Striking a balance: The importance of double materiality in sustainability reporting

The recent developments in standard-setting and policymaking hold profound implications for stakeholders worldwide. We agree with Dr. Nathan de Arriba-Sellier that the International Sustainability Standards Board (ISSB) “is sticking to a single materiality approach limited to financial risks and opportunities, rather than the more ambitious double materiality approach that is embedded in the EU’s Corporate Sustainability Reporting Directive (CSRD)”. Focusing on the underlying materiality definition – a crucial and heavily-debated cornerstone of sustainability disclosures and their standards – we aim to highlight some of the critical limitations associated with the narrower single materiality approach adopted by the ISSB. We base our arguments on scientific evidence – particularly, the findings of our current study.

Our findings highlight that a single materiality approach in sustainability reporting standards incentivises firms to focus on financially-material sustainability issues, while they neglect financially-immaterial ones. After the staggered releases of SASB’s industry-specific materiality indications between 2013 and 2016, we find that US firms improve their financially-material sustainability performance. However, we also convey that financially-immaterial sustainability performance declines in the post-release period. Accordingly, we conclude that a single materiality approach may inadvertently disadvantage and impose costs on stakeholders affected by financially-immaterial issues.

Importantly, our study’s insights are applicable to the context of the ISSB and its approach to materiality, as we investigate the effect of the SASB standards, whose materiality indications provide the basis of the ISSB’s materiality indications. In the following, we highlight three key reasons why our study’s findings should not be overlooked:

Single materiality is used as a synonym for financial materiality, which classifies sustainability issues as material only if they (potentially) influence a firm’s financial performance. The ISSB’s conception of single materiality is based on the SASB standards, which were developed predominantly for the use of investors and classify a set of sustainability issues as either financially material or financially immaterial based on firms’ sector and industry affiliation.

First and foremost, our research points to the potential harm that a single materiality approach in sustainability reporting standards may impose on various stakeholder groups. Sustainability issues often have far-reaching consequences on the lives of individuals, communities, and the planet as a whole. Neglecting the impacts of financially-immaterial issues could lead to overlooking critical social and environmental concerns, undermining the very essence of sustainability reporting.

Secondly, investors increasingly have preferences that extend beyond just financial materiality. Nowadays, more investors are becoming attuned to firms’ broader impact on society and the environment. They embrace a multifaceted approach that encompasses social and environmental considerations alongside financial performance. This growing cohort of impact and socially-responsible investors seeks to align their portfolios with firms that demonstrate a genuine commitment to sustainability, beyond a mere profit-orientation. By narrowing the focus on financial materiality, the ISSB risks alienating this essential group of investors who play a pivotal role in shaping a more sustainable global economy.

Thirdly, the World Economic Forum recently discussed the concept of dynamic materiality. The concept highlights that sustainability topics, which are only material from an impact perspective, will eventually become financially-material in the near or far future. For example, carbon emissions were considered financially-immaterial information before the adoption of the Kyoto Protocol, but now they are at the core of current sustainability disclosure regulation debates and developments – and are now financially- material. As a result, investors might not be sufficiently informed about potential financial risks if firms’ sustainability disclosures are limited to what is currently perceived as financially-material information. Combined with the findings of our study, this becomes even more concerning. When firms tend to neglect impact-material sustainability topics under a single materiality approach, the potential risk of dynamic materiality is amplified and reinforced by pursuing it in policy decisions.

Consequently, if the ISSB standards remain restricted and focused on a single materiality definition they will reflect a materiality approach that differs substantially from that of the more comprehensive frameworks such as the CSRD. Thus, firms’ sustainability disclosures will not be comparable

internationally and create barriers to increased transparency. Following the most recent and expected policy developments, the ISSB’s approach to materiality will set the stage not only for climate, but also for non-climate sustainability reporting.

As the ISSB will take over the Task Force on Climate Related Financial Disclosures (TCFD) and is likely to pursue with biodiversity standards, we expect the same dynamic with the Taskforce on Nature-related Financial Disclosures (TNFD). The ISSB would have to expand their definition of materiality as the TNFD already stresses the “engagement with affected stakeholders” and “impact analysis”. The ISSB should see this as an opportunity to integrate the TNFD’s double materiality. By integrating double materiality considerations into the ISSB's sustainability standards, the ISSB would create a robust reporting regime that reflects the realities of our world today. It would decrease information asymmetries further and empower investors to make informed decisions aligned with their values and contribute to fostering a more equitable and sustainable future.

In conclusion, let us heed the call to action and prioritise the adoption of double materiality in sustainability reporting standards in general and within the ISSB standards in particular. This is because our findings demonstrate that single materiality fails to serve the interests of various stakeholders. We implore policymakers and standard-setters to take on the challenge with courage and conviction to pave the way for a sustainable and prosperous world that leaves no one behind.

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By Prof. Dr. Max Göttsche, Dr. Florian Habermann (Catholic University Eichstätt-Ingolstadt), Max Kolb (Nature and Biodiversity Conservation Union (NABU)), Prof. Dr. Frank Schiemann (University of Bamberg), Dr. Theresa Spandel and Max Tetteroo (Climate & Company)

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