Introducing Resilience Science: A Visionary Shift for Corporate Strategy and Reporting

Background

In June, the International Sustainability Standards Board (ISSB)
issued its inaugural
standards
— IFRS S1 and IFRS S2. The Standards create a common language for
companies to report on how sustainability and climate-related risks and
opportunities affect their prospects. They reflect what investors want, and will
form the basis of mandatory climate-related reporting
requirements
in many advanced jurisdictions (aside from the United
States).

This article explores the most interesting part of IFRS S2: the
climate-resilience assessment. Building on the TCFD — which IFRS S2 has now
supplanted
— climate resilience is defined as the “resilience of a company’s strategy
and business model to climate-related changes, developments and
uncertainties” [emphasis added]. This language is worth reflecting on, as it
brings the concept of resilience science into mainstream business thinking.

Tipping points and ignorance

Invented by Canadian ecologist C.S. “Buzz”
Holling in 1973, resilience
science
explains how human-natural systems (the interconnected relationship between
humans and the environment) do not exist in a fixed state — but are instead
characterized by constant change and tipping points.

This is not how businesspeople usually think. Instead, they assume that a
complex system — like an organisation — is stable, isolated, measurable and
linear. Take COVID: Most of us thought things would be disrupted for a time
before ‘bouncing back’ to normal. The mistake is right there in the language.
Post pandemic, we didn’t go back. The way we live and work
changed.

A better understanding of the world acknowledges that systems go through
adaptive cycles of growth, decay, restructuring and renewal. As business
leaders, we must acknowledge our lack of certainty and control. We should
reimagine our actions, plans and strategies as experiments that, as in science,
must be constantly re-evaluated.

As author Nassim Taleb says in
Fooled by Randomness,
probability is “the acceptance of the lack of certainty in our knowledge and the
development of methods for dealing with our ignorance.”

That’s why IFRS S2 is not the dry reporting standard it appears at first view,
but something quite visionary — it embraces uncertainty and consents to our
ignorance. It asks us to see through the ‘illusion’ of the pristine, perfectly
self-contained balance sheet — where the ledger is always squared, and all
things are known.

Focus on the process

To explain the “changes, developments and uncertainties” that arise from the
physical and transition risks and opportunities of climate change, a company is
required to use scenario
analysis.
This is not meant to predict what might happen in the future — but to offer up
‘what if’ scenarios to help your business better think through its options and
plan accordingly.

IFRS S2 says you must disclose the “inputs and key assumptions” used in your
scenarios — not just the result. In other words, your explanation of the
process is essential. This is because investors want to test the quality of
your thinking, rather than simply reading a claim that your business is
resilient.

Staying practical

The method of scenario analysis you employ is up to you, and should be
“commensurate with your circumstances.” For most businesses, an expensive,
quantitative-modelling exercise is not required or even the best option. The
authors of IFRS S2 recognize the burden that companies face in complying with a
science-based approach to climate change.

As a result, they have sought to navigate a practical approach that requires the
use of “all reasonable and supportable information” (the floor of the effort
required) available at the reporting date without “undue cost or effort” (the
ceiling). The concept is explained by ISSB Vice Chair Sue
Lloyd in this
webinar. The
IPCC,
IEA and
PRI
all provide publicly available scenarios which provide the basis for a useful,
cost-effective and strategic approach.

Finally, your company is not required to perform a scenario analysis as part
of the reporting effort each year. The minimum requirement for updating your
scenarios is whenever you review your corporate strategy as part of the
strategic planning cycle. That said, each year you must revisit the
assumptions that underpinned your analysis and consider whether any changes
affect the assessment of your company’s climate resilience. The IFRS refers to
this annual update as a “resilience assessment.”

Scenario analysis done well will ultimately help you fine-tune your overall
strategy and business model — enhancing your business’s prospects and resilience
against the vagaries of an uncertain future.

In recent years, investor portfolios have grown too big to avoid systemic
risks
such as climate change. Recognizing their vulnerability to black swans,
institutional investors have pushed investee companies to prioritize resilience
over short-term cost optimisation; the IFRS Standards reflect the trend. As
Taleb says, the defining characteristic of change is that it cannot be
predicted: “This is the central illusion in life — that randomness is a risk —
that it is a bad thing.”