Materiality misalignment: Growing concerns around SFDR-ESRS workability  

Concerns are mounting around how investors should tackle their mandatory EU disclosure requirements on topics their investee companies may deem non-material under the bloc’s new corporate sustainability reporting rules.

The European Commission last week adopted the first set of European Sustainability Reporting Standards (ESRS).

Almost all disclosures under the new rules will be subject to materiality assessments. Investors have, as previously reported, voiced concerns this will make it challenging for them to meet their own mandatory disclosure requirements.

The first ESRS proposal by standard setter EFRAG, published last year, said all reporting indicators stemming from other EU regulation – such as the Sustainable Finance Disclosure Regulation (SFDR) – would be mandatory.

Crucially, EFRAG had endeavoured to make sure that all principal adverse impact (PAI) indicators in the SFDR would be covered by the proposed corporate disclosure requirements – but these are now also subject to materiality assessments.

The commission attempted to shed more light on the perceived misalignment between investor and corporate disclosure rules in the final ESRS rules last week.

The delegated act says that if a company concludes that a data point deriving from the SFDR is not material “it shall explicitly state that the data point in question is not material” rather than reporting no information. In addition, companies will have to provide a table with all such data points.

Furthermore, in a Q&A section accompanying the release of the standards, the commission said: “Financial market participants and financial advisers may assume that any indicator reported as non-material by an investee company does not contribute to the corresponding indicator of principal adverse impacts in the context of the SFDR disclosures.”

It added that further clarifications will be provided for each respective sustainable finance regulatory framework, including the SFDR, on the approach to be taken when a company has assessed a data point derived from another regulation and stated it is non-material.

Investor reaction

German investor industry association BVI said the commission’s comments are helpful as a first step, but do not per se alleviate the corresponding investor obligations under the SFDR in terms of obtaining and reporting data on PAIs. It called for further guidance on PAI due diligence and reporting.

A corporate reporting manager at a large auditing firm told Responsible Investor that receiving “the explicit information that the information is not material” from an investee company is more helpful to investors for their SFDR disclosures than potentially not having any disclosure at all.

“I would assume that in this case, the financial market participant can neglect the indicator in their own disclosures,” they said.

But they emphasised that more clarity is needed as the SFDR “does not know a materiality concept”. “Financial market participants, so far, should make their best effort in order to receive the data – so, we would have a data gap or misalignment between the two regulations,” they added.

Two industry participants told RI they believed the commission was trying to show asset managers it had listened to their concerns, without changing its position on materiality.

The first person said it is unlikely, at a first glance, to make a big difference and that more guidance is needed.

The second said the idea that investors can omit disclosures on a data point an investee company reports as non-material “is really weird from a legal perspective”.

As they noted, investors cannot assume that “if a company doesn’t find anything that’s material then there’s zero impact” and only report on the adverse impacts of companies that have reported their impact. “They’re just not the same thing, and it’s not how an investor would approach it.”

The corporate reporting manager echoed this, saying: “There is a risk that companies do not disclose information that [others] consider material.”

The perceived misalignment could add fuel to the emerging argument that SFDR reporting should also incorporate materiality assessments.

In a statement last week, a BVI spokesperson urged the commission to “revise the SFDR” to ensure financial market participants “only need to consider material sustainability risks and impacts”.

The association told RI that it will suggest the SFDR should also incorporate materiality assessments in the upcoming revision of the legislation, echoing views expressed by, for example, French bank BNP Paribas in the ESRS consultation in June.

Flagging disclosure requirements under the SFDR and Pillar III, BNP Paribas said: “We would therefore recommend that these disclosure requirements be amended as soon as possible to align with the ESRS materiality approach and allow the possibility for financial actors to exclude non-material information.”

The commission had not replied to a request for comment at the time of writing.