Filling in the Materiality Gaps in Non Financial Disclosure

Non-financial disclosure is the starting point to understand a company's policies for investors interested in Environmental, Social and Governance (ESG) topics. Since 2018, the EU's Non-Financial Reporting Directive (NFR Directive) has required member states to make these reports mandatory for large companies. But comparing these documents to make investment decisions is difficult, because of the discretionality left to Member States and to the minimum harmonization approach taken by the Directive.

The notion of "materiality" is a source of uncertainty. The paper "Making non-financial information count: accountability and materiality in sustainability reporting" by Chiara Mosca (Associate Professor in Business and Company Law) and Chiara Picciau (Academic Fellow in Business and Company Law) argues that the concept of materiality in non-financial disclosure cannot and should not be a duplication of materiality in accounting, auditing and financial markets regulation.

"The problem now is to find a notion of materiality that addresses ESG problems" said Mosca. 'Materiality' has a long-standing tradition with short-term financial information, but not with the long-term effects of companies' behaviors and externalities. Materiality theory can be adapted to non-financial disclosure. To move the focus, we need to be very clear about what we need to disclose."

The topic of standards in ESG investing is fast-moving and difficult to tackle, Mosca noted. "Companies could engage in greenwashing in their non-financial disclosure, and do not calculate the costs of negative externalities of their businesses that are borne by society as a whole. In this respect, the European regulatory framework is evolving quickly, but there is still a lot to be done."

The first part of the paper looks at the link between Corporate Social Responsibility (CSR) and sustainability, and the second part examines the legal strategies employed by the European lawmaker to foster sustainability, considering to what extent the European regulatory framework effectively shifts the focus of corporate governance from shareholders to other stakeholders.

The third part argues that materiality in non-financial disclosure should go beyond the benchmark of the "reasonable investor", to pay attention to the effects of social and environmental issues and to long-term risks and opportunities.

Mosca and Picciau come to two main conclusions. The first is that further EU legislative intervention governing comparable and standardized non-financial information is necessary to support ESG investing choices.

"The combined impact of the SHRD II, the MiFID II and the Non-Financial Disclosure Directive is that of enabling and inducing institutional investors and financial intermediaries to take ESG factors into account in order to make sustainable investment choices. A stronger regime of non-financial disclosure at the European level facilitates this result," the paper said.

Secondly, corporate governance still ultimately relies on shareholder (not stakeholder) interests as the fundamental benchmark against which non-financial disclosure should be assessed, even though in a new socially and environmentally responsible dimension. If companies want to be more responsible, they require the active contribution of shareholders.