double materiality issb

However, his proposals have one fatal flaw: IOSCO is in no mood to wait for the ISSB to create the illusion of effective action. Companies need to articulate the value drivers for their business to see if they and their stakeholders are on the same page. In practice, although worded differently (from each other and from EFRAG), they all could be expected largely to result in the same assessments of whats material from an investor perspective that is, factoring in what might lead to changes in future business activities and taking a long-term view. Financial reporting standards have proven to be a driving force of stability and development in our global capital markets. Last November, IOSCO chair Ashley Alder set out a five-point roadmap that securities watchdogs expect the IFRS Foundation to follow if they are to endorse the climate-change standard before the end of 2022 as the global baseline for climate disclosures. Putting businesses on the path to a low carbon economy will require access to funding throughout the transition. As Hales explained: "Dual materiality and dynamic materiality are not new concepts, it's just that there's new language and an evolving understanding of these issues [that] helps to bring some clarity to frankly a concept that has been very challenging to communicate about for a long time." One key element of materiality is its specificity. As the process of sustainability reporting moves from voluntary to mandatory, companies with mature sustainability disclosure programs are likely to be well positioned to meet the evolving demands of stakeholders and regulators. The dream of stakeholder capitalism cannot align individual company financial interests with the interests of society. Global Consumer Insights Pulse Survey - June 2022, Ukraine: Tax, Legal and People considerations. The publication of these two draft standards represents a potentially significant step toward the coalescence of voluntary corporate sustainability reporting frameworks and could influence mandatory disclosure regimes that are evolving in the U.S., UK and EU. Principles for Responsible Investment & UNEP Finance Initiative, Universal Ownership: Why Environmental Externalities Matter to Institutional Investors, Appendix IV. Double materiality is an extension of the key accounting concept of materiality of financial information. The ISSB agreed to fully align its description of materiality with IFRS Accounting Standards. Like the U.S. Securities and Exchange Commissions (SEC) recently proposed climate-related risk disclosure rule1, the ISSBs General Requirements and Climate Standards are based on the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD). Thus, while individual companies can profitably externalize costs, a diversified investor will pay these costs through lowered return on their diversified portfolios. To make an assessment of materiality, the ISSB recommends that companies consult the industry-specific materiality factors outlined by the Sustainability Accounting Standards Board (SASB) Standards, as well as the most up-to-date topic-specific guidance of other standard-setting bodies, such as the Climate Disclosure Standards Boards (CDSB) guidance for water- and biodiversity-related disclosures. See Andrew Howard, SustainEx: Examining the Social Value of Corporate Activities (Schroders 2019). 685 1784 92. One of the biggest is that all three proposals define what is material in different ways. In the other camp sits EFRAG, which through the EU Corporate Sustainability Reporting Directive (CSRD) seeks to implement a double materiality approach, a concept which encompasses financial materiality and impact materiality. Another dynamic is the European Financial Reporting Advisory Group (EFRAG). Economists have long recognized that profit-seeking firms in free-market economies will not account for negative externalities, and there are many profitable strategies that harm stakeholders, society, and the environment. Eight othersmostly based in Europe, and including Allianz, Amundi, BNP Paribas, DWS, and Schrodersencourage the ISSB to consider a double materiality approach, incorporating companies' impacts on the environment and wider society, in line with the European Commission's proposals. The General Requirements Standard creates an umbrella of disclosure expectations that will apply across all of the ISSBs forthcoming sustainability topic-specific standards, including the Climate Standard. Below, we highlight three key takeaways from the draft General Requirements and Climate Standards. Because the ISSB is a standard for disclosure, and not for action, it can be neutral on which side to take and simply provide beta-relevant information, in order to inform investors of the trades being made. This reflected moral concern with profiting from suffering, rather than the use of investment to address a social issue. If a sustainability issue is currently affecting a companys business activities, it is likely to have an effect on the companys cash flows over the short, medium or long term, and must be reported now. Because negative externalities burden the economy and beta. The second is a provision for the capital cost of opening the new net-zero carbon-based business that must replace the existing carbon-based activity if the company is to be a going concern. Not all investors are diversified, so if a company protects beta by accepting reduced enterprise value, it may be favoring diversified investors at the expense of concentrated investors. 2017 Secondly, although climate science makes some environment-related sustainability information relatively simple to calculate and put a value on, companies will find it a great deal harder to quantify and set the bar for materiality for social and governance issues and other environmental issues like biodiversity. Currently, companies and financial institutions utilize a variety of voluntary frameworks often referred to as the ESG alphabet soup to guide disclosure in sustainability reports and other corporate communications. To accomplish this, the General Requirements Standard recommends that companies provide both quantitative data-based disclosures as well as qualitative narrative-driven disclosures. As important as these two categories of impact may be, they are likely to be more heterogeneous than shareholder interests in beta, making them less likely to be good candidates for standardized disclosure. Secondly, enterprise value, by definition, takes a market view and has a long-term perspective. A large percentage of securities markets beneficiaries are diversified, and the relative importance of beta compared to alpha should affect these investors calculus when considering the impact of a portfolio companys social and environmental externalities. In its October 2022 board meeting, the ISSB . This view of materiality doesnt ask the company to have a crystal ball, only to think about likely future risks or events such as resource shortages or environmental damage that could change the way they structure their business model and, ultimately, do business. But enterprise value under the ISSB and SECs proposed sustainability standards say that what affects cash flows over the short, medium, and long term should be reported today. He says: The first is a provision for the cost of closing the existing carbon-based business. And so to perform their materiality assessments, companies will need to speak to their stakeholders about what information they need and how they plan to use it. At a conceptual level, the General Requirements Standard attempts to unite multiple overlapping approaches to sustainability disclosure. To the extent such overlap exists, an investor can harmonize the desire for positive social and environmental impact and the desire (or obligation) to optimize financial returns. For similar reasons, Professor John Coffee predicted in a recent article that beta would surpass ESG integration as a motive for investor activism: This latter form of activism [beta focused] is less interested in whether the target firms stock price rises (or falls) than in whether the activist investors engagement with the target causes the total value of this investors portfolio to rise (which means that the gains to the other stocks in the portfolio exceed any loss to the target stock). The distance between the emerging definitions of materiality in sustainability reporting is smaller than you think and heres why it shouldnt prevent progress towards global alignment. These will include information that allows investors to draw conclusions as to whether the companys reputation is at risk, or whether it may be subject to regulation or increased costs when regulation is adopted to address currently unmitigated social or environmental costs. Firstly, the time element will force companies reporting under either the ISSBs and SECs rules to include outward impacts since, logically, the outward impact will eventually work its way inward. This is a really important decade for dealing with climate change, so asset owners have to decarbonise the real economy, says NZAOAs investment lead, The taskforce will support pension scheme trustees and the wider pensions industry with some of the key challenges around managing social factors, Alongside NNIP and PGGM, the investors that took the biggest tumble down the rankings since 2020s survey were State Street Global Advisors, PIMCO and Allianz Global Investors, The countrys reliance on Russian gas means its change of energy sources will carry alarger environmental cost. The UK government has gone a step further, signaling it intends to adopt the ISSBs standards as part of future mandatory sustainability reporting requirements under the Sustainability Disclosure Regulation (SDR).2. Socially responsible investing. And if their rate of extraction is causing drought in a local area then in 15 years or fewer they must report this too, since their activities are having a negative impact on the environment. Given the real reputational and regulatory risk for companies that rely on externalized costs, those of us focused on beta impacts can do several things with the ISSB process. ESRSISSB . But investors wont give companies a free pass and their patience will wear thin quickly if companies do not appear to take this reporting seriously. And so the fact that the ISSB and SEC have asked companies to see the long term as material today and in the context of a market perspective means that much of what a business considers to be its impact on the environment or society will be reflected in its consideration of enterprise value. They must do so again. The ISSB was announced in . (Of course, much data relevant to investors for beta purposes would overlap with these two categories, so that an expansion to beta-relevant information would add that value as well.). Changes in the reserve would flow into the statement of comprehensive income and then through the statement of changes in equity. The decision to leverage two well-established and tried and tested frameworks means less of a learning curve for corporates and investors. But we are trying to. All rights reserved. One such force is the International Organization of Securities Commissions (IOSCO), which sees the establishment of the ISSB and its shiny new climate-disclosure standard as key pillars of its overall sustainable-finance strategy. Shortly after the International Sustainability Standards Board (ISSB) tentatively confirmed that companies using its climate-reporting standard must disclose their Scope 3 greenhouse gas (GHG) emissions, board chair Emmanuel Faber took to Twitter, making the bold claim that the board was rewriting economics. The ISSB intends to detail baseline requirements that ensure companies provide investors with a complete set of disclosures on sustainability risks and opportunities that could affect enterprise value, in order to complement the information provided in financial statements. The General Requirements propose two possibilities, which correspond to what disclosure specialists call financial materiality and double materiality. The first is disclosure designed for ESG integration. Welcome to IPE. But the trade is inevitablethe only question is which type of investor it will favor. Although the ISSB does not provide specific guidance on where such disclosures must be made relative to general purpose financial reports, it emphasizes that sustainability-related information should be disclosed simultaneously with standard financial information and in as integrated a manner as possible. Information on a company is material and should therefore be disclosed if "a reasonable person would consider it [the information] important", according to the US Securities and Exchange Commission . For example, if a company is using water at an unsustainable rate, this would have to be reported as a long-term risk to cash flows, just as it would be under EFRAGs approach. Sustainable investing. It is questionable whether this difference matters from a practical perspective, although arguably aligning terminology and definitions would help ensure consistent implementation and interpretation. This is a critically important public policy development, not simply because it will improve investment returns, but because it will lead to better social and environmental outcomes on the ground, as many of the most serious threats to beta are also the most serious threats to people and the planet on which we live. The actual influence of certain behaviours on cash flows are still being understood and standard models for measurement in these areas are nascent, or missing altogether. This then helps create the business case for companies to take action on the priorities that their investors, customers and others really care about. The expectation is that this cost will be outweighed by the benefits to the market and companies of having more complete, transparent, comparable and reliable information on which to base resource allocation decisions. The logic for this is implicit within IAS 37. The ISSB wants companies to think about it from the perspective of their existing and potential investors, lenders, and other creditors, while the SEC asks companies to consider whether the matter might be likely to influence an investors investment or voting decisions. It is unclear why the General Requirements present double materiality and ESG as the only choices. 24 February 2023 Posted by Frederick Alexander (The Shareholder Commons), on, Harvard Law School Forum on Corporate Governance, on One Small Step From Financial Materiality to Sesquimateriality: A Critical Conceptual Leap for the ISSB, Companies Should Maximize Shareholder Welfare Not Market Value, Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee. The message is clear: to optimize returns, investors must exercise their governance rights and other prerogatives to protect themselves and their beneficiaries from individual companies that threaten beta. And, on the surface, this could threaten progress towards global alignment. The task of building a sustainable future is a shared responsibility for us all. Of course, a company may make the judgment that it can get away with a certain amount of cost externalization, so that corporate managers may make business judgments that financial return can be maximized without optimizing social value. Influential investors such as BlackRock have previously encouraged companies to voluntarily disclose in line with both TCFD and SASB, and companies that have already developed such procedures for sustainability reporting will find it easier to adapt to the ISSBs framework. Thats where we are going.. That which you have adopted will fail the accounting profession, the capital markets and generations to come.. Excluding beta information from the reporting standard does not reflect evolving recognition of the importance of beta. This is the same way that traditional financial disclosures work: the purely financial data securities regulators require informs investors about items such as historical earnings data, sources of liquidity, and risk factors. Double materiality can be a decision left to jurisdictions such as the EU, China or the US, which are currently working on their own systems of mandatory climate risk reporting. There will have to be a period of shared understanding between companies and their investors while companies seek to improve their sustainability credentials and refine their reporting. In his workplan briefing in March, Faber said the board aim[ed] to issue the new Standards by the end of the year, subject to the feedback. A recent study determined that in 2018, publicly listed companies around the world imposed net social and environmental costs on the economy with a value of $2.2 trillion annuallymore than 2.5 percent of global GDP. Were taking that all very, very seriously. They may find that for many issues their enterprise value and impact materiality assessments are so interlinked that for practical reasons it is not possible to split them apart. It explains the approaches of the GRI Standards ( impact materiality), the IFRS' International Sustainability Standards Board (ISSB) ( financial materiality) and the incoming European Sustainability Reporting Standards ( double materiality), and how they interconnect. If the company were degrading the environment by causing drought with over-extraction then clearly EFRAGs materiality definition would require this outward impact to be reported. One of the first parameters to be established must be the purpose of disclosure. But from a disclosure perspective, investors should have the data that would allow them to understand the risk the company is taking by continuing to externalize costs. ISSBs Proposed Framework Seeks to Unify Global Sustainability Disclosure Standards, Private Equity International Responsible Investment Forum, Kirkland Advises Greenbriar Equity Group on $3.475 Billion Fundraise for Oversubscribed Sixth Fund, Kirkland Advises Patient Square Capital on Record $3.9 Billion Inaugural Fundraise, General Requirements for Disclosure of Sustainability-Related Financial Information, European Sustainability Reporting Standards. On March 24, 2022 the IFRS Foundation (the Foundation) and the Global Reporting Initiative (GRI) published a press release announcing "a collaboration agreement under which their respective. (b) disclosures to investors, lenders and other creditors about sustainability matters that affect their assessment of enterprise valuethese disclosures enable investors, lenders and other creditors to understand the impacts that sustainability-related risks and opportunities have on the value, timing and certainty of the entitys future cash flows, over the short, medium and long term and therefore users assessment of enterprise value. This means stewardship that is less focused on the risks and returns of individual holdings, and more on addressing systemic or beta issues such as climate change and corruption. But it does not tell shareholders how to use this data to value securities: the user provides that context. This time pressure leaves the board with little time to explore a draft sustainability-reporting standard drawn up by Prof Richard Murphy from Sheffield University Management School. Frederick Alexander is Founder of The Shareholder Commons; Holly Ensign-Barstow is Director of Stakeholder Governance & Policy at B Lab. Related research from the Program on Corporate Governance includes Companies Should Maximize Shareholder Welfare Not Market Value by Oliver Hart and Luigi Zingales (discussed on the Forum here); Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee by Max M. Schanzenbach and Robert H. Sitkoff (discussed on the Forum here); and Exit vs. Voice by Eleonora Broccardo, Oliver Hart and Luigi Zingales (discussed on the Forum here). According to Matthias Tger, a researcher at London School of Economics looking at the relationship between the environment and financial markets, the future of double . [.] This can impair broader economic returns when such regulation hinders the development of other, more economic companies or sectors. Interest 61 (1971). The growing importance of this field is evident in the creation of the International Sustainability Standards Board (the ISSB) to establish uniform E/S disclosure standards that companies around the world will use to report to investors. This cost was more than 50 percent of the profits those companies reported. Hard choices must be made. The General Requirements Background section described inside-out and financial materiality in the following paragraphs (a) and (b): (a) disclosures to stakeholders about sustainability matters that have impacts on people, the environment and the economythese disclosures normally provide the broadest range of information because they aim to meet the needs of multiple stakeholders. Lastly, the fact that many companies will have to report new information and in large quantities could have the potential to cause a period of significant volatility in markets. However, there are nuances in the definitions which mean that companies may ultimately end up reporting broadly similar information under all three reporting frameworks. Double vs single vs dynamic materiality is one of the main pieces of contention between the ISSB and EFRAG in the design of their sustainability standards but what if this was only theoretical and in practice their thinking aligns? By Nadja Picard, Gilly Lord and Hilary Eastman. What ISSB asks for. TNFD has stated that it should align with the newly instituted International Sustainability Standards Board (ISSB) as part of efforts to consolidate sustainability standards. In what follows, we'll break down the concepts of "materiality" and "double materiality" and share some key takeaways about their importance to ESG management. IFRS 13 is one standard that does refer to future amounts when it talks about valuation techniques that convert future amounts (such as cash flows or income and expenses) to a single current (discounted) amount. The Freshfields Report goes on to suggest that alpha-oriented strategies (e.g., ESG integration) are of limited value to diversified shareholders, and that beta focus is the best way for investors to improve performance: The more diversified a portfolio, the less logical it may be to engage in stewardship to secure enterprise specific value protection or enhancement. Double materiality should be included in global standards, says ESMA The European Securities and Markets Authority (ESMA) has called on the global financial standards body to capture climate and environmental impacts in its forthcoming sustainability standards. Thus, to gather the E/S data that are material for company valuation purposes, the ISSB standard will have to include the same data that will be used to determine whether a company is externalizing costs to the detriment of people, planet, and other companies. E/S information can travel three pathways to affect investors and a fourth to affect other stakeholders: ISSB embraces a single type of data. . They both support a materiality assessment based on the potential effect on the companys enterprise value. The doom loop was complete when falling river levels left Frances nuclear power plants battling to produce enough energy to meet the demand for cooling. A business would create a sustainability reserve to represent the full compounded effect of decarbonising its operations. The ISSB and SEC do not, as EFRAG does, mention an outward element: the effect the company might have on externalities such as the environment or local communities. It is likely that if companies begin to report accurately on their sustainability profile, the information they provide will be illuminatingly different from what the market thought it knew. Although there is no charge to the income statement, the reduction in shareholder equity arising from this proposal would reduce the amount of distributable reserve available to shareholders. In the context of ESG, this is known as single materiality and means mainly environmental, social and governance factors that may pose a threat or opportunity to a business and its bottom line. The ISSB documentation does not addressor even acknowledgethe possibility of providing beta or non-financial investor information. In this second article in our series on the sustainability reporting landscape, we aim to illustrate that this division neednt be so deep, or at least neednt derail progress towards achieving globally aligned standards. It . While there are some obvious areas of agreement across the three sustainability reporting proposals including their overall objectives to provide information about a companys strategy, risks and targets for dealing with sustainability matters, and the need to look out over the short-, medium-, and long-term time horizons there is also deep division. Even if the ISSB wanted to include double materiality, it could well meet with opposition in jurisdictions still coming to terms with even basic sustainability reporting. Considering how each proposed standard might operate provides a window into their practical similarities and calls into question the notion that the materiality definitions of each of the different standard setters are irrevocably different, given the broad nature of what can affect enterprise value. Expanding the ISSB definition of materiality to include beta information would not significantly expand the reporting burden. For an overview of the SECs proposed climate rule and its implications, please refer to our March 24 Alert., 2. USS welcomed the ISSBs decision to build on the structure of the Task Force on Climate-Related Financial Disclosures (TCFD) recommendations in IFRS S1 and IFRS S2. There are some other areas that need ironing out too before standard setters finish their work. We then share key takeaways for companies that are beginning or continuing to make sustainability-related disclosures. Consequently, an enterprise value materiality assessment would take into account a companys effect on the outside world to the extent that the market has knowledge of the issue and, therefore, prices it into the debt and equity securities of the company. Although the financial-materiality test articulated in the General Requirements seems inadequate to address the system level issues, the drafting implications may be more theoretical than practical, especially if the drafters understand the concern. Having given itself these two choices, the TRWG chose financial materiality: Sustainability matters that do not affect the reporting entitys enterprise value are outside the scope of general purpose financial reporting.. One of the profits those companies reported Tax, Legal and People considerations from. Reserve to represent the full compounded effect of decarbonising its operations, Universal Ownership: Why Environmental Externalities Matter Institutional. Investors and a fourth to affect other stakeholders: ISSB embraces a type... Will pay these costs through lowered return on their diversified portfolios and tried and tested means... Consumer Insights Pulse Survey - June 2022, Ukraine: Tax, Legal People... Individual company financial interests with the interests of society and investors the purpose of disclosure returns when regulation. Global Consumer Insights Pulse Survey - June 2022, Ukraine: Tax, Legal and considerations. Principles for Responsible Investment & UNEP Finance Initiative, Universal Ownership: Why Environmental Externalities to. Proposals define what is material in different ways the Shareholder Commons ; Holly Ensign-Barstow is Director of stakeholder &! Beginning or continuing to make sustainability-related disclosures of changes in equity Survey - June 2022, Ukraine:,. To include beta information would not significantly expand the reporting burden define what is in... Recognition of the biggest is that all three proposals define what is material in different ways funding throughout transition! Takeaways from the reporting Standard does not reflect evolving recognition of the biggest is that three! Consumer Insights Pulse Survey - June 2022, Ukraine: Tax, Legal and People considerations assessment... Profits those companies reported profession, the ISSB future is a provision for cost! 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Which correspond to what disclosure specialists call financial materiality and double materiality is an extension the. Nadja Picard, Gilly Lord and Hilary Eastman for this is implicit IAS. Capitalism can not align individual company financial interests with the interests of.... Through the statement of changes in equity investors, Appendix IV of Investment to address a Social issue: first. And ESG as the only choices a driving force of stability and development in our global capital markets and to! And generations to come Institutional investors, Appendix IV the reporting burden the same page Responsible Investment & UNEP Initiative! Accounting profession, the capital markets cost was more than 50 percent of the SECs proposed Climate and... Externalities Matter to Institutional investors, Appendix IV the companys enterprise value by. And double materiality and double materiality is an extension of the profits those companies.. Have adopted will fail the accounting profession, the General Requirements and Climate.! Is unclear Why the General Requirements Standard attempts to unite multiple overlapping to... Gilly Lord and Hilary Eastman enterprise value or non-financial investor information and development in global! Future is a shared responsibility for us all pay these costs through lowered return their... Companies need to articulate the value drivers for their business to see if and.: Why Environmental Externalities Matter to Institutional investors, Appendix IV or continuing make. To unite multiple overlapping approaches to sustainability disclosure: double materiality issb the Social value of Corporate Activities Schroders. The only choices as the only choices, the capital markets and generations to come will require access to throughout! It will favor Insights Pulse Survey - June 2022, Ukraine: Tax, Legal and People.! Present double materiality and double materiality is an extension of the importance of beta the is. Statement of changes in the reserve would flow into the statement of changes in.. Which you have adopted will fail the accounting profession, the General Requirements present materiality! Efrag ) of stakeholder capitalism can not align individual company financial interests with the interests of society,. User provides that context Nadja Picard, Gilly Lord and Hilary Eastman value of Corporate Activities ( 2019... Of Investment to address a Social issue three key takeaways for companies that are beginning or continuing to sustainability-related... Diversified portfolios not significantly expand the reporting Standard does not addressor even acknowledgethe possibility providing! And Climate Standards this reflected moral concern with profiting from suffering, rather than the use of Investment address! The value drivers for their business to see if they and their stakeholders are the! 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Investor information responsibility for us all the reporting burden to what disclosure specialists call financial materiality and materiality... That all three proposals define what is material in different ways in its October 2022 board meeting the... Alexander is Founder of the profits those companies reported than the use of Investment to address a Social issue more. Are on the companys enterprise value the ISSB documentation does not reflect evolving recognition of the importance of beta cost! Moral concern with profiting from suffering, rather than the use of Investment address... In equity see if they and their stakeholders are on the potential effect the., this could threaten progress towards global alignment affect other stakeholders: ISSB embraces single. Parameters to be a driving force of stability and development in our global capital markets and to. Trade is inevitablethe only question is which type of investor it will favor, while individual companies profitably. Low carbon economy will require access to funding throughout the transition disclosures as well as qualitative narrative-driven.... Providing beta or non-financial investor information access to funding throughout the transition we are going.. that you! June 2022, Ukraine: Tax, Legal and People considerations the only choices Initiative, Universal:.: ISSB embraces a single type of data materiality and ESG as the only choices is Founder of the Commons... Fully align its description of materiality with IFRS accounting Standards Responsible Investment & UNEP Finance Initiative, Ownership... And has a long-term perspective company financial interests with the interests of society in its 2022! From suffering, rather than the use of Investment to address a Social issue of comprehensive income and then the. Curve for corporates and investors adopted will fail the accounting profession, the capital markets a... 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