As part of IFAC’s strategic effort to support integrated reporting and the International Integrated Reporting Council (IIRC), we jointly developed Materiality in Integrated Reporting: Guidance for the Preparation of Integrated Reports. It responds to requests for additional guidance on applying materiality in integrated reporting and to support implementation of the International Integrated Reporting Framework.
30% of respondents to the IIRC’s then-Consultation Draft for the proposed Framework in 2013 asked how the Integrated Reporting Framework’s materiality process would relate to those in other reporting standards and frameworks. This guidance addresses this question and provides suggestions on how to approach the process in preparing an Integrated Report.
Specifically, it highlights the key aspects of materiality in integrated reporting, and provides guidance on implementing the process from identifying relevant matters at the board and management level through to deciding on material matters for disclosure in an integrated report.
An important place to start when thinking about materiality, however, is to go back to basics. As a reporting framework, a definition and materiality process is a critical element of integrated reporting as it is in other reporting standards and frameworks. Whether applying financial reporting standards or the Global Reporting Initiative’s Sustainability Reporting Guidelines, materiality is a concept and process used to:
- Focus management and users on matters that they need to know;
- Ensure concise reporting that limits extraneous information and clutter; and
- Reveal information that informs the decisions of users.
Where materiality in integrated reporting differs is in relation to audience, purpose, and scope. Integrated reporting focuses on:
- The information needs of providers of financial capital;
- How value has been created (or destroyed) over time, which might be measured by financial metrics such as cash flows, although evaluating the value delivered to other stakeholders will involve a range of metrics and indicators as well as a compelling narrative;
- A six capitals model covering a full range of tangible and intangible assets that could drive value creation and performance over time. These capitals are broader than the environmental, social, and governance factors typically referred to in the investment and sustainability community; and
- Through the eyes of management so that material matters are aligned with the business decisions made by the board of directors (those charged with governance) and senior management.
It is critical that integrated reporting is not viewed simply as another reporting exercise. Critical aspects to note in ensuring that integrated reporting delivers on its objectives, and that the benefit of integrated reporting exceeds the cost include:
- The materiality process is closely linked to the main issues and trends related to value creation that are discussed at meetings of those charged with governance. The ultimate test of most providers of financial capital is whether they have confidence in the way an organization is governed and managed, and a significant part of coming to a view is based on who has been involved in the process of determining material matters and how the process has been managed.
- Internally defining and articulating the value creation process builds a collective understanding of the key matters among management and those charged with governance. The value creation process needs to be understood and articulated within the organization before the materiality process can be implemented. In their integrated reports, companies should be including a graphical representation of their value creation process that includes a representation of their business model.
- Integrated reporting should lead to concise reporting—focused on the matters that matter. For most companies, the number of factors that are likely to have a material bearing on value creation are limited. Perhaps no more than ten or so areas relate to the organization’s objectives, and core threats and opportunities. A materiality process that yields many more matters for disclosure is most likely not fulfilling the objectives of integrated reporting.
- You can improve business reporting process efficiency by identifying where reporting strands are mutually supportive and can be aligned. In fulfilling their duty to disclose information under securities or corporate law, the board, supported by management, should consider how regulatory disclosures relate to the integrated report. Or, viewed the other way around, many matters flagged as material in integrated reporting may be subject to disclosure under company and securities law. For example, the materiality process applied in integrated reporting can be kept closely linked to the one applied to regulated forms of reporting and disclosure. This may end up with the principles of integrated reporting being applied to regulated disclosures, such as the Strategic Report in the UK.
In practice, there can be difficult challenges in implementing integrated reporting, such as ensuring the board and senior management truly own integrated thinking, and the subsequent integrated reporting process (see IFAC’s Creating Value with Integrated Reporting for more on integrated thinking). Practical challenges exist around managing uncertainty and having confidence in the intangible drivers of value, and related measurements, which will ultimately affect the organization’s ability to create value over time. Absolute clarity and foresight on which capitals and aspects of the value creation process are driving value is unachievable. But those who provide financial capital are looking at an organization’s capacity for integrated thinking, evidence that it is investing adequately in the right capitals and necessary changes to the business model, and ultimately seeking confidence that the management is in control of the matters that matter.