Additionally, what is material and who is a stakeholder will likely change based on country and culture so evaluation of impact and consideration of materiality will require sifting, analysis, and assessing tradeoffs. The law governing investment fiduciaries is evolving to make it clear that their fiduciary obligations permitor even requirebeta management. No business has a crystal ball and the provision of forward-looking information will inevitably mean that certain items, incidents and events are missed. For similar reasons, Professor John Coffee predicted in a recent article that beta would surpass ESG integration as a motive for investor activism: This latter form of activism [beta focused] is less interested in whether the target firms stock price rises (or falls) than in whether the activist investors engagement with the target causes the total value of this investors portfolio to rise (which means that the gains to the other stocks in the portfolio exceed any loss to the target stock). So, in practical terms, the gulf is no gulf, but a gap. Financial materiality is in line with current U.S. disclosure rules. Taking a market view adds an element of objectivity to the materiality assessment. In addition to potentially helping to drive convergence of voluntary sustainability disclosure standards, the ISSB could also play a role in the evolving regulatory shift from voluntary to mandatory sustainability reporting, again potentially helping to drive global compatibility among corporate disclosures. The law governing investment fiduciaries is evolving to make it clear that fiduciary obligations permitor even requirebeta management. Whats material depends on the issue, the context, the time frame and the stakeholder. Similarly, they might be willing to sacrifice portfolio return if it meant a healthier environment in which to enjoy their retirement, or if doing so would relieve others suffering. 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. By Nadja Picard, Gilly Lord and Hilary Eastman. 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. 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. That is why we attempt to regulate companies: the choices that are best from an individual company financial perspective are not always best for society and the environment. Thus, while individual companies can profitably externalize costs, a diversified investor will pay these costs through lowered return on their diversified portfolios. Hard choices must be made. On 3 November 2021, at COP26, the IFRS Foundation Trustees announced the creation of the International Sustainability Standards Board (ISSB). Centrality of TCFD and SASB: As described above, the ISSBs General Requirements Standard centers on the four pillars of the TCFD framework, which are geared toward integrating sustainability risk assessment into the core processes of a companys business, as well as the industry-specific disclosures outlined by the SASB Standards. In the one camp, broadly speaking, sit the SEC and the ISSB. These are difficult issues to report on, rife with judgement, and companies do not yet feel safe doing it especially when it comes to enforcement. Why? None of these practical difficulties, however, ought to derail efforts to align. 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. For purely financial information, the standard must elicit the financial metrics and qualitative descriptions that investors use to model value. Enterprise value is a global concept and is the market value of a companys shares and the market value of its debt. As important as these two categories of impact may be, they are likely to be more heterogeneous than shareholder interests in beta, making them less likely to be good candidates for standardized disclosure. A market price also factors in todays expectations about any potential implications that, at some future point in time, might affect a companys legal or regulatory situation (even if only by association). The Statement of Intent to Work Together Towards Comprehensive Corporate Reporting co-authored by five important standard setting organizations, was a 2020 document that was an important step towards the ISSB process; it describes inside-out information as being targeted at: various users with various objectives who want to understand the enterprises positive and negative contributions to sustainable development [in contrast to enterprise value information targeted] [s]pecifically to the sub-set of those users whose primary objective is to improve economic decisions. The General Requirements Standard recommends that companies disclose material sustainability-related information, defined as information that could reasonably be expected to influence primary users assessments of an entitys enterprise value, with the responsibility for the materiality assessment resting on the reporting entity. 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. The ISSBs and SECs definitions of materiality are not far off from this. In this second article in our series on the sustainability reporting landscape, we aim to illustrate that this division neednt be so deep, or at least neednt derail progress towards achieving globally aligned standards. "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. 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. Central to the debate on global alignment is the concept of materiality, which is critical to determining what gets reported. The following chart sums up the four possible uses of data for which the ISSB might be optimized: As investors have become more cognizant of the importance of corporate impact on society and the environment, disclosure standards proliferated, making it difficult to compare the impact of companies that report on different standards. 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. The growing importance of this field is evident in the creation of the International Sustainability Standards Board (the ISSB) to establish uniform E/S disclosure standards that companies around the world will use to report to investors. . ISSB releases draft definition of 'sustainability' for new reporting framework The decision does not, however, change the ISSB's decision to focus on single materiality as opposed to double materiality. Furthermore, the ISSB recommends that entities rely on industry-specific guidance for certain disclosures in addition to industry-agnostic general reporting guidance. Thus, diversified shareholders internalize E/S costs that individual companies can profitably externalize: This is a trade. For workers who are beneficiaries of many retirement plans, employment may be the most important financial asset. A group of 86 global CFOs and institutional investors, representing 620bn in assets, criticised the ISSB for not adopting the double materiality approach which would require companies to report on the impact of their activities on the environment regardless of its relevance to enterprise value. CSRD explicitly requires double-materiality reporting and so vastly expands the scope of disclosure from considering only sustainability risks that companies face (i.e. Many of the comment letters on both standards are broadly supportive, but there were some niggles among the praise. A consultation paper on the SDR is expected in the second quarter of 2022.. 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 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. There have long been investors who shunned sin stocksalcohol, tobacco, and gambling companies, for example. In such cases, E/S impact and financial return are integrated, as are disclosures with respect to each. Secondly, although climate science makes some environment-related sustainability information relatively simple to calculate and put a value on, companies will find it a great deal harder to quantify and set the bar for materiality for social and governance issues and other environmental issues like biodiversity. 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). The Technical Readiness Working Group (the TRWG) recently released a set of recommendations for general requirements for the ISSB standards (the General Requirements) that addressed this question by defining what would be material for the standards overall. There are some other areas that need ironing out too before standard setters finish their work. [.] 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. Excluding beta information from the reporting standard does not reflect evolving recognition of the importance of beta. Take the example of an estimated sustainability cost of 66m (75m). Global Consumer Insights Pulse Survey - June 2022, Ukraine: Tax, Legal and People considerations. But this could also be reportable under the ISSBs and SECs rules, since community unrest might affect their licence to operate (and therefore their future cash flows) or injudicious extraction might lead to lawsuits for environmental degradation in 15 years time, again, affecting cash flows. So, for example, if a company is planning on extracting water at a rate that is not sustainable based on the volume of water available in the area, then this will certainly ultimately have an effect on their finances because in 15 years they will have run out of water to extract or they will have to invest money sooner in exploring alternate sources of extraction. The draft standard also introduces the concept of dynamic materiality. The EU can then "top up" these standards with those covering double materiality. Crisp thinking about the purpose of the disclosure leads to clearer understanding of the decision-critical nature of beta-relevant information. The ISSB was announced in . IFRS 13 is one standard that does refer to future amounts when it talks about valuation techniques that convert future amounts (such as cash flows or income and expenses) to a single current (discounted) amount. The General Requirements Background section described inside-out and financial materiality in the following paragraphs (a) and (b): (a) disclosures to stakeholders about sustainability matters that have impacts on people, the environment and the economythese disclosures normally provide the broadest range of information because they aim to meet the needs of multiple stakeholders. For example, if climate change stays on the current trajectory, rather than aligning with the Paris Accords, GDP could be 10 percent less in 2050. Given the real reputational and regulatory risk for companies that rely on externalized costs, those of us focused on beta impacts can do several things with the ISSB process. 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. (b) disclosures to investors, lenders and other creditors about sustainability matters that affect their assessment of enterprise valuethese disclosures enable investors, lenders and other creditors to understand the impacts that sustainability-related risks and opportunities have on the value, timing and certainty of the entitys future cash flows, over the short, medium and long term and therefore users assessment of enterprise value. Who shunned sin stocksalcohol, tobacco, and gambling companies, for.. Of 66m ( 75m ) fiduciaries is evolving to make it clear that fiduciary... A consultation paper on the SDR is expected in the one camp, broadly speaking, sit SEC. 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