On the Triple Illusion of Double Materiality

By Frédéric Ducoulombier, Director, EDHEC-Risk Climate Impact Institute

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In an op-ed published by French reference newspaper Le Monde on 10 October, IFRS Foundation International Sustainability Standards (ISSB) Board Chair Emmanuel Faber represents that the double-materiality approach to sustainability reporting is a simplistic concept whose popularity derives from a “triple illusion.” Mr Faber argues that single or financial materiality is the only type of materiality that can reorient the required funds towards the just transition within the allotted time. He also represents that the ISSB has sufficiently extended the scope of accounting materiality for corporates to become stewards of “human, social, and natural capital" and concludes his Blitz with a call to “put an end to groundless disputes" to “ensure that efforts converge towards the integration of the interdependence between economics and ecology". Interestingly this offensive takes place as the first set of European Sustainability Reporting Standards (ESRS), which have double materiality at their heart, are under scrutiny by the European Commission’s co-legislators prior to definitive adoption.

An abstract of this piece was published by IPE on 13 October under the title A response to ISSB’s Faber’s ‘triple illusion’ criticism of double materiality.

The October 2023 newsletter of the Institute, published on 10 October features a Long Read Interview titled Sustainability Reporting and Material Delusions.


What are single and double materiality?

Materiality is a key principle of corporate reporting, but its definition has evolved over time to capture changing priorities and it remains contested, especially in relation to corporate responsibility and sustainability – other contested concepts.  What is reasonably established is that an information is deemed to be material if omitting, misstating, or obscuring it could reasonably be expected to influence the assessments or decisions that users make based on corporate statements. Materiality however depends on perceptions of who these users are and what they need the information for. 

What is now the traditional view of materiality in accounting is defined in relation to the financial decisions of providers of capital; Mr Faber explicitly identifies with this so-called financial materiality perspective. This perspective need not disregard environmental or social factors, or the welfare, needs and aspirations of stakeholders other than providers of capital, but these are integrated, outside-in, only to the extent that a business case exists to do so.  It follows that the only sustainability-related information that requires reporting is that which is seen as having financial materiality.  

The alternative view considers the needs of a multiplicity of stakeholders – with nature as a silent stakeholder – that are or may be impacted by the activities of the reporting entity. The added inside-out perspective calls for the disclosure of the entity’s material impacts on people and the environment irrespective of financial materiality.

The ESRS adopt a “double materiality” approach requiring entities to disclose both the material sustainability impacts of their activities (throughout their value chains) and, in alignment with the ISSB standards, any material financial risk or opportunity arising in relation to sustainability matters. 


What to make of Mr Faber’s criticisms against double materiality?

Mr Faber calls double materiality simplistic and then accuses parties espousing it of rejecting financial materiality which they would deem “simple”.  As double materiality subsumes financial materiality, it is challenging to understand how it could reject it; as it also extends financial materiality, it is challenging to see it as “simplistic,” and it is hard to believe that Mr Faber who is not a bit simple fails to understand that the French word “simple” may refer to single (in opposition to double).  But let us suspend disbelief and review Mr Faber’s case.

Mr Faber represents that double materiality perpetuates a triple illusion.

The first illusion would be that the “performative power of materiality” – described as “immediate, clear, and strong” market reaction – could extend beyond the economic sphere.  Mr Faber represents that impact materiality disclosures serve “a myriad of piecemeal usages” whose impacts are infinitesimal.  Financial materiality however is defined in relation to the judgment of a reasonable investor rather than the hypothetical reaction of an implicitly efficient market.  For centuries if not millennia investors and other stakeholders have integrated non-financial considerations into decisions that financially impact companies. As the weight of stakeholders responding in similar ways to a given environmental, social, or governance (ESG) issue increases, the issue can become financially material for capital providers. And while this typically happens gradually as societal norms change or impacts become better understood, the transition is sometimes so swift it can bankrupt blind sighted entities.

The second illusion would be that an exhaustive account of impacts be possible. However, reasonable people and the legislator amongst these, are only asking for disclosure of material impacts of relevance to stakeholders.

The third illusion would be to equate disclosure with change in corporate behaviour and let double materiality “obscure the need for political ambition”. There is theoretical merit in Mr Faber’s warning as the introduction of disclosure requirements has too often been promoted as a light-regulation solution to societal ills. Seen in this light, sustainability disclosures could be not only ineffective but also counter-productive in providing an excuse for lack of substantive action. A belief that sustainability issues could be cured by capital and consumer markets if only proper information were made available, is but market fundamentalism and is extremely dangerous. The poly-environmental crisis we are facing is evidence of market failure linked to externalities – documenting these (impact materiality perspective) and the risk that they become partially internalised (financial materiality perspective) can only go so far. What is indeed needed is legislation to require that harm caused by economic activities be brought back to safe levels and to provide companies with an explicit and convincing schedule for the internalisation of externalities. In practice however, the role of the ESRS is to ensure transparency and accountability of companies in relation to their sustainability impacts, risks and opportunities in the wider framework of the substantive sustainability goals and policies of the European Green Deal. Double materiality is not a Trojan horse of business-as-usual interests. Actually, impact disclosures are opposed by some of the very same interests that are lobbying to derail or delay substantive regulation. Mr Faber’s criticisms of double materiality do not resist proper inspection, instead of three illusions, we are left with an illusionist.


What does Mr Faber want?

Turning back to the alleged rejection of financial materiality, Mr Faber notes that it is dangerous to refuse to speak the language of the markets for “it is the markets, and the markets alone” that can fund the just transition within the time that remains.  Apparently, it is easier to imagine the end of the world than it is to imagine the end of market primacy. Using a sleight of hand, Mr Faber suggests that trillions of secondary market capitalisation – a financial stock – can be promptly redirected towards fresh flows of real transition investments provided the right public policies are enacted and the right information is available. And according to Mr Faber, the ISSB has already put the accounting house in order by recognising the interdependence of companies with their environment, which may allow companies to justify the regeneration of "human, social, and natural capital on which they rely” by good accounting practice.  It is thus urgent "to put an end to groundless disputes" and “ensure that efforts converge towards the integration of interdependence between the economy and ecology".

It may be surprising to conclude a diatribe with a plea for a truce and to seek the cooperation of people whose positions have been straw-manned and disparaged. 

Proponents of impact materiality have heard these calls to put an end to divisive narratives before and many have concluded that they were simply uttered to avoid an honest debate about material differences of views in relation to the responsibility of businesses and the integration of ESG concerns into accounting and reporting systems.  Without a serious scientific basis, it was represented, several decades ago, that in a world facing increasing environmental and social challenges, profit-seeking companies would necessarily integrate sustainability to ensure their long-term resilience and success. The mantras of corporate social responsibility and sustainability have been widely adopted, and for some companies, the exercise has been more than performative. However, two-thirds of planetary boundaries have now been crossed according to scientists.

European lawmakers have adopted an ambitious program for ecological transition and the integration of social issues into economic activities. They have deemed it necessary to assess companies' sustainability performance and monitor their alignment with public policy objectives. The delegated regulation, prepared by the European Commission, reaffirmed the legislators' commitment to double materiality. This decision came despite intense lobbying by certain industrial and geopolitical interests that advocated for abandonment of double materiality in favour of alignment with the ISSB. As the rubber meets the road on the Green Deal, the legislators' determination is put to the test. Considering Mr. Faber's sortie as the peace initiative he claims, or even as the last stand of a beleaguered rival, would be unwise; it is more of a 'pacification campaign.'