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). Notably, the ISSBs disclosure regime is predicated on an assessment of financial materiality. The ISSB will accept feedback on its General Requirements and Climate Standards until July 29, 2022, and will incorporate the comments it receives into its final sustainability reporting standards, expected by the end of 2022. 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. > ISSB 2023 . These institutions cannot simply subordinate financial returns to concern for workers lives or the environment. The draft standard also introduces the concept of dynamic materiality. The general understanding is that the ISSB will not incorporate what is called 'double materiality' - that is, it will focus largely on the impact of the changing climate on a company rather than on the impact of the company on the climate, as the assumption is this is what investors really care about. See Andrew Howard, SustainEx: Examining the Social Value of Corporate Activities (Schroders 2019). Green Finance Institute director tells Chatham House while MP support double materiality approach. 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. 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. 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. PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. However, Murphy has rejected this approach in favour of a model that compounds the future obligation because it is likely that the cost of deferring action to address environmental change will increase over time at a rate likely to significantly exceed any applicable discount rate that a reporting entity might choose. ISSB to include GRI and ESRS in IFRS S1 sources of guidance; . As unlikely as this proposition seems, the Business Roundtable, an organization composed of most major U.S. corporations CEOs, promotes this idea under the moniker stakeholder capitalism, and claims that if a company treats all its stakeholders well (which can be another way of saying it optimizes its E/S impact), it will also maximize its return to its shareholders over the long term: While we acknowledge that different stakeholders may have competing interests in the short term, it is important to recognize that the interests of all stakeholders are inseparable in the long term. Business Roundtable, Redefined Purpose of a Corporation: Welcoming the Debate (August 2019). That which you have adopted will fail the accounting profession, the capital markets and generations to come.. 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. Global Leader, Public Policy & Regulation, PwC United Kingdom, Director of Investor Engagement, PwC United Kingdom. The failure to even address beta-oriented disclosure is surprising because there is a growing emphasis on the need for diversified investors to monitor and steward the beta impact of portfolio company activity. CSRD explicitly requires double-materiality reporting and so vastly expands the scope of disclosure from considering only sustainability risks that companies face (i.e. The ISSB consultation responses show there is also wide support for the approach within the financial sector. Finally, from a rhetorical perspective, it is important that the final documentation of the ISSB standards acknowledge that investors have significant interests in beta impacts. 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. 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. Far from it, assured the ISSBs vice-chair, Sue Lloyd, during the ISSBs 21 September meeting: [F]or those listening, I think we need to be careful to be very clear that this isnt because we are not worrying about the comments that we received and the feedback that weve got. Thus, while individual companies can profitably externalize costs, a diversified investor will pay these costs through lowered return on their diversified portfolios. For example, an investor might conclude that a company can avoid reputational, regulatory, and supply chain risks by adopting better labor and energy practices. 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. The reason is that if a companys activities create the type of economic risk that threatens beta, it will almost surely be at risk for damaged reputation, increased regulation, and the increased costs that follow regulation. get as much direction as quickly as possible to really build on momentum.. We must focus on what unites us in agreement and we cannot afford for minor differences to get in the way of progress. The ISSB documentation expressly rejects double materiality, the standard European regulators embrace, which couples financial materiality with information designed to inform other stakeholder data. E/S information can travel three pathways to affect investors and a fourth to affect other stakeholders: ISSB embraces a single type of data. The last category of information is that which is relevant to stakeholders other than shareholders. Analysts will have to change their models to take into account new and essential information that companies consider material to their success and survival. However, there are nuances in the definitions which mean that companies may ultimately end up reporting broadly similar information under all three reporting frameworks. 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). The US Securities and Exchange Commission is also beavering away on its own climate-reporting proposals. They must do so again. Companies are advised to monitor the continued development of the exposure drafts and may wish to consider aligning future sustainability reporting with key components of the General Requirements Standard, including relying on company- and industry-appropriate standards such as those of SASB. union of two sets, not intersection) of impact materiality All rights reserved. There have long been investors who shunned sin stocksalcohol, tobacco, and gambling companies, for example. Ironically, as E/S investing became popular, more capital moved into these constrained fiduciary institutions. This, they say, would be a failure of the goals of sustainability reporting to influence corporate behaviour. This site uses cookies. But while an individual investor is free to satisfy ethical goals without regard to financial consequences, many investors, such as retirement and mutual funds, have fiduciary obligations to prioritize the interests of their beneficiaries. This cost was more than 50 percent of the profits those companies reported. Taking IAS 37 as a starting point is not as simple as it might seem. 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. 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 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. At a high level, the ISSB aims to help companies streamline their sustainability disclosures to facilitate an apples to apples comparison by investors. The law governing investment fiduciaries is evolving to make it clear that fiduciary obligations permitor even requirebeta management. 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. Changes in the reserve would flow into the statement of comprehensive income and then through the statement of changes in equity. And, on the surface, this could threaten progress towards global alignment. 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. In 2021, SASB and the Integrated Reporting Framework combined to form the Value Reporting Foundation, which, alongside the CDSB, will fold into the ISSB by June 2022. Challenges for the adoption of the ISSB standards; ISSB a driver for change or a compliance exercise? Sustainability reporting standards promise to do the same. 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 ISSB and EU bodies are collaborating to create an interoperability mapping table to highlight the intersection.The key challenge here is to maximise the content in the intersection and avoid having similar requirements that are excluded from the intersection because they are subtly different. 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. The ISSB documentation expressly rejects "double materiality," the standard European regulators embrace, which couples financial materiality with information designed to inform other stakeholder data. 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). 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. Because negative externalities burden the economy and beta. 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. 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. EFRAG's work is rooted in double materiality and Faber said the ISSB is "embracing [this approach] when it comes to looking at all the impacts, significant impact that companies are going to have on their ecosystem. ESG metrics will typically say something like, companies in X industry often hire low-wage workers in countries with poor regulatory schemes; this can expose them to reputational risk and cost increases over the long term and perhaps increased regulation and enforcement or fuel prices are subject to rapid change and efficiency measures can limit future costs. Accordingly, the disclosure line items will require the company to describe the programs and standards in place to assure workers are not being abused, its record in meeting such standards and relevant legal requirements, its plans to reduce fuel use, etc. This can impair broader economic returns when such regulation hinders the development of other, more economic companies or sectors. This means that beta information is decision-useful, and thus comes within the broad parameters established in the General Requirements. Adding beta information to the ISSB reporting standard would not significantly enlarge the reporting requirement because any company conduct that threatens or benefits beta is likely to create corresponding regulatory and reputational risks and benefits to enterprise value, so that most beta information should be deemed material even under a putative ESG standard. E/S information that does not affect investors, but is relevant to the impact companies have on civil society and stakeholders other than investors (stakeholder data). Before discussing the ISSB and the desirability of a sesquimateriality standard, we review several elements of E/S investing. But double materiality adds inside-out information, namely, information relevant to the companys impacts on society and the environment. CSRD""Double MaterialityFinancial MaterialityImpact Materiality . PRI, an investor initiative whose members have $121 trillion in assets under management, recognizes this need. Secondly, enterprise value, by definition, takes a market view and has a long-term perspective. 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. The planned agenda consultation has also been pushed back into next year. 1. 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. The recommendations of both the ISSB and the TCFD fall into four broad pillars governance, strategy, risk management, and metrics and targets corresponding to how the disclosing company approaches these four practices in the context of a given sustainability topic. One of the first parameters to be established must be the purpose of disclosure. For an overview of the SECs proposed climate rule and its implications, please refer to our March 24 Alert., 2. In the alternative double-materiality rubric, financial materiality is referred to as outside-in information, because it addresses how social and environmental matters affect the company. 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. Key focus areas include the Task Force on Climate-related Financial Disclosures, Materiality, and Carbon management. Please see www.pwc.com/structure for further details. 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. By Stephen BouvierNovember 2022 (Magazine). Diversification is specifically intended to minimise idiosyncratic impacts on portfolio performance. In such cases, E/S impact and financial return are integrated, as are disclosures with respect to each. 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. Climate change is an emergency that requires all hands on deck. This would be information of interest to NGOs, governments, and citizens who wanted to understand companies impact on the world. Take the example of an estimated sustainability cost of 66m (75m). Putting businesses on the path to a low carbon economy will require access to funding throughout the transition. 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. 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