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The rise of Environmental, Social and Governance issues, or “ESG”, and how it will impact the disputes landscape remains a hot topic in legal circles.  In parallel to this, ESG is also driving what has been dubbed the biggest change to corporate financial reporting and disclosure standards in a generation.^[1]

The Australian Accounting Standards Board (“AASB”) has recently issued two new international sustainability reporting standards, with mandatory reporting coming into effect as early as 1 January 2025 for large companies and those with high greenhouse gas emissions.  The new standards could provide new pathways for initiating ESG-related disputes, as well as have wide-reaching implications for company valuations and the assessment of commercial damages across more traditional areas of dispute.

The AASB has issued two Australian Sustainability Reporting Standards:^[2]

• AASB S1 – General Requirements for Disclosure of Sustainability-related Financial Information (voluntary) – an entity electing to apply this standard would disclose information about all sustainability-related risks and opportunities that could reasonably be expected to affect the entity’s cash flows, its access to finance or cost of capital over the short, medium or long term, and
  
  
• AASB S2 – Climate-related Disclosures (mandatory) – requires an entity to disclose information about climate-related risks and opportunities that could reasonably be expected to affect the entity’s cash flows, its access to finance or cost of capital over the short, medium, or long term.

There will be a phased implementation of AASB S2, a mandatory standard, over three years with the first cohort required to disclose the required information for annual reporting periods starting on or after 1 January 2025.^[3]

The standards are closely aligned with the two international sustainability reporting standards issued by the International Financial Reporting Standards (“IFRS”) Foundation in June 2023, IFRS S1 and IFRS S2.

The IFRS Foundation currently governs companies’ financial statements and reporting in more than 140 jurisdictions.^[4]  At the moment, IFRS S1 and S2 are voluntary, and it is up to each jurisdiction to decide whether they will adopt and mandate the standards.  

However, there appears to be strong support for the new standards across the Asia Pacific region with Singapore, Hong Kong and New Zealand also set to introduce climate-related disclosure requirements, or review existing standards, to align with the IFRS standards.^[5]  The mandating of ESG-related reporting, such as under AASB S2, may be seen across other countries in the region in the future.

Under the historic landscape of voluntary sustainability reporting, the level of disclosure has been highly variable between companies, inhibiting comparability and the usefulness of these disclosures to investors and stakeholders.  Global adoption of the IFRS S1 and S2, or closely aligned local disclosure requirements, would provide clarity for reporting companies and allow international comparability for investors.

New avenues for disputes

Australia’s corporate, markets and financial services regulator, ASIC, will administer and enforce the mandatory climate-related disclosures in Australia.  ASIC has stated that it will take a pragmatic and proportionate approach during the transition period.^[6]

Additional measures to ease the transition include:

• Modified liability periods until 31 December 2028, providing legal immunity in relation to certain types of statements made in sustainability reports;^[7] and
• Phasing in of audit requirements over time, with mandatory audit reports required from the financial year beginning 1 July 2030.^[8]

In the long run, however, mandatory reporting requirements will intensify ESG-related litigation risk for reporting entities and provide new avenues for disputes, specifically where there is:

1. Additional information disclosed – which may provide evidence about ESG-related risks and opportunities that parties could potentially utilise in ESG-related disputes; and
2. Increased responsibility to disclose – we may see a rise in ESG-related claims against corporations, directors, and auditors, such as class-actions, greenwashing claims and breaches of fiduciary duty.

Impact on damages

From a damages perspective, the implications are far reaching. 

The new disclosures may provide additional evidence of a company’s long-term prospects that ought to be considered in company valuations or calculations of lost profits in all areas of disputes, not just those brought in relation to ESG matters. 

The need to consider ESG factors when conducting valuations has also been recognised in the latest edition of International Valuation Standards (“IVS”), which are effective from 31 January 2025, which state:^[9]

“ESG factors and the ESG regulatory environment should be considered in valuations to the extent that they are measurable and would be considered reasonable by the valuer applying professional judgment.”

The latest IVS describe how ESG factors could be reflected under different valuation methodologies, for example:

• when performing an income-based valuation, considering whether risks and opportunities associated with the ESG characteristics of the subject asset impact its long-term forecast future cash flows and/or the risk of achieving the forecast cash flows and therefore the applicable discount rate;^[10] 
• when performing a market-based valuation, considering whether differences in ESG considerations between comparable assets and the subject asset warrant making adjustments for.^[11]

Although the consideration of ESG factors in valuations has been explicitly included in the latest IVS, the place of ESG in traditional finance theory is currently somewhat controversial.^[12]  In particular, there is lack of consensus at present over whether there is a generalised link between “good” ESG ratings and higher company value or performance.^[13]  The reason for this could be that certain ESG issues, such as climate change, represent current market failure to include external costs, i.e. costs to the planet that the company does not have to pay for.^[14]  In the current financial system, acting irresponsibly towards the environment does not always negatively impact a company’s bottom line.

An alternative view is that the market may not yet be capturing the value of “good” ESG due to a lack of information and information asymmetries.  Current ESG ratings are based on variable and subjective information, and the same companies are often rated differently between different ratings providers.^[15]  If this view is correct, there may be a disconnect between the current market price, and the fundamental value, or intrinsic worth, of companies.  In the context of a dispute involving valuation, consideration would need to be given to the basis of the value that should be applied – is the claimant legally entitled to a) the market price; or b) the intrinsic or investment value?

Despite the controversy regarding the current role of ESG in valuation theory, it is clear that the information to be disclosed under these standards includes financial information that may be relevant to a valuation, such as material information about sustainability-related risks and opportunities that could reasonably be expected to affect the value drivers of a company, including:^[16]

1. cash flows,
2. access to finance, and
3. cost of capital.

Examples of ESG issues that could have a material impact on a company’s long-term financial performance include:

• Environmental – climate change, pollution or environmental damage and scarcity of resources,
• Social – human rights, diversity and inclusion and labour practices, and
• Governance – governance structure, controls, and risk management.

We are entering a period of transition, and as this new area of disclosure develops, it could bring new and interesting challenges for both valuation and legal practitioners.  Since the incorporation of ESG factors into business valuations is relatively new territory, courts and tribunals may face novel questions, such as if and how ESG-related risks and opportunities should be reflected in the assessment of damages, with very little judicial precedent.

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If you would like to discuss how ESG-related factors may impact valuations and/or damages calculations, please contact Anna Kelly (AnnaKelly@hka.com) or Sophie Munson (SophieMunson@hka.com).

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^[1] https://asic.gov.au/about-asic/news-centre/speeches/esg-major-change-is-underway-and-we-need-to-be-ready/

^[2] Australian Sustainability Reporting Standards AASB S1 and AASB S2 are now available on the AASB Digital Standards Portal

^[3] Who must prepare a sustainability report? | ASIC

^[4] https://www.ifrs.org/news-and-events/news/2023/06/issb-issues-ifrs-s1-ifrs-s2/

^[5] The Impact of ISSB Standards Across APAC | Novata

^[6] ASIC’s administration of the sustainability reporting regime | ASIC

^[7] Modified liability settings | ASIC

^[8] Audit and assurance of sustainability reports | ASIC

^[9] International Valuation Standards, effective 31 January 2025, IVS 104, A10.06.

^[10] International Valuation Standards, effective 31 January 2025, IVS 103, A20.21.g & A20.37.g.

^[11] International Valuation Standards, effective 31 January 2025, IVS 103, A10.08.l & A10.14.h.

^[12] https://www.ft.com/content/d4082c75-3141-4a58-935b-60a44c22897a

^[13] https://www.ft.com/content/d4082c75-3141-4a58-935b-60a44c22897a and “Pushing back, moving forward: understanding the evolution of ESG”, The Economist Group 2022.

^[14] “Pushing back, moving forward: understanding the evolution of ESG”, The Economist Group 2022.

^[15] “Pushing back, moving forward: understanding the evolution of ESG”, The Economist Group 2022.

^[16] Australian Sustainability Reporting Standards AASB S1 and AASB S2 are now available on the AASB Digital Standards Portal