You know how one thing can lead to another? Well, that is what happened with the International Financial Reporting Standards Foundation’s steps into sustainability reporting. 

  • The boundary between financial and sustainability reporting has blurred
  • There is support for a Sustainability Standards Board
  • Materiality has emerged as a potential sticking point

The story begins in January 2019 with the five-yearly review by the trustees of their structure and effectiveness. This process established that it was increasingly hard to draw a line between corporate reporting and sustainability. In October 2019, the trustees set up a task force to further research the question. 

That research – a process of informal engagement with institutional investors, regulators and central banks – established that the issue of sustainability reporting was one of both growing importance and complexity. The sheer volume of organisations and interested parties who had carved out a niche in the sphere was evidence of that. The task force presented its preliminary assessment in February 2020 to the trustees, who in turn mandated the task force to consult stakeholders on the role the foundation could play in sustainability reporting.

That effort prompted the trustees to decide in June 2020 to consult through the medium of a discussion paper, on the demand among stakeholders for sustainability reporting and how the foundation might respond to that pressure. 

It is worth pausing to ask who might have an interest in sustainability reporting. Asset managers and institutional investors have a role to play. To start with, sustainability is a challenge for their clients, who face the task of deciphering a set of sometimes unreliable and poorly developed data and analysis frameworks.

At the other end of the spectrum, corporate issuers are struggling with those same fragmented reporting standards, which makes it hard to achieve comparability of sustainability disclosures. Indeed, corporates have moved into sustainability reporting through initiatives such as the Partnership for Carbon Accounting Financials. 

Meanwhile, central bankers are also interested, motivated by considerations such as financial stability and, more recently, green-finance. But it is the involvement of regulators – in particular the International Organization of Security Commissions – that could give the initiative the support needed at critical moments.

It is important not to overlook public policy. Some 189 nations have ratified the Paris Accord on climate change, while the UK, Denmark, France, New Zealand and Sweden have all set legally binding climate-change goals. Finally, the audit firms who sign off on accounts might have an important role to play in providing assurance to those relying on sustainability reporting. 

So amidst this collision of the foundation’s review of its strategic direction and effectiveness with growing pressure for action, the options boil down to doing nothing, facilitating existing sustainability objectives, or becoming a sustainability standard setter.

In response, the trustees proposed creating a Sustainability Standards Board (SSB) under the governance of the IFRS Foundation. This SSB would be responsible for developing and maintaining a global set of sustainability-reporting standards focused at first on climate-related risks. But rather than start with a blank sheet of paper, the thinking is instead to build on existing frameworks and standards.

The foundation published its proposals in September 2020 with a comment deadline of December. The purpose of the exercise was to gauge demand for a single set of globally recognised sustainability reporting standards with the foundation taking the lead as standard setter. The reaction across the 577 comment letters was more positive than even the trustees might have hoped. 

Constituents responded to the approach with an overwhelming ‘yes’. BlackRock wrote: “BlackRock strongly agrees that there is a need for a global set of internationally recognised sustainability reporting standards. With the increased awareness of the financial materiality of environmental, social and governance – collectively sustainability – factors to companies’ long-term performance and prosperity, investors and other stakeholders need a clearer picture of how companies are managing sustainability factors today and for the future.”

BlackRock had, if anything, helped to drive the push for an ordered approach to sustainability reporting. In January 2020, the firm’s chief executive officer Larry Fink noted that markets had started to price climate risk into the value of securities, a development which he said would “spark a fundamental reallocation of capital”. That momentum, he observed earlier this year, rather than faltering in the face of COVID-19, had in fact “accelerated even faster” than anticipated.

Sandra Peters, the CFA Institute’s global policy chief, also supported the establishment of a single sustainability rulemaker. She wrote: “Investors amongst others are, therefore, now calling for convergence and a single framework. Standardisation of metrics and disclosures on the effects of sustainability issues on a company’s present and future results is needed to bring consistency and comparability in sustainability reporting.”

One aspect of the foundation’s proposals that will require some soul searching is materiality. At present, IFRSs focus on financial materiality and treat information as material if leaving it out from an entity’s financial statements would influence investors’ decisions. IAS 1, Presentation of Financial Statements, defines information as material “if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general-purpose financial statements make on the basis of those financial statements which provide financial information about a specific reporting entity.”

Although some stakeholders believe that the foundation should extend this entity-focused view of materiality to its work on sustainability reporting, others think it should embrace the concept of double materiality. Double materiality has as its starting point the idea that a reporting entity should account for the impact of its activities on, for example, the wider environment to a broader range of stakeholders. 

The concept is not new and can be found in the EU’s Non-financial Reporting Directive. The directive treats financial materiality as information aimed primarily at investors, while environmental and social materiality looks beyond this to civil society, employees and consumers. 

Jonathan Labrey, the International Integrated Reporting Council’s (IIRC) global strategy lead, says this is the right approach. “We hope that the concept of dynamic materiality, developed last year by the global alliance of five framework and standards organisations, will gain traction.

“This approach develops the European concept of double materiality and embeds the idea of a filtering process aligned to the information needs of different stakeholders and over multiple time horizons – a much more realistic and relevant way of understanding what is material in a multi-faceted business environment.”

The IIRC is not the only voice with a track record in supporting a broader assessment of a business’s value and impact – beyond the financial – that supports a wider take on materiality.  

The Sustainability Accounting Standards Board urges in its comment letter: “As the Consultation Paper points out, the Trustees considered a more broadly defined perspective on materiality that would include an organisation’s significant impacts on the economy, environment, and people.

“This broader perspective on materiality is called “double materiality” [and we] agree with the Foundation’s conclusion that addressing double materiality would substantially increase the complexity of the SSB’s task as well as the time involved.”

How the IFRS Foundation and its trustees balance the pressure to act boldly on materiality with the “gradualist approach” set out in September 2020 remains to be seen.