{"id":5486,"date":"2024-09-27T15:44:13","date_gmt":"2024-09-27T13:44:13","guid":{"rendered":"https:\/\/eaa-online.org\/arc\/?p=5486"},"modified":"2024-09-27T15:52:50","modified_gmt":"2024-09-27T13:52:50","slug":"double-materiality-and-esrs-issb-interoperability","status":"publish","type":"post","link":"https:\/\/eaa-online.org\/arc\/blog\/2024\/09\/27\/double-materiality-and-esrs-issb-interoperability\/","title":{"rendered":"Double Materiality and ESRS-ISSB Interoperability"},"content":{"rendered":"

Since EFRAG and the ISSB began developing their respective sets of sustainability reporting standards, we’ve been grappling with a question that we\u2019ve never really found a satisfying answer to (maybe we haven’t thought hard enough): On what grounds can a firm argue that a <\/strong>material impact<\/b><\/em> (\u201eI\u201c; <\/strong><\/span>only ESRS) that it has on people or the planet is NOT also a <\/span><\/strong>financially material risk or opportunity<\/span><\/b><\/em> (\u201eRO\u201c; <\/span><\/b>both ESRS and IFRS SDS<\/span><\/b>)?<\/span><\/b><\/span><\/p>\n

How does this relate to interoperability<\/em>? If no such argument can be made (i.e., if all impacts are\u00a0also ROs),<\/span>\u00a0<\/span>then interoperability between ESRS and IFRS SDS is perfect and the standards are symmetric<\/em>: compliance with one implies compliance with the other.<\/span> (Do we then need both sets of standards?) But if that scenario (material impact: yes\u2014material financial RO: no) does exist, then interoperability is only partial, due to asymmetric<\/em> standards<\/span><\/em>, where compliance with ESRS (double materiality) would imply compliance with IFRS SDS (financial materiality), but not vice versa<\/i>. <\/span><\/span><\/p>\n

One of us raised this question again during today\u2019s EAA online workshop with Richard Barker (ISSB) and Kerstin Lopatta (EFRAG SRB)<\/span><\/a>. Richard Barker provided a compelling answer. He pointed out that this very dilemma\u2014impact on people and the planet, but no corresponding financial materiality for investors\u2014is what defines an externality<\/em>: an action by a firm that affects the environment or society without financial consequences for the firm. As we all know, externalities do exist empirically. They are, after all, the main reason for the sustainability reporting conversation we are having, with climate change being the prime example of a large-scale externality due to market failure. Firms want to (and can, and do) argue that (some of) their societal and environmental impacts are not financially material, and in many cases, investors agree. So, thank you, Richard, for the much-needed clarity!<\/span><\/p>\n

But after the workshop, we began to wonder: What kind<\/em> of impacts can investors (and firms) safely view as financially immaterial when\u2014in a world of viral news, investigative journalists, and NGO campaigns\u2014almost any<\/i> impact can turn into a reputational crisis? A seemingly trivial environmental or social misstep can quickly escalate into consumer boycotts, loss of talent, strained supplier relationships, or regulatory pushback (e.g., Rana Plaza<\/a>\u00a0or <\/u>Exxon Valdez<\/span><\/a>)\u2014all of which investors will eventually factor into stock valuations. So, are investors deeming some impacts immaterial simply because (and only as long as) they aren\u2019t aware of them<\/em>? Is there even a perverse incentive to be (or stay) unaware\u2014because becoming aware via public disclosure will deflate the stock? Might asking for such disclosures trigger the very financial impact that incumbent investors have an incentive to avoid?<\/span><\/p>\n

We wonder: Shouldn’t disclosure requirements address this very gap\u2014by bringing information to light and ensuring that stakeholders, and eventually investors, recognize these impacts as financially material because they\u2019ve been revealed? Shouldn’t disclosure requirements aid investigative journalists, NGOs, and other societal actors\u2014and, ultimately, investors themselves\u2014in getting managers to disclose what they’d rather keep secret: their firms\u2018 negative externalities? And doesn’t it seem a design flaw of standards that managers themselves<\/em>, via the materiality assessment, get to second-guess what investors might find financially material\u2014ultimately getting to decide what they’d like to disclose? (Under ESRS, the double<\/em> materiality assessment at least forces managers to confront the impact materiality perspective explicitly.)<\/span><\/p>\n

In other words, shouldn\u2019t disclosure requirements aim to internalize externalities rather than just elicit what investors are already aware of? Shouldn\u2019t they flush out matters that become financial material only through their being disclosed<\/em>? In the extreme: Can a standard setter add value by giving investors information that we know<\/i> they consider financially material because they already have it and are acting on it? Or should it contribute to enriching investors\u2018 information sets by giving them access to information that they may<\/i> care about but currently cannot<\/i> because they are kept in the dark about it? <\/span><\/p>\n

To us, these considerations speak in favor of a low materiality threshold, and of allowing investors to decide for themselves if they care. Circling back to the above: There seem to be good reasons for aligning impact materiality and financial materiality to a near overlap. Why not adopt EFRAG\u2019s double materiality approach and let investors sort out for themselves which of the reported impacts they think affects firm value? And why not put the onus on management to explain why<\/i> they assume that a material impact of their firm on people and the planet would NOT cause investors to reconsider their firm\u2018s valuation if they knew about it? Should we allow managers alone to decide which matters are worthy of investors\u2018 attention?<\/span><\/p>\n

Consider this thought experiment. Assume Exxon learned about the dangers of human-caused greenhouse gas (GHG) emissions decades ago, as California Attorney General Rob Bonta insinuates in California’s lawsuit against Big Oil<\/a> for damages related to human-made climate change. Assume that there had been IFRS SDS at the time. Would Exxon then have had to disclose that fact (and its GHG emissions) as financially material? Would we have wanted them<\/i> to make that call? Or wouldn’t we have preferred forcing them to disclose their GHG emissions (and any other environmentally questionable practices)\u00a0and\u00a0letting<\/em><\/span>\u00a0investors decide<\/i> whether they consider them financial risks for Exxon, if only in the long run?\u00a0How about Big Tobacco and cancer risk?<\/span><\/p>\n

While Richard\u2018s thankfully answer clarified the issue conceptually, we believe important questions remain open, and we\u2019d love to hear your thoughts. Please share your comments below. And a big Thank You to the EAA for these incredibly insightful online workshops\u2014they bring together great speakers and thoughtful moderators on critical issues.<\/span><\/p>\n

Thorsten Sellhorn<\/a> and Victor Wagner<\/a><\/span><\/p>\n","protected":false},"excerpt":{"rendered":"

Since EFRAG and the ISSB began developing their respective sets of sustainability reporting standards, we’ve been grappling with a question that we\u2019ve never really found a satisfying answer to (maybe we haven’t thought hard enough): On what grounds can a firm argue that a material impact (\u201eI\u201c; only ESRS) that it has on people or […]<\/p>\n","protected":false},"author":46,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"ngg_post_thumbnail":0},"categories":[1],"tags":[],"acf":[],"yoast_head":"\nDouble Materiality and ESRS-ISSB Interoperability - ARC<\/title>\n<meta name=\"robots\" content=\"noindex, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Double Materiality and ESRS-ISSB Interoperability - ARC\" \/>\n<meta property=\"og:description\" content=\"Since EFRAG and the ISSB began developing their respective sets of sustainability reporting standards, we’ve been grappling with a question that we\u2019ve never really found a satisfying answer to (maybe we haven’t thought hard enough): On what grounds can a firm argue that a material impact (\u201eI\u201c; 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