The April 2024 report by the European Systemic Risk Board (ESRB) examines how climate-related risks are addressed within International Financial Reporting Standards (IFRS) and their impact on financial statements, focusing on financial stability. It identifies four key issues: incomplete incorporation of climate-related risks in market prices, potentially leading to asset overvaluation or liability undervaluation; challenges in valuing non-financial assets and liabilities due to inadequate consideration of climate risks in impairment tests; difficulties in integrating climate factors into models for expected credit losses and insurance cash flows; and the need for enhanced disclosures to improve transparency. These issues stem from uncertainty about the timing and extent of climate risk materialization, which could lead to “information shocks” and affect financial stability through sudden market adjustments, fire sales, or increased capital costs.
The report highlights that while IFRS standards allow for reflecting climate-related risks, their principles-based nature and lack of explicit guidance can result in inconsistent application, complicating the accurate representation of these risks in financial statements. It suggests amendments to standards like IAS 1, IAS 36, IAS 37, IFRS 7, and IFRS 13 to better incorporate climate factors, alongside prioritizing guidance on pollutant-pricing mechanisms. Additionally, it emphasizes the importance of connectivity between financial and sustainability reporting to avoid contradictory disclosures, which could undermine market trust and lead to suboptimal economic decisions with potential systemic consequences.
To enhance financial stability, the ESRB recommends improving the implementation of IFRS standards through better disclosure practices and guidance for financial institutions, particularly on expected credit losses and insurance contract cash flows. It also underscores the critical role of auditors in ensuring robust disclosures and the need for assurance in sustainability reporting to align with financial statements. Ongoing work by standard-setters like the IFRS Foundation, ESMA, and EFRAG, alongside initiatives like the European Sustainability Reporting Standards (ESRS), is seen as vital to addressing these challenges and ensuring comprehensive, comparable climate risk disclosures.