Materiality Matters: Sustainability Standards for the Form 10-K

By Jean Rogers, Founder and Executive Director, the Sustainability Accounting Standards Board (SASB).

Materiality: what does it mean in relation to sustainability, and how can an improved understanding of it change how companies manage and investors invest?

As mentioned on this blog last September, SASB is developing industry-specific accounting standards for use by corporations and their investors, designed for use in the mandatory filings of publicly-traded companies in the US, such as the Form 10-K. These standards will help companies address, and investors analyze, the most material environmental, social and governance (ESG) issues in their industry. We solicit feedback on our standards via Industry Working Groups, which include industry experts across three interest groups: market representatives, corporate representatives and intermediaries.

At SASB, we follow the Security and Exchange Commission’s (SEC) definition of materiality. In simple terms, some matters are important to the fair presentation—to the reasonable investor—of an entity’s financial condition and performance. We believe that a reasonable investor would want to know about financial impacts, industry norms, shareholder and stakeholder concerns, and opportunities for innovation. Our materiality tests—which help us identify the top 10 or so material sustainability issues per industry—capture these variables. SASB has adopted this legal definition because no additional regulation is required: the SEC already requires material issues to be disclosed in the Form 10-K. SASB provides much needed guidance on what issues are material in each industry, and SASB standardizes the form of disclosure, so that investors can benchmark performance.

Incorporating sustainability into materiality matters because we live in a changing world. Amidst great uncertainty and resource constraints beyond access to capital, we face mega-trends like climate change and population growth. Intangible assets now compose 80% of S&P Market Value, up from 15% in 1975. Yet, our capital markets have failed to evolve to provide the information that investors and the public need to assess how companies are performing in this new world. We must be able to understand how well companies are using all forms of capital to create long-term value and achieve economic prosperity.

The implications of ignoring sustainability challenges could be profound, for capital markets and human health. A recent study from The Actuarial Profession found that resource constraints could trigger a long term deterioration of the global economy, including: low economic growth (low rates of returns on real estate and other asset); inflation (low real wage growth); and demography (social and economic trauma leads to declines in life expectancy). This study, while painting a dire picture of a worst case scenario, also represents hope: the actuarial community is now calling for the accounting of ESG risks in financial evaluation models.

At SASB, we also believe that the incorporation of ESG information into standardized reporting structures will restore stability to the US capital markets. In our work so far, we’ve seen that companies are not currently prioritizing the management of material sustainability issues. In a review of the CSR reports of the top 5 U.S. companies in each of the 5 industries in Health Care, between 70% – 80% of harvested KPIs related to immaterial issues. Most data reported has no demonstrated links to a material effect on valuation. Current disclosure—reinforced by ratings and rankings—is focused on “quantity” over “quality.”

SASB helps surface data on the issues that truly matter to performance on an industry-by-industry basis. Our working groups thus far tell us that SASB standards yield decision-useful data for corporations and investors alike.

Evaluating the materiality of sustainability issues involves looking beyond conventional measures of assets and liabilities, to those embedded in aspects of social and environmental performance and stakeholder relationships. Identifying material sustainability issues may not only determine whether our future economy succeeds or fails—but whether our future health prospers or declines.