Responsible Investment Officer - ACTIAM
The financial sector has become an important driver of climate action in recent years. Investors have come together in alliances that advocate net zero emissions, while 90 central banks and financial regulators have joined forces in the Network for Greening the Financial System. The European Union also sees the financial sector as a motor in the transition towards a more sustainable society.
“Although the basic definition of double materiality is now generally accepted, its actual meaning is still a subject of debate.”
In general, climate action in the financial sector consists of setting minimum ethical thresholds and managing climate-related risks. Significant strides have been made particularly with regard to climate risks in recent years. Thanks to the work of the Task Force on Climate-Related Financial Disclosures (TCFD) and other bodies, there is now a growing general acceptance that climate-related impacts on business operations can be material and that such information should be disclosed.
However, some activities can have significant externalities without affecting the value of a company. Take the presence of conflict minerals in the supply chains of electronics companies. The purchase of minerals extracted in conflict areas in many cases contributes to the perpetuation of the conflict and thus human rights violations. On the other hand, conflict minerals have not been proven to negatively impact business value. In other words, it is not financially material in the traditional sense of the word.
In 2017 however The European Commission introduced double materiality as part of the Non-Binding Guidelines on Non-Financial Reporting Update (NFRD). Double materiality means that a negative or positive effect of a company can also be material if it does not affect its value. Companies therefore should assess and publicly disclose these externalities as part of their reporting.
Double materiality is already recognised partly in the EU's Sustainable Finance Disclosure Regulation (SFDR). Furthermore, the current Special UN Envoy on Climate Action and Finance, Mark Carney (formerly the Chair of the organisation that created the TCFD) is calling for the disclosure of double materiality to be made obligatory worldwide in the run-up to the COP26 climate top to be held in Glasgow later this year.
Although the basic definition of double materiality is now generally accepted, its actual meaning is still a subject of debate. In principle, a company's impacts on the climate or the environment as a whole can be material. But how do we know exactly what a material impact is? The material impact of water pollution can perhaps be measured fairly accurately, but what about the impact of companies on social equality, for example?
Therefore, double materiality is still an abstract concept. Its true meaning will very probably be a subject of dispute for some time yet. Until there is an actual method for measuring and reporting double materiality, everyone will interpret it in their own way, thus making it an arbitrary construct with inherent risks of greenwashing.
Introducing double materiality into reporting will increase the amount of attention given to non-financial topics. Companies made to report on them will be more readily inclined to take action and set goals to reduce their impacts, while government authorities will be able to implement and impose policies. In that case, double materiality would have a role in predicting whether a topic also becomes financially material over time.
How do you view this concept as a portfolio manager? To what extent do you take account of investment impacts on society if they don't – or don't yet – have any direct impact on the investments themselves?