New Metrics
Reporting 3.0:
Progress Toward a More Common Definition of True Materiality

Drawing on the work of Reporting 3.0 - in particular, its Reporting Blueprint and forthcoming Accounting Blueprint - this panel on the final afternoon of New Metrics ‘16 facilitated an animated discussion on true materiality, exploring the broad range of definitions of materiality, and whether they may coalesce into a more common definition or continue to be disparate for different audiences.

Bill Baue, facilitator of the Reporting 3.0 Platform, started the conversation by giving a brief description of Reporting 3.0 - a multi-stakeholder community generating knowledge to design future-fit reporting in a neutral, pre-competitive space - and questioned the gap between the state of current reporting practices and where reporting is not serving its true function of supporting the emergence of a green & inclusive economy. Having different definitions of materiality is another challenge for companies - one end of the spectrum is more shareholder-centric, its audience is mainly investors and focuses internal – questioning the impact of materiality on the company (SEC and SASB definitions) versus another end of the spectrum is stakeholder-centric and focuses on expansive view of external impacts of the materiality (GRI definition). This was definitely an eye-opening moment for me: If we keep defining materiality in the context of economy and pleasing shareholders, we’ll be stuck at the same system. However, when we apply systems thinking and consider the impacts on all stakeholders, only then we can progress towards a flourishing future.

Ralph Thurm, founder and Managing Director of A|HEAD|ahead, then shared a statement that has echoed in his mind since he started this work in 1988: “There is no sustainable business in an unsustainable world.” He asserted that our economic system is a leader in our common decision-making, although it should be a laggard (following the lead of ecological system, in which our economy is embedded), and that there will never be sustainability if we do not change the economic system boundaries. He said we are still at the beginning of what we are supposed to do and stressed the importance of the relationship between integral thinking and true materiality. We use a very reduced understanding of sustainability in the way we operationalize it in companies and amplifying the areas that companies do less bad. Sustainability is about doing good, and all of the standards are giving us the recipe for that. Thurm then asked the audience what has materiality really delivered? As long as we have a collective global footprint that is still growing, that means we are failing on the materiality exercise altogether. Thurm then ignited a spark for the audience to make a connection between the micro performance of the organizations versus the magnitude of the urgencies we face. We developed policies, looked at disclosure standards and developed assurance around that, but we forgot to take people on board. Sustainability - the ability to sustain - is not exciting for most people.

One thing that is exciting is leaders saying that they want a ‘green and inclusive economy’ – but what does that look like? There are companies, such as Interface, that have an ambition to be gross positive. And we have more and more entrepreneurs and business disruptors that are giving us glimpses into what a sustainable, inclusive economy could look like. But they are absent from the conversation because they are not interested in the disclosure of decreasing our footprint - they want to increase our handprint. Thurm then questioned how reporting might look if we addressed the failures.

There are three main areas that he would like organizations to address:

• First, the company’s purpose and its right to exist considering the urgencies of the planet; what legacy do you want to leave behind? This question will lead to a different viewpoint of disclosure, as right now, we have a disclosure system that tells us how we cure symptoms, and does not go deep enough to explore the root causes of the symptoms and how can businesses can solve them (having the SDGs is a good step forward, but it is just another 'do no harm step' without changing any of the economic system boundaries).
• Second, disclosure should take on contextualization, leadership attitude, and description of the ambition level of the company. We need to move towards a multi-capital-based, context-based accounting system. Only then can we prove that financial capital hasn't been built by “breaking the backs” of other capitals.
• Third is scalability - we have failed to scale sustainability so far, and it is around education, collaboration and advocacy for the new economic system. Companies want leveled playing fields and for that we need to ask what it would mean to internalize the external effects of cost accounting? How would pricing mechanisms translate this into market decision-making? How would a taxation system look like if we turn it upside down (less tax on wages, more tax on resource use)? It is time to recalibrate the questions around reporting and sustainability accounting.

Thurm closed by saying true materiality is asking the right questions and getting the right answers while taking purpose, success measurement and scalability into account and developing a materiality process that is not hooked on the existing standards.

Julie Gorte, SVP for Sustainable Investing at Pax World, joined the conversation mentioning the crush of the stock market and took the audience back to how financial reporting started, compared sustainability reporting to mainstream reporting, and pointed out that there is no punishment mechanism for not complying with sustainability materiality issues. Gorte then mentioned that there is nothing that prevents the investor from bringing social and environmental information into the investment process in terms of the discharge of the fiduciary duty. These things are considered material, there is nothing in law that says otherwise, and we just have habits of not using them. The more we analyze the definition of materiality the less important anything else becomes. Investors should look more into the ESG data and when we talk about long-term outlook it shouldn’t be only a year or 5-year outlook. From a risk perspective, a lot of ESG issues are undetermined-term risks (we couldn’t predict Hurricane Sandy, but we know we can expect more storms like that in the future because of climate change. And we don’t know when a company with a horrible safety record, such as BP, will cause another catastrophe when it won’t fix its safety systems). That’s why we pay attention to these risks; we don’t try to time the market on these issues.

Brendan LeBlanc, Partner at EY Climate Change & Sustainability Services, appraised the presenters, saying they are talking about changing the rules of the game, and not just for reporting and data. And then he took the concept of materiality back to today; if stakeholders were sophisticated enough, today’s materiality and frameworks would need to be shifted. One main challenge is that companies can’t identify their stakeholders - we need to be asking whose wellbeing is impacted by an organization. Thanks to the SEC, investors are able to see the full context of a company’s financial performance. Shareholders were the only stakeholder that mattered - the duty and the care you owed them was a report written in the language of financial capital. LeBlanc asserted the need for companies to clearly identify who their stakeholders are and why, and what kind of duty the company owes them, using their language to communicate the importance of these sustainability issues in the capital they care about. He concluded by saying he would rather see organizations do far fewer things and do those things really well, including being very transparent about challenges. He wished stakeholders broadly were more sophisticated and asked smarter questions to push organizations more. Instead, we settle for the illusion of progress, which is more dangerous than no progress at all.

Sanford J. Lewis, attorney at Sanford Lewis, closed the session saying he was excited and at the same time concerned about the existing standards of sustainability reporting. He stated that the SASB definition covers a very small range of what should be material with a primary focus on topics where the evidence is available. The SASB definition often omits some materiality issues, such as longer-term, portfolio-wide or systemic risks, a multi-capital or contextual view, financial impacts external to sector, persistent externalities, company-specific issues, emerging issues requiring new metrics or additional evidence of financial impact, ethical issues and political contributions. For these issues, evidence of financial materiality is not yet there, but investors are beginning to be concerned. Lewis insisted companies need to think systemically, think about types of material issues beyond SASB. He is worried that everyone is looking for cookie-cutter solutions, and we don’t live in such a world where those solutions exist.