

It would be a mistake for the IFRS Foundation not to embrace ‘double materiality’ as part of its evolving ESG standards setting process, argues Federated Hermes, the $46.9bn (€38.4bn) Anglo-American listed asset manager.
The principle of double materiality in corporate reporting would involve standards able to cover the impact of ESG factors in companies and investors, and vice versa, the impact of companies and investors in society, therefore encompassing the needs of other stakeholders.
In its response to a consultation on the role the IFRS Foundation could play in sustainability reporting, senior ESG figures at Federated Hermes, Ingrid Holmes and Bruce Duguid, said they do not agree with the proposed approach to materiality, initially focused on what is more relevant to investors.
Holmes and Duguid said: “Double-materiality considerations are key to setting effective and meaningful strategy at the company level. This would be a backward not a forward step, given the leadership role played by the European Commission on this issue.”
In line with the EU’s position, which might seek to set its own non-financial reporting standards in 2021, the European Securities and Markets Authority (ESMA) also responded to the IFRS Consultation suggesting that double materiality would be needed from the outset.
ESMA also wants the IFRS Foundation to expand the initial scope of the project and its associated Sustainability Standards Board (SSB) to include SDG-related issues. The preference of the IFRS Foundation is to build ESG standards starting from those related to climate risk.
“Double-materiality considerations are key to setting effective and meaningful strategy at the company level”
But some investors do not necessarily agree with this approach either, for example Canada’s C$119bn Alberta Investment Management Corporation (AIMCo). AIMCo said it would support a broader sustainability framework from the outset, covering a wide range of ESG factors, including climate risk.
“Climate change risks may be non-linear and unpredictable and virtually impossible to fully disaggregate. So too other fundamental risks such as social inequity or worker safety may be inherently linked to each other and to climate change vulnerability.”
AIMCo also said it supported an initial single materiality approach before transitioning to double materiality. It cautioned, however, that there will be overlap between the two concepts, particularly for investors focused on risk-adjusted returns over the long run.
“The IFRS should consider that the impact of business operations on the environment and surrounding communities will be important to a wider group of stakeholders, surrounding communities, and likely to the firm’s social license to operate,” AIMCo stated.
Seattle-based firm Russell Investments said that while there seems to be more global consensus on the topic of climate-related disclosures, existing initiatives such as the Sustainable Finance Disclosure Regulation (SFDR) in the EU or the frameworks of SASB and GRI, are moving beyond climate.
Russell stated: “Focusing solely on climate is likely to lead to IFRS standards addressing only a fraction of the need that already exists. Rather than focusing on climate as the guiding principle, we would emphasize a focus on decision relevant sustainability factors (with allowance for what is material for a company to vary by industry).”
Likewise Eurosif, the European forum for sustainable investment, said it favours a holistic approach towards reporting of ESG issues, particularly drawing from the lessons of the COVID-19 pandemic.
It said: “Acknowledging that the measurement and reporting of climate factors is more advanced at the moment, SSB could start working at a different pace and level of detail in the three dimensions of sustainability. The fact that social issues are less advanced in terms of measuring and reporting means that more efforts should be put on this side.“
Eurosif also disagreed with the approach taken by the IFRS Foundation on materiality. “It is vital from the start to make clear that the scope and end goal of the SSB is to adhere to financial as well as environmental and social materiality (‘double materiality’).”
Also from the heart of the EU, the Dutch central bank took issue with the current approach to materiality. The DNB said: “We doubt that a clear distinction can be made between information that is solely about the impact of a company on the environment and information that is solely about how a company is affected by environmental challenges.”
The central bank said that both environmental and social challenges may expose financial institutions to risks, the management of which it should examine as a supervisor. For example, risks caused by biodiversity loss, water stress, scarcity of resources and human rights controversies.
The DNB however understands why the IFRS Foundation is initially prioritising climate-related risk, given its urgency, but it noted that biodiversity loss should come immediately after that.
“Because of the material exposures financial institutions have to risks resulting from biodiversity loss, it is considered to be one of the greatest risks to society and the economy.”
Australia’s AU$79bn government owned investment manager, Queensland Investment Corporation (QIC), however, backed the IFRS Foundation’s approach to avoid “getting mired in the complexity of double materiality” as otherwise it could risk delaying the whole project.
QIC said: “We support the gradualist approach focussing initially on those sustainability metrics most relevant to investors and other market participants. Once the climate-related metrics have been developed then broader environmental, social and governance factors should be addressed.”
Support, although more nuanced, came from Norges Bank Investment Management which said that climate comes first “but not at the expense of other topics”.
The European Fund and Asset Management Association (EFAMA) also supported a “climate-first” approach and observed that “a full-fledged double-materiality approach” may add complexity to the task and potentially impact or delay the adoption of the standards.
EFAMA, however, said: “The work that is already being carried out in the EU should set solid foundations to the process of integrating double materiality in a global standard.”
Similarly, former central banker Mark Carney, now UN Special Envoy for Climate Action and Finance, distinguished two building blocks for the standard-setting work ahead.
A first foundational layer focused on climate disclosure “before broadening out to cover wider sustainability factors” as he believes market demand and public policy imperatives are most acute regarding climate.
After that, a second global ‘building block’ of standards can be explored for global convergence on wider impact reporting.
Carney, however, noted that not all jurisdictions have the same requirements and priorities.
“For instance, in the European Union, non-financial reporting is needed to derive specific information to allow companies, asset owners and asset managers to report against legally binding Taxonomy and Sustainable Financial Disclosure Regulations.
He added: “Conversely, some jurisdictions might be unwilling to implement disclosure requirements relating to sustainability impacts at all.”