As all readers are doubtless aware, the International Sustainability Standards Board has issued its first two exposure drafts, General Sustainability-related Disclosures and Climate-related Disclosures, both open for comment until July 29, 2022.

At my usual pace of posting, I could likely devote this blog entirely for the next few years to the two exposure drafts and the reaction to them, to the exclusion of anything else (but don’t worry, there’ll still be the occasional eruption of bizarreness). For today, let’s briefly touch on what’s likely to be one of the main recurring issues. The exposure drafts define sustainability-related financial information as being material “if omitting, misstating or obscuring that information could reasonably be expected to influence decisions that the primary users of general purpose financial reporting make on the basis of that reporting, which provides information about a specific reporting entity.” This reflects the current wording in the IFRS conceptual framework. The basis for conclusions to the general disclosure document expands:

• materiality judgements about sustainability-related financial information will differ from those for general purpose financial statements. Notably, information about sustainability-related risks and opportunities is unconstrained by definitions of assets and liabilities and the criteria for recognition. To prepare sustainability-related financial information, it is expected that preparers will have to consider financial implications over longer time periods than those considered in preparing general purpose financial statements; preparers will also need to consider financial implications of interactions throughout their value chain. Materiality is assessed in relation to the effect of significant sustainability-related risks and opportunities on enterprise value.

For the purposes of the proposals, enterprise value is defined as ‘the total value of an entity’ and is ‘the sum of the value of the entity’s equity (market capitalization) and the value of the entity’s net debt.’ This value “reflects users’ assessments of future cash flows, including the value they attribute to those cash flows, reflecting the cost of capital. As such, the intent is certainly to cast a broad net. Inevitably though, the document concedes that “how the concept of materiality is interpreted, applied and enforced is likely to vary in each jurisdiction.” And however broad the net, it’s not as broad as would be imposed by a “double materiality” concept (as argued for by many), in which a company judges materiality both from the perspective of its own performance and position and value, and from that of the environmental and societal impact of its activities on a broad range of shareholders. Needless to say, many practical issues may arise in applying that “double materiality” concept.

The Accountability, Sustainability and Governance Research Group at the University of Bristol recently hosted an Academic Roundtable themed “The ISSB and the Materiality Debate” “to discuss academic views on the recent formation of the International Sustainability Standards Board (ISSB) and the debate around different conceptualizations of materiality.” The Organizing Committee of the event subsequently drafted an open letter to EFRAG and the IFRS Foundation.

The letter calls for:

• …the (ISSB and EFRAG) to acknowledge that an entity’s financial sustainability is interdependent with the sustainability of the planet and society. The underpinning argument here is that the “outside-in” materiality perspective (also referred to as “financial materiality”) is inherently interdependent with the “inside-out” materiality perspective (also referred to as “impact materiality”). An entity’s value-creation activities are unsustainable if they simultaneously produce negative social and environmental externalities especially where these contribute to surpassing social and planetary boundaries, as these externalities may have subsequent implications for the entity’s enterprise value over the short, medium, and long terms. Relatedly, an entity’s ability to effectively and substantively address their negative externalities (and create more positive externalities) is ultimately dependent on the transformation of their business model(s)….
• …a better articulation of the “dynamic” nature of the two materiality perspectives to understand how sustainability matters can come to be considered as financial dependencies, risks, and opportunities over time and in alignment with the scientific evidence monitoring the environmental sustainability and social well-being of our planet and its inhabitants. We believe that the conceptualization of financial and impact materiality perspectives as “dynamic” is more helpful than a “double-materiality” dichotomy which implies incommensurable differences.

Not being an academic myself, I’m not altogether sure to what extent that last point is semantic rather than substantial. Either way, the broad point I suppose (or part of it anyway) is that any narrowly-focused financially-driven approach to reporting in this area will be doomed, whether in terms of its ability to generate decision-useful information, or its broader credibility and contribution. But will all practitioners truly be capable of reporting to the standard that the “dynamic” concept implies, and will investors and other readers be capable of processing and acting on it for the greater good? Not in any kind of short term anyway. To that end, it’s relevant that the letter also expresses concerns “that the ISSB standards could unintentionally come to be perceived as a ‘global ceiling’ instead of acting as a ‘global baseline’, in the absence of a jurisdiction-led or market-led innovations to ensure that sustainability reporting remains progressive….”

The opinions expressed are solely those of the author