As if “materiality” under the securities laws wasn’t a difficult enough concept, investors supporting various ESG frameworks and standards have been adding to the complexity. Responsible Investor published a short piece that summarizes comments submitted by six global asset managers on the IFRS 2020 Consultation on sustainability reporting. Unfortunately for those working on the company side, it means having to play “mix and match” with ESG reporting frameworks to try to satisfy multiple investor mandates.
To break it down, we have:
1. Traditional materiality, which relates matters that are directly linked to financial impacts from the viewpoint of the “reasonable investor”. As has been long established. traditional materiality focuses on financial risks TO the company. SASB takes this approach with its standards.
2. What I call “new materiality,” reflecting the perspective of stakeholders and impacts of a company. New materiality goes beyond a pure financial perspective and compels companies to evaluate their impact ON stakeholders and the communities in which they operate. This is the direction GRI takes in its reporting framework.
3. “Double materiality,” which encompasses both traditional and new materiality matters. Under the EU Non-Financial Reporting Directive (EU NFRD), companies are required to assess and report on both financial and non-financial matters. The European Financial Reporting Advisory Group (EFRAG), which advises the European Commission, follows the double materiality path.
4. “Dynamic materiality” – a concept acknowledging that materiality is a moving target, stemming from the idea that “stakeholders of companies have the capacity to determine what is material for a company” enabled by technology and social media. Some see this as similar to traditional materiality (in that as new information becomes known, it adds to what is important to investors in the total mix of information); others may liken it to The Blob of materiality.
Traditional Materiality: Financial Costs and Risks
This is using the old-school materiality lens (i.e., TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976)) to a company’s ESG matters. The archetypal approach would be to gather and evaluate input from a variety of corporate departments/functions to reflect the multidisciplinary nature of ESG. However, counsel should assess potential liabilities to disclosing as newly material an activity or matter that is itself not new. In other words, why was something not considered financially material previously? Given that the SEC issued guidance on climate change disclosures in 2010, some may question why climate matters were not disclosed in the past.
New Materiality: Non-Financial Impacts Beyond the Fenceline
The two critical elements of new materiality that radically differ from traditional materiality are:
– Assessment and consideration of things that don’t directly affect corporate finances, or may be contingent/not estimable.
– Assessment and consideration of external stakeholders beyond investors. There is a hidden recursive double-whammy here as it requires understanding both what information external stakeholders consider important, and how the stakeholders will react (which rather depends on the extent and nature of the information made available to them).
A good overview of new materiality is here.
Double Materiality: What Does Commissioner Peirce Think?
Acting Corp Fin Director John Coates suggested last month that global comparability would be a desirable thing for ESG reporting. Although he laid out some advantages to doing that, it doesn’t seem like people are rushing to embrace the idea. SEC Commissioner Hester Peirce made a statement last week to caution against a move toward global sustainability reporting framework. In particular, she took issue with the “double materiality” – here’s an excerpt:
The European concept of “double materiality” has no analogue in our regulatory scheme and the addition of specific ESG metrics, responsive to the wide-ranging interests of a broad set of “stakeholders,” would mark a departure from these fundamental aspects of our disclosure framework. The strength of our capital markets can be traced in part to our investor-focused disclosure rules and I worry about the implications a stakeholder-focused disclosure regime would have. Such a regime would likely expand the jurisdictional reach of the Commission, impose new costs on public companies, decrease the attractiveness of our capital markets, distort the allocation of capital, and undermine the role of shareholders in corporate governance.
Let us rethink the path we are taking before it is too late.
Dynamic Materiality: “Anything You Say Can and Will Be Held Against You”
The idea of dynamic materiality has potential significant legal uncertainty and complexity, but may also be an accurate reflection of where things stand today. As John pointed out a couple weeks ago, what is “material” took a recent odd (perhaps scary) turn when a supposed April Fool’s day joke by VW didn’t go as planned.
Richard Levick has long helped companies with crisis communication strategies (he also spoke on a webcast for us a couple years ago about “Politics as a Governance Risk” – even more relevant now). Richard recently wrote about companies being stuck between Scylla and Charybdis on responding to social issues of the day:
Brand neutrality is dead… Political contributions have become the new supply chain liability. But so is your DEI, environmental footprint, labor practices and more.
In the past, companies feared consumer boycotts. Today, the speed, ubiquity and ease of global social media – combined with intangible assets (including brand value) making up 90% of current company market valuation – make reputational risk a material matter regardless of which materiality you choose. And that could make an argument validating dynamic materiality.
– Lawrence Heim