27 September 2022

Touching the void [of sustainability reporting]

ISSB chair Emmanuel Faber reported from the 'frontline of the climate crisis' this summer as he posted a picture on his LinkedIn taken from the Col du Midi - a pass at 3,586m altitude in France's Mont Blanc massif.

"Col du Midi around 9:30 pm. Leaning against Mont Blanc, 'a room with a view' on the Grandes Jorasses, in the evening light. For how much longer?," the caption read. "It didn't even freeze last night on the glacier, at 3600m altitude. And on the massif, it hasn't frozen below 4500m this week. Climate emergency."

Source: Emmanuel Faber, LinkedIn

As is customary in the era of social media, this post was met with a number of criticisms mostly fuelled by the ISSB's 'reluctance' to utter the words "double materiality".

But are these criticisms justified? Ultimately the objective of both the international and European standards - on paper at least - is to contribute to better decision making and help the transition to a sustainable economy.

Some believe that only double materiality – considering the impact of environmental and societal externalities on a business as well as the business own impact on the environment and society – will achieve a move to a sustainable future. Other believe that single materiality – how a business is impacted by these externalities – is a language that capital market understands and is the way to move the line in finance and the economy.

The question then is whether reporting under IFRS sustainable standards (ISS) or the European Sustainability Reporting Standards (ESRS) would create two different reporting that would lead to different decision making for companies and their investors?

The place where Faber took his picture might give interesting answers.

On the southwestern side of the Col du Midi, down below, lies the Glacier des Bossons. Due to its proximity with Chamonix town centre, it used to be the place of choice for mountain guides to take their clients on 'ice schools' – teaching them the skills of ice climbing.

But global warming has meant the glacier receded, long before it stopped freezing at high altitude, and Faber and the ISSB became 'LinkedIn superstars'. With the easy access compromised, and the glacier now too dangerous for neophytes, mountain guides moved the 'ice schools' to another glacier, the Mer de Glace, accessible by train from the city centre to the Montenvers station. A fine example of climate adaptability, illustrated in research by Ludovic Ravanel, researcher at the CNRS and a member of bureau des guides de Chamonix.

Funnily enough, Montenvers is where one would land by walking (or skiing) down from the north-eastern side of Col du Midi – the famous Vallee Blanche, one of the Alps' crown jewels in off-piste skiing itineraries, from the Aiguille du Midi all the way down to Chamonix city centre, with a hop over the Mottets hill that looks like the rounded hip of the glacier's moraine.

But the Mer de Glaces itself has not been spared by climate change. Today one is lucky to finish the Vallee Blanche in town. It's impossible to hop over Les Mottets without taking off one's skis and walking up the hill. And the most likely scenario is that one will end the day at Montenvers and have to take the train down to Chamonix.

The gondola next to the Montenvers train station was built as recently as 1988 to take tourists down close to the ice where they can visit a man sculpted cave in the glacier, but now it lands instead in the middle of rocks. Rather than taking people down, it's a more welcome sight for skiers looking to go up.

The zigzagging staircase that goes down from Montenvers to the Glaciers has signs all the way along: "the glacier was here in 1800... in 1920... in 1960...." – documenting the giant's melt.

Source: Adobe Stock

The Companie du Mont Blanc (CMB) operates the train, the chairlift and the rest of the chairlift installations in Chamonix. It has now approved a three-year €53m investment plan including a €25m envelope to upgrade the Mer de Glace gondola – essentially chasing the glacier, another example of 'climate adaptability'.

But soon enough there won't be a glacier where the new gondola will land. Would having to report from a double or single materiality standpoint impact the decision to build a chairlift, that in 10 or 20 years' time will be obsolete because the glacier will have disappeared?

The site management has been leased, following a public tender, by the city of Chamonix to the Compagnie du Montenvers Mer de Glace SAS, a subsidiary of the CMB that owns 60% of it, the Banque des Territoires – Caisse des Dépôts et Consignations owns 30%, and Crédit Agricole des Savoie the remaining 10%.

CMB is listed on the Euronext and, as such, will have to comply with the Corporate Sustainability Reporting Directive (CSRD) and the European sustainability reporting standards (ESRS). Corporate Disclosures has asked both banks if the potential information CMB will have to report under CSRD would change the way they approach the decision to back these type of project – they did not reply.

CMB chief executive Mathieu Dechavanne is under no illusion that sustainability will be a key factor in getting funding in the future.

"I'm convinced, and I tell my staff this constantly, that everything we do on sustainability – including reporting but also beyond it – will be key in the future for our ability to raise funds from investors," he tells Corporate Disclosures. "I can easily imagine, going forward, that companies will be rated on their sustainability and that this rating will become, over time, a key driver for banks to allocate capital to one company/project or another."

Dechavanne admits that the upcoming reporting requirements under the EU's CSRD and their international counterparts at the IFRS Foundation are, at the moment, "still a bit blurry in my mind", and that he will meet with the auditors at the end of September to work out the compliance plan.

CMB doesn't really quantify the financial impact of environmental and social externalities for now, Dechavanne acknowledges. But it has started to measure its emissions, which will lead to a diagnostic and in time will be translated into financial indicators, he says.

CMB already does some sustainability disclosures in line with the provisions of paragraph 2 of Article L. 225-100-1 of the French Commercial Code (see box out).

Paragraph 2 of Article L. 225-100-1 of the French Commercial Code:

To the extent necessary for an understanding of the development of the business, this chapter sets out the key non-financial performance indicators, including social, environmental and societal information.

Most of these are impact-focused, but not very prescriptive. For example, it states that "the group's activities do not generate any type of discharge into the air, water or soil that could seriously harm the environment", without explaining how it reached this conclusion. The annual report also talks about the CMB's role as a 'citizen corporation', visual and noise pollution from its activities and investment in the local community and initiatives. But it hardly links all these back to the company's business model and strategy. If there is no glacier, biodiversity, snow and by extension no tourists in 10 years, how will the CMB continue to operate?

This will change with the ESRS, and to some extent the ISS (if they had to report under those). But to answer the question on whether single and double materiality reporting lead to different decision making, one needs to look at what will be reported under each set of standards and why, as well as, and perhaps most importantly, who the audience will be.

It's hard at this stage to ascertain what the exact disclosure requirements under ISS and ESRS will be, more so because the standards are at a draft stage and likely to change.

Currently the ISS only covers climate, and with a single materiality approach the CMB would have to report any risk material to its future cash flow: for example, the glacier melting and tourists no longer showing up to use the chairlifts.

Under the ESRS on the other hand the CMB would have to report on the environment, biodiversity, pollution and social considerations, but also governance matters, and not only on how these impact the balance sheet, but also how the company's activities affect the environment and society.

For example, a new chairlift on the Mer de Glace could potentially mean more tourists so more cars in the valley and therefore more pollution, potentially having an accelerating impact on the melt of the glacier and the obsolescence of the new chairlift which in turn will impact cashflows.

However, what comes before the disclosure is the company's own materiality assessment.

"Both, the ESRS and the IFRS sustainability standards will require transparency on the outcome of this assessment and how it has been conducted. The materiality assessment determines the content of the report," Christoph Töpfer, a policy and research officer at the German Environment Agency (UBA), explains.

But will a materiality assessment under the ISSB's ISS and the EFRAG's ESRS be fundamentally opposed or complementary?

ISSB's Faber told the European Parliament that the ISSB standards recognise double materiality in the materiality assessment of a company, but that it applies a financial filter when it comes to the reporting. For some this means a complementarity: the ISSB's reporting stops at what is financially material and the ESRS go further. But for others the premise of a single materiality assessment and double materiality assessment are so philosophically opposed that the two approaches are in conflict.

Materiality assessment

Being based on the double materiality principle, the draft ESRS expect a comprehensive description of the assessment process for impacts, risks and opportunities. The materiality test for draft IFRS S1 and S2, on the other hand, is "information that could reasonably be expected to influence decisions that the primary users of general purpose financial reporting make on the basis of that reporting".

But the requirements to describe the process under the international standards remain, according to Töpfer, "rather generic".

"Direct and indirect impacts of a company on sustainability matters are covered only implicitly in IFRS, namely if they are deemed to become a significant risk for the company (e.g. because of specific dependencies or for reputational or liability reasons)," he says.

Although the ISSB and Faber have said publicly that their standards consider wider impacts in the materiality assessment prior to reporting under what is financially material, most stakeholders admit that the draft standard are not so clear. Beyond paragraph 26 a) and the guidance in paragraph 17 in IFRS S1 (see box out), things are not really spelled out, as Töpfer notes: "The IFRS drafts do not explicitly require a company to explain if and how it has identified sustainability matters that it is impacting and, based on these, determined the ones that affect enterprise value in the short, medium and long-term."

IFRS S1, paragraph 17:

"An entity's sustainability-related risks and opportunities arise from its dependencies on resources and its impacts on resources, and from the relationships it maintains that may be positively or negatively affected by those impacts and dependencies.


When such impacts, dependencies and relationships create risks or opportunities for an entity, they can affect the entity's performance or prospects, create or erode the value of the enterprise and the financial returns to providers of financial capital, and the assessment of enterprise value by the primary user.

However even if it was only one paragraph and it needs to be review for greater clarification, which Accountancy Europe has called for in its comment letter to the ISSB, senior manager Jona Basha says the ISSB exposure drafts "make it clear and provided examples that the company must not only think of the current business dependencies on climate change and other sustainability matters, but also on the impact of the company's activities on the environment, people and economy, that may come back to impact them in the longer term".

"Under the ISSB exposure drafts, as long as a company is able to reliably estimate that a sustainability matter will impact enterprise value in the short, medium, or long term, it shall report on it," she explains.

For Philippe Zaouati, CEO at Mirova, this a "cynical approach" because all the "impact data that could be collected has no real interest to the ISSB".

Regarding the debate on single versus double materiality, Töpfer says that considering longer time horizons for financial materiality, the so called 'dynamic materiality' approach may only bridge part of the gap between both concepts. He adds: "It should – from my perspective – be acknowledged that reporting purpose, target groups and consequently information requirements of the ESRS are broader than those of the of the IFRS drafts."

IFRS's single materiality concept is likely to produce relevant information for stakeholders that are interested in how well a company manages its sustainability-related risks and opportunities, with the purpose of maintaining or increasing enterprise value over time, he explains. "It is, however, unlikely to produce comprehensive information on how a company is actually contributing to the transition towards a carbon neutral and sustainable economy or how it may be driving systemic (instead of individual) risks."

Single vs double materiality in a water shell

A fictitious company owns less than 20% of the equity in an associate somewhere along its structure. This associate has determined that, over the very long term, it will impact water. In its extreme case, the entire group has nothing to do with water apart from that little exposure somewhere very distant from its core activity. When the group consolidates, this is immaterial, and those water issues will ultimately not end up being disclosed under ISSB. But in the same situation under ESRS, they may be disclosed depending on scale, scope, remediability and likelihood of the potential impact.

Basha says: "That is where the two differ, the ISSB remains focused on what ultimately impacts the company, with the ESRS on the other hand we are interested about what happens to water."

Accountancy Europe came up with a chart of concentric circle in 2019 to explain single (grey) versus double (grey + yellow) materiality.

Figure: Materiality Lens

Source: Accountancy Europe, <a href="https://www.accountancyeurope.eu/wp-content/uploads/191220-Future-of-Corporate-Reporting.pdf" target="_blank">https://www.accountancyeurope.eu/wp-content/uploads/191220-Future-of-Corporate-Reporting.pdf</a>

A few years down the line, and with two sets of sustainability standards in the making, Basha says: "We've learnt [since] that eventually the difference between impact on enterprise value creation and wider impacts may be smaller than we initially thought."

Accountancy Europe deputy CEO Hilde Blomme adds: "In a way, as soon as you can reliably determine the financial impact on the company, the enterprise value and double materiality become the same. But as long as the financial impact can't be determined or estimated the two will be different and as a consequence the reporting will be different."

And here lies the crux of the issue: complying with one set of standards is already seen as burdensome, but complying with two sets of different standards is a company's worst nightmare. Some European companies may want to find international investors, and some international companies may seek investors in Europe. On top of that some international companies have operations in Europe and will have to report under ESRS for those. So if there is no alignment it means double reporting for companies.

The ISSB's answer to this question has been its strategic positioning of the 'building block approach', whereby the ISSB provides a global baseline for sustainability reporting on top of which jurisdictions (including Europe) add their specific requirements - Undersand: the ISSB will provide the investor focus reporting requirements, on top of which jursidictions can add the wider impact requirements if they wish.

MEPs have quizzed Faber on this issue, questioning how, if one standard is rooted in single materiality and the other in double materiality, they can be complementary rather than in conflict? Faber replied honestly that he couldn't guarantee there wouldn't be any conflict but it needn't be so.

Building block approach

"It doesn't have to be a competition and, whether you want to approach it from a double materiality angle or from an investor-focused angle, these don't have to be competing alternatives," IFAC director of public policy & regulation, David Madon says. "So our letter to EFRAG encourages trying to have the conversation about double materiality in a way that can be more relatable to the building block conversation."

At Accountancy Europe, Blomme and Basha believe the success of the building block approach lies in three areas: the materiality approach, the scope and the structure.

"It is possible to add on [double materiality considerations on top of single materiality ones], because at the end of the day materiality is a judgment and how well you able to exercise that judgment," Basha says. "So you exercise a judgment and either you stop at what is financially material or you continue to broader impacts, as demonstrated in our concentric circles."

On scope, both standard setters have agreed they will address the full range of ESG issues, but while EFRAG has gone all out from the start (with 13 standards covering environment, social and governance), the ISSB has prioritised a climate standard before looking at other topics. So there is a time lag, which Blomme says is important to consider, but in theory over time there should be an alignment.

When it comes to structure, Blomme says: "If you compare the words and you have not gone behind what they mean, you might think this is not the same. But despite different structures and definitions, they are based on the same concepts, standards and frameworks such as the TCFD."

So at the moment, the current proposals lead to two different reporting. But there is "hope", Basha and Blomme say that it comes closer together and that the building block approach works.

"It's not about endorsing the ISSB and telling to EFRAG to do the rest, that is not the idea," Basha clarifies. "The idea is to maximise efficiencies, minimise costs so that when companies report under ESRS – which has a broader scope – they will have automatically also reported under ISSB because standards are aligned."

Decision useful/impactful

So let's imagine for a second that the ISS and the ESRS are aligned and leave aside accountancy cold wars and go back to the main issue at hand: would having to report from a double or single materiality standpoint impact the decision to build a chairlift that in 10 or 20 years' time will be obsolete because the glacier will have disappeared? Will the European and/or international sustainability standards spur changes in the way business is done for the benefit of the environment and society?

When it comes to the international standards, Mirova's Zaouati is sceptical. For him discussing the issue of sustainability is harder today than it was a couple of years ago.

"A few years ago, people across the table didn't believe in climate change or that it was material to the financial sector, it was easy to discuss because you just had to prove your point," he says. "Today all the business leaders are saying they are doing the job, even if they are not, so it is very difficult to tackle this, and my concern is that the ISSB through its single materiality approach is a symbol of the lack of action behind the words and commitments – i.e. business as usual."

ACCA subject matter expert in corporate reporting Yen-Pei Chen believes the issue is a bit more nuanced and depends on particular circumstances. "The ISSB approach may not look like a revolutionary change in reporting from the EU – where these conversations have been happening for longer, and perhaps there is more awareness of the topics – but for preparers and companies from other part of the world, the ISSB is far from business as usual," she says.

For IFAC Madon, it's inevitable that there will "always be cynics to gain the system, but that doesn't mean the ISSB's focus isn't purposeful".

He says: "Building block one, investor information, is the unifying piece more of us around the world can agree on. 140 countries agree on IASB assessments of materiality for financial reporting, that's the glue, the franchise, that can get more people - 140 countries - to do the same on sustainability reporting. Nobody's right. Nobody's wrong. But we can all agree better on the investment perspective, that far outweighs cynics trying to game that system."

So what about the European standards?

UBA's Töpfer believes the CSRD will fundamentally change corporate reporting. Looking at its predecessor - the NFRD - research of UBA and others shows that the information that can currently be found in the non-financial statements is in most cases insufficient to understand a company's impacts and risks, he says.

"Undoubtably, applying the ESRS will not be an easy task and the new requirements will put an extra-effort on companies, but they will also generate information that capital markets and stakeholders of companies were long missing and that is urgently needed for shaping the transition to a sustainable economy," Töpfer continues.

"Reporting can change companies'/management's behaviour. It may not be the reporting per se, but I am positive that strong requirements to publicly disclose information on sustainability performance and risk management will trigger internal discussions, lead to the setup of processes and organisational structures, the acquisition of dedicated personnel and, most importantly, action. The European standards will be a driver of change in company and management behaviour."

Blomme says reporting will play a part because it is in the human nature to pay more attention to something "if you have to put it on a piece of paper and make it public, and let's not forget in the case of CSRD you'll also have to provide assurance on that information".

A thought confirmed by CMB's CEO Dechavanne who says sustainability reporting "will impact our decision making".

Reporting may have an impact on decisions, Datamaran SVP of innovation & accounts, Donato Calace says, but he tempers: "It doesn't guarantee that it will lead to the right decisions to achieve this big cultural shift that we need."

"The direction of these decisions doesn't really depend on standards or materiality assessment, it depends on the pressure from society, regulators, industry peers and other stakeholders," he continues. "Now, hopefully, what this new wave of standards will achieve is creating a platform of transparency that would enable those pressure groups to push companies to act in a certain way."

Again, the CMB is a good example here, the €50m investment project at the Montenvers has been 10 years in the making. Initially the project planned for the new chairlift to be extended as the glacier melted. But at the regional environmental authority, where the project must be greenlighted because the Mont Blanc massif is a protected natural zone, NGOs and policymakers blocked it until it was reviewed and the final project provided that the chairlift will never go higher.

"My job is changing," Dechavanne says. "I think I spend 30% of my time communicating with external parties including NGOs."

He admits he is sometimes frustrated by that, especially that it consumes so much time, but he says "at the end of the day the final project coming out of a consensus is often far better than what we had originally designed".

Would having to report from a double or single materiality standpoint impact the decision to build a chairlift that in 10 or 20 years' time will be obsolete because the glacier will have disappeared?

"We are not running after the glacier," he replies. "What we are doing is facilitate access to the mountain altitude. Even if there is no ice there will still be demand to go up to 2,400m altitude, perhaps to access and climb the surrounding summits, there will always be demand to go up, even more so if it is 35 degrees down in the valley."

That conviction will very soon have to be translated into evidence and metrics and will have to go into the company's reporting. Under the European standards, not only will the reporting be aimed at investors, but also at local authorities, environmental NGOs, and indeed society at large – and this wider audience could potentially act on what they read.

The ISSB, the Banque des Territoires – Caisse des Dépôts et Consignations and Crédit Agricole des Savoie were contacted for comments.