A guide to IFRS’ S1 & S2 sustainability financial disclosure implementation (3), By Innocent Okwuosa

An emergent conceptualisation in the sustainability discourse is double materiality.

Evidence from the field of implementation shows that the lack of clarity in materiality assessment among implementing entities in Nigeria lies in deciding what constitutes material SRRO, which entities should prioritise. The confusion arises because entities in Nigeria which previously engaged in sustainability reporting did so from the perspective of corporate social responsibility (CSR), in which the motivation is giving back to the society and sharing prosperity.

In the implementation of IFRS S1 and S2, one of the documents required by Financial Reporting Council (FRC) of Nigeria during the Phase Two of the implementation (see the Revised Roadmap for Implementation of IFRS S1 & S2 in Nigeria), is the identification and materiality assessment of Sustainability Related Risks and Opportunities (SRRO). As S2 is the only standard that deals with a sustainability topic (climate related risks and opportunities), it means that International Sustainability Standard (ISSB) has no standards dealing with other sustainability topics apart from climate risks.

Reporting entities therefore need a lot of guidance in the identification and materiality assessment of SRRO.  In my last piece, (i.e. Part 2), I provided guidance on the identification of SRRO by those adopting IFRS S1 and S2, given the confusion that arises when a sustainability topic is not covered by IFRS Sustainability Standards. IFRS S1 requires an entity to refer to a hierarchy which technically limits the reference to sustainability standards that prioritise investors information needs. Today, I want to provide further guidance on another aspect of the identification of SRRO, which is the materiality assessment.

The first point to note in materiality assessment is that ISSB Sustainability Standards focus on SRRO that are expected to affect the prospect of an entity. This explains why IFRS S1 (para 3) requires an entity to disclose information about all sustainability-related risks and opportunities that could reasonably be expected to affect the entity’s cash flows, its access to finance or cost of capital.

An emergent conceptualisation in the sustainability discourse is double materiality. In this, we have financial materiality and impact materiality. Financial materiality relates to SRRO affecting an entity’s financial performance, position, cash flows, access to finance or cost of capital. This is a view of investors in the use of sustainability disclosure to make informed investment decision. Impact materiality refers to social and environmental impact of corporate operation and serves the interest of stakeholders like NGOs, environmentalists, human rights activists, government, etc.

A clear guidance on identification and materiality assessment of SRRO under IFRS S1 and S2 is to focus on those SRRO that can affect the prospect of an entity (i.e. its financial performance, position, cash flows, access to capital and cost of capital). IFRS S1 (para 18) states that in the context of sustainability-related financial disclosures, information is material if omitting, misstating or obscuring that information could reasonably be expected to influence decisions that primary users of general purpose financial reports make on the basis of those reports.

IFRS S1 (B14) indicates that the decisions of primary users relate to providing resources to the entity and involve decisions about: (a) buying, selling or holding equity and debt instruments; (b) providing or selling loans and other forms of credit; or (c) exercising rights to vote on, or otherwise influence, the entity’s management’s actions that affect the use of the entity’s economic resources. Specifically, IFRS S1 (B19) makes it clear that materiality judgements are specific to an entity. Consequently, a SRRO is not material simply because our stakeholders care and are asking about them. It is not material because we want to show the impact of our sustainability engagement.

Therefore, implementing entities must distinguish between: (1) financial materiality which considers the financial impact of SRRO on the prospects of an entity, and (2) impact materiality which considers social and environmental impact of an entity’s corporate operations. While investors are interested in financial materiality, society and stakeholders like environmentalists, NGOs, human rights activists, are interested in impact materiality. Materiality assessment under IFRS S1 and S2 is based on financial materiality and not impact materiality.

Evidence from the field of implementation shows that the lack of clarity in materiality assessment among implementing entities in Nigeria lies in deciding what constitutes material SRRO, which entities should prioritise. The confusion arises because entities in Nigeria which previously engaged in sustainability reporting did so from the perspective of corporate social responsibility (CSR), in which the motivation is giving back to the society and sharing prosperity. In giving back to the society and prosperity sharing, they visualise making impact to the society. This impact is not exactly, the same as social and environmental impact of corporate operation.

The above lack of clarity manifests in field evidence, which shows that there is a continuation of effort on the part of IFRS S1 and S2 implementing entities to continue with sustainability reporting that showcases giving back to the society, which they visualise as making impact to the society. They now want to have two sustainability reports – one that complies with IFRS S1 and S2, the actual sustainability report required by FRC, and another called impact report or corporate responsibility report, which addresses the needs of certain stakeholders and some rating agencies.

Thus, there is a continued manifestation of lack of clarity in the identification and materiality assessment of SRRO and what should form the content of IFRS S1 and S2 Sustainability report. But I wish to expand our view of IFRS S1 and S2 materiality a bit from my last piece, (i.e. Part 2), where I hinted, drawing from IFRS S1(2), that: an entity’s ability to generate cash flows is inextricably linked to the interactions between the entity and its stakeholders, society, the economy, and the natural environment throughout the entity’s value chain.

When IFRS S1 (3) talks about SRRO that could reasonably be expected to affect the entity’s access to capital, or cost of capital, IFRS S1 (2) helps us understand the capital to be the six capitals of integrated reporting which are (a) Financial Capital (b) Manufactured Capital (c) Natural Capital (d) Human Capital (e) Intellectual Capital and (f) Social and Relationship Capital. Materiality assessment therefore extends to the financial materiality of sustainability issues around the six capitals of integrated reporting within the context of the interactions between the entity and its stakeholders, society, the economy, and the natural environment throughout the entity’s value chain. Herein lies the merger of financial and impact materiality and the extinction of double materiality. TO BE CONTINUED.

Innocent Okwuosa is the immediate past Chair of the Nigeria Integrated Reporting Council (NIRC); the 59^th president of the Institute of Chartered Accountants of Nigeria; and an adjunct associate professor at Pan Atlantic University, Lekki, Lagos. He consults with Entop Consulting Ltd.