double materiality issb

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). In its October 2022 board meeting, the ISSB . Companies occasionally need to report new information and markets need to work out how to digest it. Diversified shareholders will internalize the costs of this negative-sum behavior through the economic harm the rest of their portfolios absorb. Pause on that figure: prioritization of individual company financial return leads to one third of all listed companies around the globe destroying more value for society than they create for their own shareholders. But it does not tell shareholders how to use this data to value securities: the user provides that context. E/S Information that impacts future cash flows from the company to investors and thus the value of the enterprise (ESG integration or just ESG). Double materiality 13 Double materiality is a concept which provides criteria for determination of whether a sustainability topic or information has to be included in the undertaking's sustainability report. Indeed, Institutional Shareholder Services, the worlds leading proxy adviser, recently announced it would do exactly that in its benchmark recommendation policy, treating a companys climate damage to the economy in parallel with damage to the enterprise. Once such a standard is established, failure to adhere will become a reputational and regulatory risk, so that the question of meeting that standard becomes financially material. ISSB has indicated it will consult with stakeholders on other sustainability topics later in 2022, potentially including water, biodiversity and social issues. Furthermore, the ISSB recommends that entities rely on industry-specific guidance for certain disclosures in addition to industry-agnostic general reporting guidance. The ISSB agreed to fully align its description of materiality with IFRS Accounting Standards. 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. 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. Green Finance Institute director tells Chatham House while MP support double materiality approach. But investors wont give companies a free pass and their patience will wear thin quickly if companies do not appear to take this reporting seriously. Take the comment letter from David Russell, the UK Universities Superannuation Schemes head of responsible investment. - 2023 PwC. The US Securities and Exchange Commission is also beavering away on its own climate-reporting proposals. Integration with Financial Reporting: Like the SECs proposed climate rule, the General Requirements Standard recommends that sustainability-related information be disclosed alongside an entitys general purpose financial reports as part of the ISSBs emphasis on the materiality of sustainability-related disclosures to investors. This is known as the single-materiality approach, as opposed to a double-materiality approach that considers impact both ways. All of this will edge companies closer towards a materiality assessment based on both the companys impact on the world around it as well as the potential effect on its enterprise value; in other words, and for all practical purposes, applying a double materiality concept. USS welcomed the ISSBs decision to build on the structure of the Task Force on Climate-Related Financial Disclosures (TCFD) recommendations in IFRS S1 and IFRS S2. What has the Net Zero Asset Owner Alliance actually said about carbon offsets? Another dynamic is the European Financial Reporting Advisory Group (EFRAG). Three big new sustainability reporting proposals from the US Securities and Exchange Commission (SEC), the European Financial Reporting Advisory Group (EFRAG), and the International Sustainability Standards Board (ISSB) promise to change how companies communicate sustainability information to their stakeholders. Thus, while individual companies can profitably externalize costs, a diversified investor will pay these costs through lowered return on their diversified portfolios. 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. Finally, a number of prominent global financial regulators including the SEC, the UK Financial Conduct Authority, the European Commission, the European Financial Reporting Advisory Group (EFRAG), the Japanese Financial Services Authority, the Sustainability Standards Board of Japan Preparation Committee and the Chinese Ministry of Finance have agreed to join a working group focused on compatibility between the ISSBs standards and new regulations. Thats where we aregoing. The net result for the [diversified] investor can be negative when the costs across the rest of the portfolio (or market/economy) outweigh the gains to the company; A company or sector securing regulation that favours its interests over others. Consequently, this low bar for materiality will mean that the initial volume of information companies may feel under pressure to report will be massive. Please see www.pwc.com/structure for further details. ESRSISSB . In such cases, E/S impact and financial return are integrated, as are disclosures with respect to each. Crisp thinking about the purpose of the disclosure leads to clearer understanding of the decision-critical nature of beta-relevant information. Although the ISSB does not provide specific guidance on where such disclosures must be made relative to general purpose financial reports, it emphasizes that sustainability-related information should be disclosed simultaneously with standard financial information and in as integrated a manner as possible. There have long been investors who shunned sin stocksalcohol, tobacco, and gambling companies, for example. Swiss Re Institute, The Economics of Climate Change: No Action Not an Option (April 2021). The ISSB intends to detail baseline requirements that ensure companies provide investors with a complete set of disclosures on sustainability risks and opportunities that could affect enterprise value, in order to complement the information provided in financial statements. Those subtle differences are time frame and taking a market (by definition, an outside) view. 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 Dig down to paragraph 85 of Agenda Paper 3B/4B from the ISSBs September meeting, and youll learn that the board will publish IFRS S1 and IFRS S2 as early as possible in 2023. So, in practical terms, the gulf is no gulf, but a gap. 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. 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 documentation does not addressor even acknowledgethe possibility of providing beta or non-financial investor information. Standard-setting International Sustainability Standards Board Consolidated organisations Why? The complex nature of the investment market, with some investors picking stocks for their portfolios and others being invested in index funds, means that companies have to cater to a massive array of information needs. They both support a materiality assessment based on the potential effect on the companys enterprise value. At a time when regulation alone seems increasingly inadequate to the task of addressing threats to the environment and our social fabric, an apparent retreat from a constructive market reform in a document as influential as the ISSB standards would be a serious setback. The return to such diversified investors chiefly depends upon beta, not the performance of individual companies. 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. Nevertheless, portfolio theorys prescription of diversification certainly suggests that widely held entities should give strong consideration to diversified investors interests. In light of the diversification mandate of Modern Portfolio Theory, and the importance of beta to diversified investors, this anachronistic hyper-focus on enterprise value is troubling. Principles for Responsible Investment & UNEP Finance Initiative, Universal Ownership: Why Environmental Externalities Matter to Institutional Investors, Appendix IV. And, in practice, a small one at that. 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. . 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. Just like any issue that can factor into the market price for a debt or equity security, sustainability issues can affect the likelihood, timing and amounts of potential cash inflows and outflows resulting from a companys activities over any time horizon. It is important to understand that ESG data are often provided without much context. The decision to leverage two well-established and tried and tested frameworks means less of a learning curve for corporates and investors. DWP sets up Taskforce on Social Factors for UK pensions industry, Threefold rise in asset managers holding board responsible for ESG, Accounting: Long-haul climate change reporting, Print advertising rates and specifications, Digital advertising technical specifications (pdf), Standard Terms and Conditions for Event Sponsors, 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. Ensure that the drafters of the ISSB keep front of mind the fact that most of the investors for whom ISSB is being created are diversified. 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. 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. Sustainability and accounting specialist with a particular interest in assessing and quantifying sustainability risks and opportunities, and in particular climate-related risks and opportunities. The ISSBs collaboration agreement with GRI further bridges the gap; a no gaps, no overlaps approach gives a holistic picture of sustainability performance on the basis of both impact and enterprise value. For all the reasons discussed in Section A.4, diversified investors have a financial need to know whether portfolio companies are externalizing social and environmental costs. Of course, a company may make the judgment that it can get away with a certain amount of cost externalization, so that corporate managers may make business judgments that financial return can be maximized without optimizing social value. The doom loop was complete when falling river levels left Frances nuclear power plants battling to produce enough energy to meet the demand for cooling. Companies will finally have clear instructions on how to report on their sustainability impacts, risks, and opportunities, and investors and other stakeholders will be able to better track progress, compare performance, and hold companies to account. 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. Challenges for the adoption of the ISSB standards; ISSB a driver for change or a compliance exercise? 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. Many of the comment letters on both standards are broadly supportive, but there were some niggles among the praise. The ISSBs and SECs definitions of materiality are not far off from this. 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. We will not move. 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. "Enterprise value is a backward-looking, lagging indicator," it said, adding that . Companies and investors have, in the past and on other topics, risen to the challenge. For example, if a company is using water at an unsustainable rate, this would have to be reported as a long-term risk to cash flows, just as it would be under EFRAGs approach. Despite all the talk of urgency from IOSCO, the climate-change standard will not be in place until next year. The application of 'double materiality' has always been a central theme for GRI since its inception, largely due to the fact that its development is based on a multi-stakeholder approach, in which trade unions and civil society groups hold significant influence. The ISSB documentation expressly rejects "double materiality," the standard European regulators embrace, which couples financial materiality with information designed to inform other stakeholder data. 685 1784 92. Such a standard, rising above a single focus on financial materiality but rooted in investor return, would not rise to the level of double materiality, and might best be described as sesquimateriality.. Yet diversified portfolios remain exposed to nondiversifiable risks, for example where declining environmental or social sustainability undermines the performance of whole markets or sectors Indeed, for investors who are likely to hold diversified portfolios in the long-term, the question is particularly pressing since these are likely to be the main ways in which they may be able to make a difference. Ruchir Agarwal and Gita Gopinath, A Proposal to End the COVID-19 Pandemic, IMF Staff Discussion Note (May 2021). The publication of these two draft standards represents a potentially significant step toward the coalescence of voluntary corporate sustainability reporting frameworks and could influence mandatory disclosure regimes that are evolving in the U.S., UK and EU. 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). They threaten the functioning of the economic, financial and wider systems on which investment performance relies. By Nadja Picard, Gilly Lord and Hilary Eastman. This recognition that change at one firm can affect the value of other firms in the portfolio implies a new goal for activism: namely, to engineer a net gain for the portfolio, possibly by reducing negative externalities that one firm is imposing on other firms in the investors portfolio. Were taking that all very, very seriously. This includes activities that relate to other organisations in the value chain or in the sector if they could have potential consequences for the company itself. These phrases refer to the need for investors to pay more attention to the environmental and social (E/S) impacts of the businesses in which they invest. 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. "The focus should be on double materiality and not on enterprise value," the HSBC Bank (UK) Pension Scheme said in its submission to the ISSB. Though there are aspects of ISSBe.g. In the other camp sits EFRAG, which through the EU Corporate Sustainability Reporting Directive (CSRD) seeks to implement a double materiality approach, a concept which encompasses financial materiality and impact materiality. Indicator, & quot ; it said, adding that this negative-sum behavior through the economic harm the of! Another dynamic is the European financial reporting Advisory Group ( EFRAG ) sustainability topics later in,! 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