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?
The EU has fully embraced the concepts of impact and resilience being the two sides of the same coin and has embedded double materiality in its sustainable agenda. Consequently, EFRAG, in designing its ESRS, has taken a double materiality approach.
The ISSB on the other hand went for a '1.5 materiality' or, to be more technical, a 'dynamic materiality' approach whereby 'impact disclosures' that don't currently affect the long-term value creation of the company are left out of the reporting, targeted at investors but will be included 'as soon as they impact the financial result'.
However, the approach hasn't convinced everyone.
"The attempt to bridge the gap on double materiality by calling it dynamic materiality doesn't really answer the question," Richard Howitt, former CEO of the IIRC, says. "It's a neat way of answering the criticisms and give the appearance of being consistent with the enterprise value creation approach. But in the end, if the dynamic materiality only means it comes into the finance books too late, that doesn't answer the question at all. That's a bit of a worry."
Donato Calace, VP of Innovation & Accounts at Datamaran and a member of EFRAG Expert Working Group on EU Sustainability Reporting Standards, asks: "Can you give me an example of an ESG issue that doesn't have a financial impact as well? There might be ESG issues for which we haven't understood yet the financial implications, but the implications are there. The financial accounting rules we have are not able to catch those implications just because they are externalities at this point."
Corporate Disclosures asked Sue Lloyd, vice chair of the ISSB, if she could give an example. She answered: "The reality is that this is dependent on the sector and individual characteristics of a business [...] In practical application, companies will have to justify to their investors why a specific sustainability risk is not material and be prepared to answer searching questions on how they reached this conclusion."
In a LinkedIn post, ISSB chair Emmanuel Faber went a bit further.
"It is not about being 'outside in', when others would be 'inside out'. We look at both directions as we start with requesting the identification of all significant sustainability risks and opportunities," he wrote. "But we only keep as part of our remit this information that is financially material, in other words, that can inform the assessment of enterprise value."
He took the example of carbon emission disclosures: "It would be hard to argue that this is an 'outside in' perspective, even more so when we include Scope 3 and financed emissions. But we propose to request those disclosures under the condition that this informs assessments of enterprise value."
What if the difference was only parochial?
Even if the ISSB and EFRAG standards tend to be opposed in debates on the issue, Calace says: "It may be that there is way more consensus than what was initially thought around these aspects and, although there is a bit of a tug of war on the label, maybe we don't need those debates."
He argues that the ISSB's draft standards, in particular ISS 1, have a number of references which are "essentially the language for a double materiality approach without saying 'double materiality.'"
"So, the ISS [International Sustainability Standards] sort of already embed the thinking that there are two directions of impacts. Maybe we don't need all these parochial debate about single or double materiality."
Accountancy Europe CEO, Olivier Boutellis-Taft says that while the debate between single and double materiality is interesting on a theoretical level, the urgency of the climate issue calls for pragmatism and that doesn't leave time for theoretical debates.
"My personal view is that pretty quickly things, that may not yet appear as financially material today, will be very soon," he says. "And at the end of the day, what does impact materiality do? It's going to highlight some of the externalities that the business creates, it will inform stakeholders but it is not going to integrate them in the pricing system so one could question how useful they will be to foster the transition that is required."
More pressing issues
Perhaps the only difference between the two set of standards, Calace continues, might be that the European ones clearly state that an entity needs to report an issue that has an impact on the environment and society.
"The ISS are a bit unclear because they say: 'we recognize that issues, that don't have yet financial implications, may develop that over time.' What do you do with that information? You call them, 'issues that are not yet material but could become material.' Do you report on these or not?"
"But for me it is more a matter of timeline rather than a matter of scope, although many frame it as a matter of scope," he adds.
Howitt shares this assessment, arguing that investors are increasingly saying they want impact information, "so you watch that investor demand make that difference over the next years".
For Calace, the main issue, rather than the different approach between EFRAG and the ISSB, is that many see the ESRS as too burdensome. "On the topic of materiality, the main issue is that they are equating materiality assessment to impact assessment, and that is not the same thing."
A company should conduct an impact assessment on issues that it knows is material, otherwise it would be an excessive burden, Calace says. "But the way the ESRS are structured right now, it is asking companies to conduct an impact assessment for all the topics that are in the standards, and also other potential topics that are not covered in the standards and then disclose the outcome of this impact assessment."