Internal Controls, Sustainability, and IFRS
How two new sustainability standards impact reporting and disclosure, and what companies should consider to ensure they are compliant.
On June 26, 2023, the International Sustainability Standards Board (ISSB) unveiled its first-ever standards for sustainability disclosure. Designated International Financial Reporting Standards (IFRS) S1 and S2, they focus on general sustainability- and climate-related disclosures.
As demand grows from investors, regulators, customers, and other stakeholders for companies to disclose their sustainability practices and impact on the environment and society, these standards could help with the assessment of a company’s long-term sustainability, its ability to manage risks and opportunities, and to compare companies across industries.
IFRS S1, General Requirements for Disclosures of Sustainability-related Financial Information, requires companies to disclose financial information about their sustainability-related risks and opportunities that is useful to primary users of general-purpose financial reports in making decisions related to providing resources to the company. IFRS S2, Climate-related Disclosures, requires companies to disclose the same related to climate.
As this information could affect the company’s cash flow, access to financing, or cost of capital, the requirement for reporting and transparency might influence strategy, objectives, and decision-making processes.
With these new sustainability standards taking effect for annual reporting periods beginning on or after January 1, 2024, companies should reassess their systems of internal controls to comply with the disclosure requirements.
The table below shows internal controls that companies may need to consider.
| Internal Control Areas | Points to Consider |
|---|---|
| Data collection, verification, and management | · Accuracy and reliability of sustainability data for reporting · Manage the increased volume of sustainability data |
| Risk assessment and management | · Controls and processes to identify, assess, and manage risks and opportunities · Consistency with its strategic decisions and operations |
| Technology infrastructure | · Invest in new technology and IT controls |
| Training and awareness | · Invest in employee training and awareness programs · Policies and procedures to evaluate competencies |
| Governance | · Establish authority and responsibility |
| Integration with financial reporting | · Communication and monitoring from management and those charged with governance · Facilitate external audit |
| Stakeholder engagement | · Inclusion of processes for engaging with stakeholders |
Data Collection, Verification, and Management
The IFRS standards and reporting promote transparency and accountability regarding sustainability- and climate-related risks and opportunities. By requiring the collection and validation of data, a company can ensure accuracy and reliability for reporting.
Doing so will require robust internal controls similar to those used in financial reporting, and internal controls may need to be updated to manage the storage, access, and protection of a larger volume of data. As sustainability reporting is often required by regulatory bodies or industry standards, integrating sustainability metrics into internal controls helps ensure compliance and reduces the risk of penalties and legal issues.
Risk Assessment and Management
As sustainability reporting involves identifying, assessing, prioritizing, and monitoring risks and opportunities related to sustainability and climate, internal controls must include processes to effectively assess, manage, and mitigate risks. It is also key to ensure that those charged with governance have considered trade-offs associated with the risks and opportunities.
Sustainability reporting also highlights long-term sustainability goals and opportunities. Therefore, aligning internal controls with these goals can ensure that strategic decisions and operations are consistent with sustainability objectives.
Technology Infrastructure
Companies may need to invest in new technology and IT controls to manage sustainability data, especially if they are transitioning to digital reporting platforms. Information systems should be able to capture internal and external sources of data related to sustainability and climate risks and opportunities.
Training and Awareness
Companies may need to invest in employee training and awareness programs to ensure that all personnel understand the sustainability goals and the importance of reporting, and can carry out their internal control responsibilities. Companies may need to monitor the contributions of employees to these objectives. Processes may include policies to determine whether appropriate skills and competencies are available or will be developed to oversee strategies designed to respond to risks and opportunities related to sustainability and climate.
Governance
Sustainability reporting may necessitate changes in corporate governance to ensure that sustainability considerations are integrated into strategy and decision-making processes. Internal controls should reflect shifts in governance by having a governance body (which may include a board, committee, or equivalent) or individuals responsible for oversight of risks and opportunities related to sustainability and climate. Companies should also consider updating policies and procedures to reflect the responsibilities of those charged with governance and management.
Integration with Financial Reporting
Aligning the processes for sustainability and financial reporting requires careful coordination and internal controls to ensure that both are accurate and consistent. Policies and processes should consider how, and how often, those charged with governance and management are informed about sustainability- and climate-related risks and opportunities and decisions on significant transactions. Companies may also need to establish controls and policies to facilitate external audits of their sustainability disclosures to ensure that the data, processes, metrics, and targets adhere to reporting standards.
Stakeholder Engagement
Internal controls may need adjusting to address the broader set of stakeholders associated with sustainability reporting compared with traditional financial reporting. Sustainability reporting can lead to increased stakeholder scrutiny and engagement, and effective internal controls can help manage these interactions and ensure that stakeholder concerns are addressed, and the company’s reputation maintained. Communication methods should take into considering the timing, audience, and nature of the engagement.
As the ISSB is currently developing these sustainability standards, we expect that additional standards might be promulgated to address the needs of the stakeholders. Regular reviews and updates of internal controls, policies, and procedures are necessary to adapt to changing sustainability reporting standards and evolving practices.
Companies focusing on sustainability could drive innovations and efficiencies in their processes that lead to cost reductions. Internal controls can monitor and optimize these changes to ensure that they are implemented effectively and align with the company’s strategies, objectives, and decision-making processes.
For more information, please contact Grant Thornton Japan at info@jp.gt.com or visit www.grantthornton.jp/en
