Alexandra Tracy, President, Hoi Ping Ventures, looks at the difference between single and double materiality, and explains the basis of Hong Kong’s upcoming implementation of the new ESG reporting regime.

At the United Nation’s Climate Change Conference in Glasgow (COP26) in 2021, investors, policymakers and companies alike heaved a sigh of relief to hear the announcement of the formation of the International Sustainability Standards Board (ISSB), which would end the ‘alphabet soup’ of voluntary disclosure initiatives, and put in their place a concrete and efficient reporting framework.

Building on the work of many of the then-existing initiatives, including such venerable organisations as the Climate Disclosure Standards Board, the Task Force on Climate-related Financial Disclosures (TCFD) and the Sustainability Accounting Standards Board, who had led the development of the market over multiple years and are now subsumed into the International Financial Reporting Standards (IFRS) Foundation, the ISSB’s mandate has been to develop a common set of high-quality, consistent standards for sustainability disclosure.

By mid 2023, the ISSB had published its first two highly anticipated disclosure standards – IFRS S1, covering general sustainability concerns, and IFRS S2 on climate disclosures. By the end of the year, the ISSB was able to announce that more than 20 policy and regulatory bodies around the world had issued statements of support for the new standards, with many countries planning to implement national disclosure frameworks aligned with them.

Hong Kong Exchanges and Clearing Limited (HKEX), which was one of the earliest adopters of the ISSB’s reporting principles, incorporated the ISSB standards into its Environmental, Social and Governance Reporting Code (ESG Code) – renamed from ‘Guide’ to indicate the heightened expectations of listed companies. The ESG Code will be implemented in phases from January 2025. In addition to mandatory disclosure of Scope 1 and Scope 2 greenhouse gas (GHG) emissions, Main Board listed companies must provide information, on a ‘comply or explain’ basis, on climate-related risks and opportunities, governance, strategy, risk management, and metrics and targets.

Harmonisation – up to a point

So far, so straightforward.

But the ISSB is not the only standard-setting body in the world and, while there is widespread support for efforts to harmonise global disclosure rules, there is also a substantial sticking point – how to define ‘materiality’ for the purposes of financial reporting.

Materiality refers to the significance or relevance of information in a company’s decision-making processes. The ISSB’s standards are based on financial, or ‘single’, materiality, taking into account sustainability issues only to the extent that they create financial risks and opportunities for the company, and which could affect its financial performance, that is, its cash flows, access to finance or cost of capital over the short, medium or long term.

The alternative approach is to assess ‘double’ materiality, which involves evaluating both financial materiality and so-called impact materiality, or measuring how a company’s operations impact on society at large, not just on its own performance. And while the ISSB has been formulating IFRS S1 and IFRS S2 on the basis of single materiality, its counterparts in the European Union have been taking a different path.

The European Union path

The phrase ‘double materiality’ was coined in 2019 by the European Commission when it laid out its philosophy that: ‘EU sustainability reporting standards need to be consistent with the ambition of the European Green Deal and with Europe’s existing legal framework, the Sustainable Finance Disclosure Regulation and the Taxonomy Regulation. They need to cover not just the risks to companies, but also the impacts of companies on society and the environment.’

In July 2023, the European Commission adopted a regulation in the European Sustainability Reporting Standards (ESRS) detailing the requirements for companies under the EU’s Corporate Sustainability Reporting Directive (CSRD), which came into force earlier that year. One of the key features of the CSRD is the explicit recognition of double materiality. According to the ESRS, therefore, companies are obliged to report on the actual, or potential, positive or negative impact on the people and the environment around them over the short, medium and long term.

In order to meet this reporting requirement, which is highly complex and detailed (comprising 10 topics, 36 sub-topics and 92 sub-sub-topics), companies must undertake rigorous assessments of their operations, supply chains and broader interactions with a wide range of stakeholders. When assessing what is material, CSRD guidance suggests that the severity of an impact should be analysed based on its scale, scope, likelihood and difficulty to remediate.

The identification, measurement and disclosure of these impacts requires companies to put in place a systematic materiality assessment process, often involving new methodologies and data collection mechanisms. Under the CSRD, reporting companies are also obliged to provide third-party assurance of their sustainability disclosures.

Double materiality in practice

The divergence of approach between the ISSB and EU regulators does not reflect any disagreement on the importance of sustainability disclosure as part of a corporate reporting regime. The ISSB’s framework leans heavily on the work of the TCFD, which emphasises the financial impacts of climate change, and encourages companies to assess and disclose climate-related risks and opportunities affecting their businesses.

Rather, the issue is whether incorporating double materiality into the mandatory standard is practicable. There are currently hardly any economic frameworks that can be used by investors to calculate external social and environmental costs on a consistent basis. Metrics that are available, such as those related to biodiversity, are at a very early stage of development and tend to be applicable only to specific localities. As Emmanuel Faber, Chairman of the ISSB, wrote in an opinion piece in Le Monde in October last year: ‘The non-economic aspect of double materiality does not motivate any immediate, clear or strong sanction. A major issue for one player will be secondary for another.’

Certainly, the exercise of carrying out a double materiality assessment could be viewed as demanding. According to the CSRD guidelines, in order to assess its impact on the wider world, a company needs to understand the sustainability-related expectations for its sector, and consider the areas it may impact throughout its own operations and its full value chain, as well as all the parties who may be affected. As part of this exercise, the company is expected to carry out extensive stakeholder engagement through surveys, interviews or focus groups.

Moves toward interoperability

While the ISSB has strongly resisted calls from regulatory authorities and industry associations such as the European Securities and Markets Authority and the European Banking Federation to move in the direction of double materiality, it is taking steps to improve its comparability and interoperability with other sustainability reporting standards, and to minimise reporting burdens, costs and complexity for companies.

For example, the ISSB and the European Financial Reporting Advisory Group have jointly published interoperability guidance for companies applying both the ISSB standards and the ESRS. This states that disclosure which is considered material under the ISSB framework is aligned with the assessment of whether that disclosure is financially material in accordance with the ESRS and vice versa (but also makes clear that the ESRS requires companies to evaluate additional sustainability matters that are not covered in IFRS S1 or IFRS S2).

The ISSB has also made substantial efforts to collaborate with the Global Reporting Initiative (GRI), a voluntary global standard-setter for sustainability reporting used by a large number of companies around the world, which takes the impact materiality approach. In 2022, the two organisations signed an agreement seeking to coordinate their work programmes and to align where possible to reduce the reporting burden for companies using both standards.

A global baseline, but local implementation

The ISSB standards provide a comprehensive global baseline of sustainability disclosure standards, but national policymakers are free to decide on how to mandate them or how to combine them with jurisdiction-specific requirements. In addition to Hong Kong, regulators in Asia are considering their own road maps towards adoption and pathways toward mandatory application.

In many cases, this will lead to a phased approach. For example, in Singapore, from January 2025 new ISSB-aligned climate-reporting requirements will apply to listed companies on a mandatory basis. This will be stepped up to include limited assurance from an independent auditor to support disclosure of Scope 1 and Scope 2 GHG emissions from January 2027. Singapore is notable for being the first jurisdiction in Asia that plans to introduce the same mandatory climate-related reporting requirements over time for large non-listed companies.

Japan is also moving toward incorporating ISSB-aligned standards into its own framework. The Financial Services Agency is planning to apply a new mandatory disclosure rule in phases, beginning with the largest listed companies in the financial year ending March 2027. All companies listed on the Prime section of the Tokyo Stock Exchange are eventually intended to be covered.

The Ministry of Finance of the People’s Republic of China has also published a draft framework for corporate sustainability disclosures that is broadly in line with the ISSB rules. Its structure is similar to IFRS S1, outlining how companies should disclose information in four key areas – governance, strategy, risk management and metrics. However, in a major diversion from the ISSB approach, the Chinese proposal is based on the concept of double materiality. Like the CSRD, it clarifies that impact materiality must be judged over the short, medium and long term on its scale, scope, likelihood and difficulty to remediate. Companies are furthermore required to make ‘reasonable efforts’ to collect sustainability information on risks, opportunities and impacts throughout their value chains, or to provide the best available proxies, such as industry average figures.

Hong Kong implementation

In planning for its adoption of the ISSB standards, HKEX did not reject the concept of double materiality out of hand. The GRI, with its focus on impact materiality, has been for some years a popular benchmark for Hong Kong companies in putting together their sustainability or ESG reports. Indeed, in its conclusions on the market consultation this year with regard to the new regime, HKEX reported that the materiality reporting principle of its ESG Code was developed in 2012 with reference to GRI standards.

However, HKEX clarified that under its ESG Code, materiality is defined as ‘the threshold at which ESG issues determined by the board are sufficiently important to investors and other stakeholders that they should be reported’, which it believes is sufficiently wide to encompass a range of materiality considerations, including, but not limited to, financial materiality. Therefore, an issuer is obliged to disclose material information about sustainability-related risks and opportunities that could reasonably be expected to affect its cash flows or its access to finance or cost of capital over the short, medium or long term, which is consistent with the ISSB approach.

Following on from the implementation of new standards by HKEX, ESG reporting in Hong Kong is expected to converge more closely with the ISSB framework. The Hong Kong Institute of Certified Public Accountants is currently consulting on local sustainability reporting standards for companies, to be aligned with the ISSB standards, for introduction in August 2025.

Alexandra Tracy, President

Hoi Ping Ventures

Hoi Ping Ventures provides bespoke research and consulting on green finance and sustainable investment in Asian emerging markets.