The ISSB IFRS Chronicles: Decoding Materiality

As 2024 ended, the Financial Reporting Council (FRC), acting as Secretariat to the UK Sustainability Disclosure Technical Advisory Committee (TAC), gave the green light endorsing IFRS S1 and S2. The stage is set for a pivotal year, aligning UK businesses with this global sustainability reporting standard. Now is the perfect time to dive into the standard, starting with materiality.

Accountants everywhere are well-acquainted with the concept of materiality—after all, it's the cornerstone of financial reporting. However, in the realm of sustainability reporting, materiality extends well beyond its traditional boundaries. In this new era, its influence now spans governance, strategy, risk management, and value chain interactions, marking a significant departure from its role in IFRS Accounting Standards.

Under ISSB IFRS S1 paragraph 17, companies must disclose material information about sustainability-related risks and opportunities that could reasonably affect their future prospects. Put simply, information is material if leaving it out, getting it wrong, or burying it, could influence the decisions of primary users of general-purpose financial reports—namely existing and potential investors, lenders, and other creditors. When we talk about a company's prospects, we're looking at cash flows, access to finance, and cost of capital over the short, medium and long term.

Materiality Judgments
Materiality is unique to each and every company, but under the ISSB Standards, companies must look beyond their own operations and consider their entire value chain when assessing sustainability-related risks and opportunities. The focus of the Standards is not merely on the size or immediacy of a sustainability risk or opportunity but how it could reasonably be expected to impact the company’s future prospects. This includes factors such as cash flows—considering their amount, timing, and uncertainty—as well as returns in the form of dividends, interest payments, and market value. The aim is to equip investors and other stakeholders with decision-useful information and a robust assessment of the company’s financial stewardship in the context of its sustainability-related risks and opportunities.

Sustainability-Related Risks And Opportunities
IFRS S1 sets out that sustainability-related risks and opportunities can arise throughout a company’s value chain from its interactions—both direct and indirect—with its stakeholders, society, the economy, and the natural environment. This broad definition recognises that companies both depend on and impact resources and relationships within their interconnected value chain.

The standard also makes it clear that a company's dependencies and impacts on resources and its relationships can work both ways—either contributing to preservation and regeneration or leading to degradation and depletion. It is these interactions that create sustainability-related risks and opportunities which might affect the company's financial position over the short, medium and long term.

Approach And Sources Of Guidance
The standard encourages companies to assess materiality from an outsider's perspective—considering what an informed external party would reasonably expect and find relevant in decision-making, taking into account both company-specific and external factors.

While the ISSB Standards don’t prescribe a specific method for identifying sustainability-related risks and opportunities, they do guide companies toward resources in order to ensure thorough and consistent materiality assessments. For instance, IFRS S1 requires companies to consider the Sustainability Accounting Standards Board (SASB) Standards, which provide valuable industry insights into sustainability-related risks and opportunities arising from specific activities and outputs.

Similarly, IFRS S2 recommends additional resources that companies can tap into including the Climate Disclosure Standards Board (CDSB) Framework Application Guidance, and national standard setters such as the European Sustainability Reporting Standards (ESRS), if these resources can help meet the informational needs of primary users.

Proportionality Mechanisms
A value chain assessment for a company can be incredibly complex, which is why IFRS S1 provides helpful and practical proportionality mechanisms. The standard outlines that companies should work with the information available at the reporting time, without incurring undue cost or effort. Instead of undertaking exhaustive and costly searches for data, companies should focus on defining their value chain scope using reasonable and supportable information. This pragmatic approach acknowledges the varying levels of reporting maturity and helps companies fulfil their reporting requirements effectively, while balancing cost-efficiency and managing the overall reporting burden.

Interoperability Considerations
When the TAC endorsed IFRS S1 & S2 they highlighted some potential challenges for UK companies dealing with multiple reporting frameworks. While the basic definition of materiality lines up across frameworks, its practical application differs notably between the ISSB Standards and the European Sustainability Reporting Standards (ESRS).

A key difference being the ISSB Standards focus on financial materiality, while ESRS brings in the concept of double materiality, looking at both financial and impact considerations. This creates some extra complexity for UK companies who will need to report under both these frameworks.

Looking closer to home, the TAC also highlighted additional implementation challenges related to materiality that the UK Sustainability Disclosure Policy and Implementation Committee (PIC) will need to address—one such challenge being the Companies Act 2006. The sustainability reporting requirements within the act are based on the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), and companies must disclose governance and risk management processes related to climate risks, regardless of their assessment of climate-related risks and opportunities.

In contrast, IFRS S2 allows companies to omit such disclosures if no significant risks and opportunities are determined by the company. Interoperability, practical implementation and easing the reporting burden will be a key piece of work for the PIC before the standards come into force.

Practical Implementation Guidelines For Materiality 
The IFRS Foundation supports a structured four-step materiality process, similar to that outlined in IFRS Practical Statement 2 on Making Materiality Judgements, to help companies identify material information related to their sustainability risks and opportunities. In true sustainability fashion, it has been repurposed from financial reporting as a valuable starting point for addressing materiality in sustainability reporting.

As we stand at the threshold of this new era in sustainability reporting in the UK, the evolution of materiality in sustainability reporting represents more than just a change in disclosure requirements; it signals a fundamental shift in how we think about and communicate what could reasonably impact a company’s financial prospects.

While maintaining its essential role in ensuring decision-useful information, materiality has evolved to encompass the intricate interplay between a company’s own operations, its value chains, society, the environment and the economy. How the new ISSB standards are implemented, their interoperability, and the broader definition and application of materiality will be key to balancing the usefulness of disclosures for users, with the reporting burden for companies.