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Allen White

Allen White

Ratings, rankings and indices are converging around materiality

December 2015 User View by Allen White, Vice President, Tellus Institute; Co-Founder Global Reporting Initiative and Corporation 20/20; Founder, Global Initiative for Sustainability Ratings, United States

THE User Views of 2015 on Materialitytracker lead us to conclude that the boundaries between financial and non-financial are rapidly dissolving. Debates over the relevance of environmental, social and governance (ESG) issues to long-term business prosperity increasingly feel like yesterday’s controversy kept alive only by a shrinking number of ESG “deniers.” Meanwhile, debates increasingly have turned away from “if” to “how.” How can materiality be brought to bear in the decision-making boards, executives and managers seeking to build companies that are resilient, innovative and, generally, future-fit?

I recall a heated debate in the early days of GRI when a vocal civil society representative repeatedly challenged a technical committee, immersed in designing the 2000 G1 Guidelines, to answer the question, “Relevant to whom?” This question and the discussion that followed, was the precursor to the 2002 G2 Guidelines “Relevance” Principle which, in turn, laid the foundation for the Materiality Principle in the 2006 G3 Guidelines.

In the ensuing years, materiality has become a core concept in the rapidly changing world of ESG disclosure, appearing in various forms in virtually every reporting-related framework and initiative including the International Integrated Reporting Council (IIRC) and the Sustainability Accounting Standards Board (SASB). Beyond reporting, the materiality principle appears in kindred initiatives such as the Global Initiative for Sustainability Ratings (GISR), whose mission is to enhance clarity, transparency, relevance and impact of sustainability ratings, rankings and indexes worldwide. GISR’s definition echoes those that appear in the various reporting initiatives:

“A rating should assess performance based on sustainability issues relevant to the decision-making of stakeholders for which a rating is designed.”

The GISR Principles (version 1.1 2015) explain the basic materiality test for a rating as being whether exclusion of an issue would significantly alter the decisions of a rating user. It notes that materiality is not constant. It varies over time and across users, even within specific stakeholder groups or individual constituencies (such as different types of investors). The GISR guidance also recognizes that evidence of both short-term and long-term performance is useful to the materiality determination process, as well as the interdependence of sustainability materiality and financial materiality.

Parallel to developments in the equities field, pressures are mounting on credit rating agencies to accelerate integration of ESG content into assessing fixed income securities. A recent example: Moody’s downgrade of Volkswagen following revelations of deceptive emissions data which many observers attribute to flawed corporate governance.

How credit raters calculate the risk of climate change on creditworthiness has also come under scrutiny. In a recent report, the Centre for International Environmental Law (CIEL) has cautioned that inadequate accounting for climate risks may lead rating agencies to repeat the mistakes of that contributed to the recent financial crisis. Finally, The Principles for Responsible Investment (PRI) is active in advancing ESG in fixed income investing, potentially leading to a joint investor-credit rater “Statement on ESG and Credit Ratings”.

As materiality has moved to center stage in guiding company and investors’ search for relevant performance metrics, global economic, social and geo-political trends continuously expose possibilities for augmenting or reprioritizing material issues. Mass refugee flows triggered by civil strife, climate instability and economic inequality; plummeting oil prices in the face of a global oil glut; persistent uncertainty in global financial markets in the wake of the 2008-2009 financial crisis. Trends such as these point to a new form of materiality: systemic risks which are rarely recognized, much less assimilated, by investors despite their irrefutable relevance to long-term performance of their portfolios. This omission has been highlighted by US-based Investment Integration Project.

Such risks bring an additional layer of complexity to an already complicated materiality landscape because systemic risks are simultaneous—that is, at the same time they may affect and be affected by investment decisions, especially those made by large institutional and sovereign funds that control the bulk of world’s assets under management.

Amidst the dynamics of an interdependent world looms an additional force that is reshaping the concept of materiality: a small but growing movement to rethink the very purpose of the corporation. Those who subscribe to the myopic, shareholder-centric purpose are likely to find themselves on the wrong side of history in the coming decade as the role and responsibilities of business will be subject to increasing scrutiny.

Already, the “Statement of Significant Audiences and Materiality Campaign,” launched by Bob Eccles and colleagues has assembled a database of 30-plus national laws—including all G20 countries–pertaining to the duties of corporate boards. This database uncovers new opportunities for broadening the definition of fiduciary duty beyond company shareholders. It will fuel ongoing debates about the obsolescence of shareholder value as the paramount purpose of the corporation, and accelerate the shift toward a broader, more inclusive concept of its raison d’etre (see

In a mere decade and a half, materiality has moved from novelty to mainstream in shaping how business does business. Operationalizing the concept will always remain work in progress, reflecting the constantly shifting conditions shaping global business in the 21st century. Pressures to bring a more holistic, long-term perspective to materiality in law, regulation and strategy are inevitable, and methodological innovation will continue apace. Engaged investors and companies alike will be well served by active participation in shaping this future.

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