use the three year phasing period, for example, and decide the approach that makes sense for their business, as well as their auditor who will be providing assurance of the disclosure in due course.

Understanding this appetite should be followed by investigating whether the organisation has the right level of sustainability literacy. For ASRS that's very much about understanding the potential impacts of climate change on the business. For the CSRD in Europe, we are seeing the finance and the sustainability communities coming together to solve the disclosure and the reporting questions that need solving – to do this effectively they need a common understanding, and both need to be literate in the topics. From that point, you have the building blocks to make sure people in the business understand their role in the disclosure. ASRS or CSRD involves lots of different people to drive meaningful change going forward, not just those charged with creating the report, the sooner you can help them realise that their job is changing, using language they understand, the better.

Also, start with the end in mind. Of course you need a compliant disclosure - that goes without saying - but disclosure is just a tool to drive a business's response to climate change and its work to achieve net zero emissions. Disclosure is a tool to engage customers, investors, suppliers and other stakeholders in the change that you want to see, rather than a tick box exercise for an organisation.

Matty, as an assurance expert, what advice would you give to companies as they prepare to report under ASRS?

Firstly, the information that companies need to report under ASRS is very different to what companies are used to reporting, mainly because most of what is required under ASRS is not financial information. Just consider the need to report on the governance that is in place, the strategy, the risks and opportunities, transition plans and risk management - we can see the depth and breadth of non-financial information that has to be disclosed.

The auditing of non-financial information is not the same as looking at historical financial information. It's a new concept to most audit firms and they will be developing their approaches now – and these are likely to change over time as they learn more.

For historical information, it's easier to provide assurance over events that have occurred in the past, as compared to those yet to happen. For greenhouse gas emissions, the assurance provider can use accepted frameworks such as the GHG Protocol and examine historical supporting information for the disclosures made. But, for example, one of the requirements of the new standards is to disclose climate resilience assessments and scenario analysis. This work is forward looking and requires a different type of supporting information for the disclosures made. Auditors will need to work out how they get enough evidence to sign off on an assurance report.

It's important to engage with your assurance provider early to understand what evidence they will need you to provide to be in a position to assure your disclosures. If you can start producing disclosures with the supporting information your assurance provider needs, then you're going to have a much quicker and more seamless assurance experience.

Victoria, what work is needed to understand what is material and what is not?

This is the most frequently asked question. Looking at the concept of double materiality, which is a central plank of the EU’s Corporate Sustainability Reporting Directive, the first thing we do is to encourage clients not to think of this as a completely new concept in their long-established enterprise risk management approaches. But what they might not have done historically is look closely at materiality through the ESG opportunity lens. Environment, Social and Governance topics can drive corporate value, whether that's through access to new markets and customers, access to new sources of green finance, or to ensure a more sustainable and secure supply chain. Some of these may have much longer-time horizons than a typical enterprise risk management approach because those impacts will be experienced over longer time frames than the typical short-term business planning cycle.

Also, what's really important for double materiality is that an organisation looks at their impact on the outside world, whether that's on society or the environment. Clearly those impacts are well understood when you are looking at your domestic market. But if your value chain stretches into other markets that may not have mature ESG criteria attached to them, then transparency may be a challenge. And the concept of double materiality under CSRD, unlike other previous reporting regimes like GRI, dictates that the company consider their whole value chain and make sure that any risks or opportunities that have an impact up those value chains, are well understood. Since I've been in Australia, I've been speaking with businesses which supply customers in Europe and need to make sure they have CSRD compliant disclosures as well as preparing for ASRS. So really, taking that double materiality lens to their financial materiality planning and making sure that they're able to properly quantify risks as well as opportunities, has been a key topic of conversation.

Victoria, both your answer and Matty's answer previously, highlight how different financial disclosures are from ESG disclosures and how complex the audit of these reports will be. Matty, given this background, what are the key differences you see between financial reporting, sustainability reporting, and what will be required under ASRS?

For financial reporting, there's actually a specific auditing standard that covers financial materiality and how an auditor should think about it. We don't yet have a similar auditing standard for materiality in relation to sustainability disclosures.

This is a big difference when we think about the audit of financial report, with that auditing standard in mind. Materiality is set by the auditor of the information being assured. The company being audited has little or no input into what will be material from a financial reporting perspective.

For ASRS disclosures, as Vics pointed out, it's a big question that the company itself has to answer. They have to choose what's material and what's not. But here's the challenge! Even though the company determines materiality, the auditor will have their own view. This may or may not align with the company's view.

This is important to remember - an auditor won’t have a specific auditing standard for sustainability disclosures. The underlying question that an auditor will seek to answer is could a disclosure, be it financial or non-financial, alter the decisions of the users of the climate report prepared in accordance with the ASRS? So engage early with your assurance provider to make sure you understand what they're thinking about in terms of materiality.

Victoria, do you have any further pieces of advice that you'd like to give our listeners?

It can be tempting to get lost in the red tape when you are faced with a new disclosure requirement. I want to remind people that the disclosure is merely an output. The real outcome is the opportunity to really drive value from a different level of conversation and action on climate change in your organisation.

I've heard it said that every dollar spent on disclosure is a dollar that can't be spent on progress. I think that's nonsense. The two should never be mutually exclusive. Of course it costs money to meet the needs of a new disclosure requirement in terms of internal resources and auditing, but why not use the opportunity of a looming mandatory disclosure deadline to galvanise action within your organisation? Why not use it to secure a budget and direct resources towards the activities that will drive the most meaningful impact for you and your stakeholders, as far as your climate change strategy is concerned?

Final pieces of advice, Matty?

I’m talking to many large listed of companies about ASRS and even the largest ones who've been reporting climate and sustainable information for many years, acknowledge they've still got a lot of work to do to meet the requirements of the new standards. I think we need to keep that in mind and start now.

I think the second point is that the systems, processes, procedures and controls for gathering the information that is going to be required for ASRS standards are very different to the ones that are in place for financial reporting. You'll need new systems. A lot of work will be needed to ensure accurate and timely reporting which require investment in both people and IT systems.

(Mary) concluding comments

What we've learned in this podcast today is the need to start with the end in mind. To be clear about what our ambitions are, because that way money spent on disclosure will be invested to best effect. Starting with the end in mind includes having conversations with your auditor and your assurer. How is this data going to be assured? How do you make sure that you're spending money well on your assurance exercise? The other part that that really came out for me today is the opportunity. Yes, you have to do this, it's mandated, but you have to do this because your investors are asking for this information. Prepare the information well and you will understand your opportunity and where you need your company to be to survive in a carbon free, climate-impacted world. There's a huge opportunity and it is about the long term investability and sustainability of your company.