Is ‘Materiality’ in the Eye of the Beholder? Part II

Part II of II:

In my previous post, we looked at materiality’s determination focusing on changing components in the eye(s) of the beholder(s). We now turn our attention to the role of non-market actors in terms of their impact on the moving definitional target of materiality. In other terms many have formulated this as a matter of stakeholder interests and concerns. For example, Eccles and Spiesshofer distinguish sustainability reporting (SR) from integrated reporting (IR) by arguing the former’s audience is stakeholders, while the latter’s are investors (and ‘significant audiences’).

While I think there is a difference between the two types of reporting (SR and IR) especially as RI focuses on materiality (as previously defined), I’m not convinced that the difference is a stark one, or indeed a too meaningful one. This is because ‘stakeholders’/civil society (SR) influence over time component parts of what the reasonable investor might come and in fact often has come to consider material. This is so in two ways. The first is that stakeholders (and ‘significant audiences’) impact what major market actors think and how they act. Many U.S. Securities and Exchange Commission guidance actions make this explicit, for example. This process is complex and for the moment is beyond the scope of this piece. But to the degree it is true, what a reasonable investor thinks is value or voting salient is influenced over time, and often strongly so, by stakeholders, that is, by ‘society’ and changing norms, discoveries, scientific knowledge and the like.

The second way that the reasonable investor may come to view what was once immaterial as material is due to the very nature of major market actors themselves. That is to say, large institutional owners are in their vast majority universal owners –UOs — (owning a representative cross section of the ‘whole’ economy). Additionally, most of these institutions are also fiduciaries (at least in common law nations). I’ve characterized this combination as the investment and ownership system of fiduciary capitalism. ((With my colleague Andrew T. Williams, most developed in our book, The Rise of Fiduciary Capitalism (University of Pennsylvania Press, 2000).))

As UO’s manage the investments and pensions of about 65% of the adult U.S. population (for example) their fiduciary obligation (which arguably to the investors or beneficiaries) is to the management of the whole portfolios, not just to each component part. Thus UOs (and others) have tended increasingly to take into account the negative and positive externalities economic activity necessarily produces. Therefore, looking at a portfolio holistically means accounting for these externalities, proportions of which are internalized within the portfolio as a whole. Portfolio internalization excludes traditionally viewed ‘social costs’ of externalities (e.g. impact on health and water), but could include such effects as second order portfolio impacts. In the carbon case for example, green house gas impact almost all sectors of their investments and are demonstrably ‘material’ (read: have economic and financial impact) on the portfolio’s value.

For example, as this has become clearer and clearer over the last twenty or so, carbon moved from being a ‘stakeholder’ issue to a stockowner issue as well. It thereby became increasingly material in the eyes of the reasonable investor. Witness, for example, the growth of markets to price carbon (all driven by various types of government mandates). Thus, there has been a strong overlap between market and ‘non market’ actors in part due to the very nature of UO’s and the fact that they in the last thirty or so years to dominate markets across asset classes in the U.S., U.K. and some other countries.

This takes us to item three: that integrated reporting (IR) needs to take account of this ownership transformation that underlies fiduciary capitalism and pay close attention to the dynamics of materiality’s component parts. This does not in any way vitiate the need for IR, or its necessary focus on materiality, but rather I think suggests that IR needs to take full account of the market dominance of universal owners that are fiduciaries. They in turn have been key in influencing the market’s views of materiality. In somewhat oversimplified terms, UOs and others have been both the ‘eye’ and the ‘beholders’. UO’s have played a critical role in defining materiality regarding E, S, and G.

One implication is that when a firm’s board sets out to determine what is material, engaging with a range of its owners (in most cases the hugely dominant owners) should be a critical priority. UOs do not and will not necessarily share a singular view of what is material on all matters, but it is clear, for example, the in the last twenty years or so governance (G) went from a marginal issue to a core one that is ‘material’. Many environmental issues are moving along the same curve, as are some social issues, e.g. labor conditions in the supply chain. ((Asset owners (and some asset managers) have worked to find common ground, whether through the Principles for Responsible Investment or other organizations and alliances. See for example, CalPERS,

In future posts, I want to look at what various perspectives on what is ‘material’ may imply for the multitude of rating and ranking entities, indexes and organizations about which the Global Initiative for Sustainability Ratings (GISR) is attempting to track and evaluate. ( I will also raise the question of whether E, S, and G data (each considered separately, not as one ‘ESG’ acronym) can or even should be standardized whether within on legal jurisdiction or across them. I also want to discuss the problem of third party assurance and auditing, again focusing separately on E, S, and G, and, as appropriate, various sub components (e.g. carbon as part of E) as part of integrated reporting.