Copyright 19972023 IPE International Publishers Limited, Registered in England, Reg No. 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. Planetary forces much greater than cataclysmic weather events have decided that. 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. Below, we highlight three key takeaways from the draft General Requirements and Climate Standards. In the one camp, broadly speaking, sit the SEC and the ISSB. When the economy suffers, so do diversified shareholders. Thats why we were created. 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. 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. This convergence is illustrated in Figure 1 below. For financial reporting, for example, companies assess materiality from the perspective of one stakeholder group: investors and lenders, the primary users of financial statements. However, sustainability reporting is not just about the sustainability-related impacts on the company (or its enterprise value) that can be material, but also the impacts of a company on the environment, climate or other sustainability issue so-called double materiality, Russell added. The ISSB consultation responses show there is also wide support for the approach within the financial sector. Diversified investors cannot avoid certain common risks almost all companies face. But this could also be reportable under the ISSBs and SECs rules, since community unrest might affect their licence to operate (and therefore their future cash flows) or injudicious extraction might lead to lawsuits for environmental degradation in 15 years time, again, affecting cash flows. 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. Driven to assist organizations to elicit positive change.<br>TCFD | CDP | SBTs . These are difficult issues to report on, rife with judgement, and companies do not yet feel safe doing it especially when it comes to enforcement. Importantly, the inside-out concept as discussed in the General Requirements is not designed to address beta; instead, it is focused on how the E/S performance of a company affects society overall. Hard choices must be made. One of the biggest is that all three proposals define what is material in different ways. Standard-setting International Sustainability Standards Board Consolidated organisations By Stephen BouvierNovember 2022 (Magazine). This site uses cookies. What should be the role of investors when it is governments that have the most power to effect change? Materiality: The First Step in ESG Management The easiest way to think of materiality is as a relevancy filter for the issues that matter most to an organization. This then helps create the business case for companies to take action on the priorities that their investors, customers and others really care about. Single MaterialityDouble Materiality Outside-in Perspective . All Climate Climate Risk CSRD Disclosure Disclosures Double Materiality Emissions ESG Management ESG Ratings ESG Strategy ESRS EU Financing Green Finance How To InsightsEN ISSB Materiality Net Zero Regulation Reporting Reporting Standards Risk Scope 3 Emissions Social Standards Sustainable Finance Taxonomy Uncategorized . The ISSB will deliver a global baseline of sustainability disclosures to meet capital market needs. 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. 685 1784 92. 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 . Indeed, in another section of the General Requirements that discusses the materiality concept in more detail, the TRWG uses a definition that would certainly include beta information: General purpose financial reporting includes financial statements of and sustainability-related financial information about a specific reporting entity. One example, Becker claims, is the understand of materiality. Forest fires raged across Europe, part of a London suburb caught light, and hurricane-force winds left a trail of destruction in southern Austria. ISSB to include GRI and ESRS in IFRS S1 sources of guidance; . As a result, businesses and their stakeholders will continue to have limited ability to make truly informed resource allocation decisions. The law governing investment fiduciaries is evolving to make it clear that fiduciary obligations permitor even requirebeta management. This is known as the single-materiality approach, as opposed to a double-materiality approach that considers impact both ways. The compliance burden for companies will be high but for investors with multiple companies to monitor, the information burden will be even higher. It suggests that corporate activity that threatens critical systems is not material if that activity does not threaten enterprise value at the company in question. 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. 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. Global Leader, Public Policy & Regulation, PwC United Kingdom, Director of Investor Engagement, PwC United Kingdom. EFRAGs definition of double materiality encompasses an inward element (effects on the company from external sources) and an outward element (effects the company has on externalities). Given the ISSBs potential to influence voluntary and mandatory sustainability reporting expectations, companies may wish to consider using its standards to help inform their sustainability disclosure strategy. EFRAG refers to impacts on people and the environment [that] may be considered pre-financial in the sense that they may become material for financial reporting purposes over time. It means prioritising the long-term, absolute returns for universal owners, including real-term financial and welfare outcomes for beneficiaries more broadly. We thank Paisley Ashton-Holt, Tom Beagent, Henry Daubeney, Will Evison, Alan McGill, Andreas Ohl, Atul Patel, Naomi Rigby and Katie Woods for their insightful contributions to this article. 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. But double materiality adds inside-out information, namely, information relevant to the companys impacts on society and the environment. Their primary obligation is to protect the financial interests of their beneficiaries and clients by protecting and growing their investment portfolios. A market price also factors in todays expectations about any potential implications that, at some future point in time, might affect a companys legal or regulatory situation (even if only by association). outside-in materiality - or ESG reporting as it is most commonly adopted today), to also disclose the impact of those same companies on society and the environment (i.e . As dynamic materiality makes these relevant to investors, the ISSB can then take over responsibility for the . 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. 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. 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. "Enterprise value is a backward-looking, lagging indicator," it said, adding that . A consultation paper on the SDR is expected in the second quarter of 2022.. Diversified shareholders will internalize the costs of this negative-sum behavior through the economic harm the rest of their portfolios absorb. These institutions cannot simply subordinate financial returns to concern for workers lives or the environment. What has the Net Zero Asset Owner Alliance actually said about carbon offsets? Furthermore, the Global Reporting Initiative (GRI) which provides standards for companies to disclose their environmental and social impacts to a broader set of stakeholders than investors and is the most widely used disclosure system globally has pledged to coordinate its future standard-setting activities with those of the ISSB to provide two pillars of international sustainability reporting. But it does not tell shareholders how to use this data to value securities: the user provides that context. 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. Thats why we were created. The following chart sums up the four possible uses of data for which the ISSB might be optimized: As investors have become more cognizant of the importance of corporate impact on society and the environment, disclosure standards proliferated, making it difficult to compare the impact of companies that report on different standards. 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. Changes in the reserve would flow into the statement of comprehensive income and then through the statement of changes in equity. The ISSB documentation expressly rejects double materiality, the standard European regulators embrace, which couples financial materiality with information designed to inform other stakeholder data. 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. This idea extended beyond security selection and included influencing corporate behavior by voting shares and engaging with management. EFRAGs proposed standard only asks that companies break the shackles of certainty and short-term thinking to report on the things that they are likely already or should be factoring into their business planning anyway. He says: The first is a provision for the cost of closing the existing carbon-based business. Companies occasionally need to report new information and markets need to work out how to digest it. All rights reserved. The ISSB's superpower may lie in illuminating issues that are emerging across the global markets for consideration by investors and the broader markets. The ISSB documentation does not addressor even acknowledgethe possibility of providing beta or non-financial investor information. For example, if climate change stays on the current trajectory, rather than aligning with the Paris Accords, GDP could be 10 percent less in 2050. As one work describes this, [a]ccording to widely accepted research, alpha [over- or under-performance of individual securities] is about one-tenth as important as beta [and] drives some 91 percent of the average portfolios return. Stephen Davis, Jon Lukomnik, and David Pitt-Watson,What They Do with Your Money(2016). 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. IFRS Advisory Council questions ISSB on future of SASB standards. They must do so again. Of course, there would be no need to decide between prioritizing E/S impact or financial return if business decisions that optimize one always optimized the other. [.] 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. 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. On March 31, 2022, the International Sustainability Standards Board (ISSB), an investor-focused initiative of the International Financial Reporting Standards (IFRS) Foundation, released long-anticipated drafts of its sustainability reporting standards: the General Requirements for Disclosure of Sustainability-Related Financial Information (the General Requirements Standard) and a Climate-Related Disclosures framework (the Climate Standard). However, there are nuances in the definitions which mean that companies may ultimately end up reporting broadly similar information under all three reporting frameworks. 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. Double materiality. We will not move. This reflected moral concern with profiting from suffering, rather than the use of investment to address a social issue. ISSB chair Emmanuel Faber has effectively ruled out the use of double materiality The board now expects to issue its climate-change standard next year Developments in the EU, US risk fragmenting the sustainability-reporting landscape Climate change denial has been a tough ask this summer. 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. PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. The International Sustainability Standards Board (ISSB) is analysing feedback to its consultation on two proposed standards and will consider how to respond to stakeholder comments on topics such as enterprise value and materiality, the head of the IFRS Foundation said. See Thomas C. Schelling, On the Ecology of Micromotives, 25 Pub. But the context for beta-relevant data is such that an enterprise value-based E/S disclosure regime may in many cases be very close to good enough for beta as well. Because the ISSB and SEC approaches focus solely on the effects to the future cash flows of the company, critics complain that it does not take into account certain negative impacts the company might have on the environment and society because those impacts have no calculable effect on its value. The ISSB drafters should recognize the risk that excluding beta could, at the margins, lead to the omission of decision-critical information for investors concerned with company impact on social and environmental systems that support other portfolio companies. No business has a crystal ball and the provision of forward-looking information will inevitably mean that certain items, incidents and events are missed. Enterprise value is a global concept and is the market value of a companys shares and the market value of its debt. Although the TCFDs recommendations are specific to climate-related risks and opportunities, the ISSBs General Requirements Standard advises that this approach be applied to all sustainability issues that could impact enterprise value, such as those posed by social or nature-related issues. Whatever the aim, they missed. 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