Navigating materiality

In the evolving landscape of sustainability reporting, materiality has emerged as a cornerstone concept, particularly within the framework of the International Financial Reporting Standards (IFRS) Sustainability Standards (IFRS S1: General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2: Climate-related Disclosures).

IFRS S1 and S2 are pivotal standards that guide companies in disclosing information about sustainability-related risks and opportunities as well as risk and opportunities related to climate that could reasonably be expected to affect the entity’s prospects. Understanding and effectively applying materiality in this context ensures stakeholders receive relevant and reliable information, fostering transparency and accountability.

Under IFRS Sustainability Standards, materiality is defined consistently with the IFRS Accounting Standards definition. Information about sustainability-related risks and opportunities is material if omitting, misstating, or obscuring that information could reasonably be expected to influence decisions that primary users of general-purpose financial reports make on the basis of those reports, which include financial statements and sustainability-related financial disclosures and which provide information about a specific reporting entity. [IFRS S1, para 18]

In applying the above definition, the decisions of primary users relate to providing resources to the entity and involve decisions about buying, selling, or holding equity and debt instruments, providing or selling loans and other forms of credit, or exercising rights to vote on, or otherwise influence, the entity’s management’s actions that affect the use of the entity’s economic resources. [IFRS S1, para B14]

Whilst the definition of materiality is consistent with IFRS Accounting Standards, how that materiality is determined and applied can be different.

The definition and application of materiality under IFRS Sustainability Disclosure Standards differ from those under other existing sustainability frameworks and standards in several ways:

1. Financial materiality perspective: Different existing sustainability reporting frameworks such as the Global Reporting Initiative (GRI) or the European Sustainability Reporting Standards (ESRS), use different definitions of materiality. Under ESRS a ‘double materiality’ approach is required that focuses on both financial materiality and ‘impact materiality’. Impact materiality requires an ‘inward-out’ approach where entities must consider how their actions could impact, and be material to, a broad range of stakeholders.
2. Investor-centric focus: The IFRS Sustainability Standards prioritize the information needs of primary users, particularly investors, lenders, and other creditors. While other frameworks, such as the Global Reporting Initiative (GRI), may place equal emphasis on a wider array of stakeholders, including communities and employees, the IFRS Sustainability Standards are specifically designed to meet common information needs of primary users of an entity’s financial report.
3. Specificity and guidance: IFRS S1 and S2 provide specific guidelines and requirements for reporting climate and sustainability-related risks and opportunities. This contrasts with some other frameworks, which may offer more general principles and less prescriptive guidance. The specificity of the IFRS Sustainability Disclosure Standards helps ensure consistency and comparability across companies and industries.

The definition and guidance for materiality is within IFRS S1, but it is applied across both IFRS S1 and S2. Within IFRS S1, for example, there are a few ways this is defined:

1. An entity need not disclose immaterial information even if it is part of minimum requirements.
2. An entity shall disclose additional information when compliance with the specifically applicable requirements in an IFRS Sustainability Disclosure Standard is insufficient to enable primary users to assess the effects of sustainability-related risks and opportunities on the entity’s prospects.
3. An entity shall not obscure material information.

Whilst IFRS S2 is specific to climate-related disclosures, its objective is still to provide information on climate-related risks and opportunities that is useful to primary users of general-purpose financial reports, and that could reasonably be expected to affect the entity’s cash flows, its access to finance or cost of capital over the short, medium, or long term. [IFRS S2 para 1 and 2]

Given the pervasive and broad-ranging impact of climate, it is expected that many organizations will provide the disclosures required by IFRS S2.  However, the scope of the standard still explicitly incorporates materiality and states that ‘climate-related risks and opportunities that could not reasonably be expected to affect an entity’s prospects are outside the scope of this Standard’. [IFRS S2 para 4]

The impact of effectively applying materiality under IFRS Sustainability Disclosure Standards is multifaceted:

1. Enhanced stakeholder trust: Transparent and reliable sustainability disclosures build trust among stakeholders. Investors, in particular, gain confidence in the company’s ability to manage material sustainability-related risks and opportunities, which can positively influence investment decisions.
2. Improved risk management: By identifying and disclosing material sustainability issues, companies are better equipped to manage risks that could affect their long-term viability.
3. Competitive advantage: Companies that excel in sustainability reporting can differentiate themselves from their peers. Demonstrating a commitment to sustainability in the context of what is assessed as material can enhance a company’s reputation and attractiveness to customers, employees, and investors.

To effectively implement materiality in sustainability disclosures, management should consider the following actions:

1. Identify applicable reporting frameworks and establish a materiality assessment framework:  IFRS S1 and S2 are one reporting regime, however multi-national groups are likely to be affected by a range of sustainability reporting frameworks. Understanding the range of frameworks and their interoperability is crucial to developing efficient reporting processes. Then develop a robust framework for assessing materiality under relevant frameworks. If only the ISSB regime is relevant a financial materiality approach could be applicable, but in practice many organizations consider double materiality assessments to cover alternative frameworks and voluntary reporting.
2. Integrate sustainability into corporate strategy: Ensure that sustainability considerations are embedded into the company’s overall strategy and decision-making processes. This integration will facilitate the identification and management of material sustainability issues.
3. Invest in data management and reporting systems: Implement advanced data management and reporting systems to enhance the accuracy and reliability of sustainability disclosures. Utilize technology to streamline data collection, analysis, and reporting processes.
4. Provide training and resources: Equip management and employees with the necessary knowledge and resources to understand and apply materiality in sustainability reporting. This includes training on the IFRS Sustainability Disclosure Standards and best practices for sustainability reporting.

Materiality is a critical concept in the IFRS Sustainability Disclosure Standards, guiding companies in providing relevant and decision-useful sustainability information. By effectively identifying, managing, and reporting material sustainability issues, companies can enhance their transparency and accountability, ultimately supporting better decision-making by stakeholders. The evolving nature of sustainability challenges underscores the need for a dynamic and proactive approach to materiality in corporate reporting.