From the investment perspective, the Impact dimension is closely linked to two relevant factors: the first concerns the effects of this impact and its dynamics on risk-return, its application and economic, social or environmental function; the second, to the element, or elements, of the economic materiality provoked by the action of the investment in this same dynamic. In other words, impact in real terms is a measure of the benefit of a human action to society as a whole and to the environment or planet. This is the positive dimension of impact, but the measure of this benefit can have a negative dimension that needs to be taken into account in this risk-return dynamic, its application and function. Therefore, "there is no way to disassociate the dimension of impacts on investments without linking them to this concept of dual materiality” . [Paulo Miranda]
The concept of dynamic materiality recognizes that the economic materiality of an issue may change based on anticipated or unexpected circumstances. What is financially immaterial to a company or industry today may become material tomorrow, a process called 'dynamic materiality'.
Former U.S. Supreme Court Justice Thurgood Marshall, in a landmark 1976 case, wrote that an item is material if there is “a substantial likelihood that a reasonable investor would consider the information important in deciding how to vote or make an investment decision.” ”.
Critics of the current SEC proposal argue that the existing materiality principle is sufficient to incorporate climate or other environmental, social and corporate governance (ESG) issues into company reports. On the other hand, the SEC and supporters of the new rules say that while many US companies are releasing a lot of data about their climate activities, the information is inconsistent and non-standard, making comparisons difficult for investors. New disclosure rules are needed to fill the information gaps. And when it comes to materiality serving as a determinant of what companies should and should not disclose, there is significant uncertainty about what is actually material.
Although there are different views between those who believe that materiality (or relevance of ESG factors) is defined by the financial performance of the company or sector resulting from the management of ESG factors and those who point to materiality as defined by social or environmental impact of a certain factor, the fundamental thing for those who invest in ESG is to understand the concept of materiality for their own business.
Dual materiality, a concept recently introduced by European regulators, is increasingly where investors and fund managers look to understand the risks of their investments in socio-environmental pillars, but also for the profitability of the companies in which they invest, and how socio-environmental impacts can have financial consequences, over the years, for your own investment. Another way of looking at dual materiality is to understand the impact of sustainability on finance and also on society and the environment.
Some experts argue that the meaning of dual materiality is still up for debate and requires further analysis. “Yes, in principle, the impacts of a company or portfolio on the climate or the wider environment can be material – but how do we know exactly what a material impact is?” asks Matthias Tager, PhD candidate in Environmental Policy and Development at the London School of Economics.
Reset Capital points out, as an example, that a bank's CO2 emission is not as relevant as an oil company's carbon footprint. For a bank, pointing out advances in GHG emissions can even be seen as greewashing, that is, “when the company fuss about improving an irrelevant ESG metric in its business and fails to do its homework on what really matters”, according to to Reset.
In this specific example, James Giffor, head of impact consultancy at Credit Suisse, believes that “Decarbonizing your portfolio is not the same as building a portfolio that helps decarbonize the world. Forcing companies to reduce emissions and reorganize their businesses for a low-carbon future can be an arduous and complicated process, so investors who want to drive change must choose their approach wisely.”
“I believe that each perspective of the notion of dual materiality needs to be considered in its own environment. It is not the convergence of the two perspectives that makes a matter material. Impacts on the environment and society cannot be de-prioritized on the basis that they are not financially material, or vice versa. In addition, a company should start with assessing the external impact component of the dual materiality principle, followed by identifying the subset of financially material information for the company and stakeholders,” said Peter Paul van de Wijs GRI Chief External Affairs, in a press release. GRI publication .
In this regard, experts from the SASB (Sustainability Accounting Standards Board), cited by the Financial Times ( https://www.ft.com/content/92915630-c110-4364-86ee-0f6f018cba90 ), highlight the importance of “understanding the public that is aimed at reporting on sustainability”.
The answer, according to Matthias Tager, fundamentally depends on seeing why information about environmental impacts should be material in the first place. In his opinion, there are two likely reasons: “Environmental impacts can translate into financial risks, for example through legal liability or damage to a company's reputation. A reasonable person may consider the material informational for reasons other than the direct financial repercussions. The question of what dual materiality means becomes a question of who is the 'reasonable person' and what are their interests, which in turn define what counts as material – in other words, [what is] important to them.” .
Three questions for…
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Given that dual materiality is the focus of investors, how should companies and organizations prepare their reports if they are looking for investment?
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While ESG parameters do not reach global unification, how should companies seeking to demonstrate dual materiality seek parameters for disclosure ?
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And what about investors? How do they decide on their investments given the alphabet soup in which ESG parameters still lie?
The answer, says Tager, fundamentally depends on seeing why information about environmental impacts should be material in the first place. In his opinion, there are two likely reasons:
Environmental impacts can translate into financial risks, for example through legal liability or damage to a company's reputation.
A reasonable person may consider the material informational for reasons other than the direct financial repercussions. “The question of what dual materiality means becomes a question of who is the 'reasonable person' and what are their interests, which in turn define what counts as material – in other words, [what is] important to them. ,” Tager explains.
