Identifying climate risks for disclosure under AASB S2: Gross or net of risk mitigation activities?

As Group 1 entities prepare for their first sustainability (climate) reports for 31 December 2025, many are grappling with the question, ‘Should entities consider risk mitigation activities when identifying sustainability-related risks that could reasonably be expected to affect their prospects (AASB S2 Climate-related Disclosures, paragraph 10(a))?’ In other words, does the entity consider disclosing risks:

• Net of mitigation activities (i.e., the residual risk after considering them), or
• Gross (i.e., the inherent risk, ignoring mitigation activities)?

The International Sustainability Standards Board’s Transition Implementation Group on IFRS S1 and IFRS S2 (TIG) discussed this exact question in the context of broader sustainability risks. After considering the requirements of IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2 Climate-related Disclosures, the TIG determined that it depends on the facts and circumstances for each entity.

Let’s explore how they came to this conclusion, noting that sustainability risks in the TIG discussion can simply be substituted for climate-related risks in Australian reporting.

What do IFRS^® Sustainability Disclosure Standards say about disclosing climate risks gross or net?

IFRS S1 notes the following regarding disclosure of sustainability:

• Paragraph 1: The objective is to disclose information about an entity’s sustainability-related risks and opportunities that are useful to primary users of general purpose financial reports in making resource allocation decisions.
• Paragraph 17: Requires disclosure of material information about risks that could reasonably be expected to affect the entity’s prospects.

Factors to consider

Entities must consider an external perspective, what primary users would expect to see. They need to assess information and decide if misstating, omitting or obscuring this information could reasonably be expected to influence primary users’ decisions.

Risk mitigation activities could, for example:

• Reduce the entity’s exposure to a risk, or eliminate the risk entirely
• Change the expected likelihood and frequency of the risk occurring, or
• Change the expected impact of a risk,

thereby changing how the entity’s prospects are affected.

Are risk mitigation activities in place?

When identifying sustainability-related risks that could reasonably be expected to affect the entity’s prospects, whether or not risk mitigation activities are in place at the time of reporting can make a difference.

Risk mitigation activities are planned, but not in place

It is more likely that a sustainability-related risk will have to be identified where no risk mitigation activities are currently in place, even if they are planned. This could occur, for example, if an entity’s assets are at risk of damage due to increasingly severe weather events - the entity plans to mitigate this risk by selling these assets, but the entity remains exposed to this sustainability-related risk at the time of reporting.

Risk mitigation activities are in place

Sometimes an entity may have risk mitigation activities in place, but decide that a sustainability-related risk must be identified because the entity operates in a particular industry known for exposure to certain sustainability-related risks. For example:

• Supply chains include operations in countries with high incidences of human rights violations
• Entities operate in high-emission industries, such as mining
• Entities operate in industries associated with waste generation, such as retail operations that make use of packaging, and therefore, higher GHG emissions throughout their value chain.

In other instances, though, an entity may not identify a risk because it is not reasonably expected to affect prospects, such as where sustainability-related risks are highly regulated. This could occur, for example, where there are stringent regulations regarding wastewater treatment and the entity has implemented risk mitigation activities, including the ‘best-in-class’ equipment to facilitate wastewater treatment, undergoes mandatory routine equipment maintenance, conducts daily random tests of water quality, and has never failed to meet regulatory obligations related to water quality.

Apply judgement

IFRS S1 and AASB S2 do not specify whether or how an entity is required to consider risk mitigation activities when identifying sustainability-related risks. An entity must, therefore, apply judgement based on its own facts and circumstances.

Disclose judgements about how risk mitigation activities affect risk identification

Entities must disclose information about what judgements the entity made in identifying sustainability-related risks that could reasonably be expected to affect the entity’s prospects. This includes providing information about its judgements about how risk mitigation activities were considered when identifying sustainability-related risks.

Key takeaways from TIG discussions

Regarding the identification of sustainability-related risks that could reasonably be expected to affect an entity’s prospects, key takeaways from the TIG discussions include:

• It’s not only about which risks the entity itself considers could reasonably be expected to affect its prospects; it’s also about what external parties expect to see reported.
  • Different entities will use different approaches. Judgement is required, but each entity should establish a consistent methodology from year to year for assessing risks.
• Caution needs to be exercised when identifying sustainability-related risks ‘net’ of mitigation activities.
• When assessing each risk, including whether information is material, consider the nature of the risk, its potential magnitude and financial effect, and the likelihood of its effect on the entity.
• Consider the nature and effectiveness of risk mitigation activities.
• Regardless of the entity’s best efforts regarding risk mitigation activities, the entity’s prospects could still reasonably be expected to be affected by the sustainability-related risk.
  • Risk identification is not a ‘set and forget’ one-time assessment; it must be reassessed regularly.
  • Once a risk has been identified that could reasonably be expected to affect the entity’s prospects, information must be disclosed about it and any risk mitigation activities if it is material.

How we can help

As you prepare your first mandatory sustainability report, now is the time to critically assess how your entity identifies climate-related risks, whether gross or net of mitigation activities. Establishing a consistent, well-reasoned methodology is essential, and so is clearly disclosing the judgements made. If you’re unsure how to approach this, our sustainability team is here to support you.