The adoption of the Corporate Sustainability Reporting Directive (CSRD) and the European Sustainability Reporting Standards (ESRS) represents a significant step towards a transition to a more sustainable and inclusive economic system. The CSRD is more than just a reporting mechanism, as it is situated within the broader context of the European Commission’s Sustainable Finance Action Plan (2018) and European Green Deal (2019). The Directive aims to facilitate more responsible and transparent business practices. The CSRD, together with the ESRS, broadens not only the scope of reporting for a larger number of European companies. It also strengthens sustainability in reporting by explicitly introducing a requirement for ‘double materiality’. This is a positive step in the right direction but further steps must be taken to achieve accounting regulation that will truly contribute to sustainability.
What is double materiality and why should we care about it?
Double materiality in corporate sustainability reporting requires companies to report both on how sustainability matters affect the companies and their investors, and the impacts of those companies on people and the environment. Information regarding companies’ impact on people and the planet is pivotal to connect business practices to the broader policy objectives of the European Green Deal. An impact materiality perspective in corporate sustainability reporting is therefore necessary for shaping and monitoring the new EU green political economy.
Double materiality as an EU constitutional principle
According to the Preamble of the CSRD, corporate sustainability information is expected to ‘contribute to the European public good’ (Recital 39). However, this notion is not defined by the CSRD, so it must be derived from EU law and especially the EU constitutional framework, the Lisbon Treaty, amending the Treaty on European Union (TEU) and the Treaty establishing the European Community, renamed the Treaty on the Functioning of the European Union (TFEU).
Article 3(3) TEU describes the socio-economic model that the EU aims to pursue and sets the objective of sustainable development at its foundation. The concept of ‘European public good’ should therefore align with this sustainable development objective. The TEU and the TFEU rank the highest in the EU legal hierarchy and therefore are the basis for secondary legislation as directives. Additionally, the teleological interpretation of EU law requires interpreting secondary legislation so that they in the best way achieve the Treaty objectives set in them. This means that any provisions in the CSRD, including the notion of information materiality, should be consistent with its Treaty objectives both in the content and in the interpretation.
Based on our analysis ‘European public good’ should be interpreted to mean ‘European common good’ as in the Treaties, requiring a collective effort for sustainable development, which includes protection of the rights of future generations.
How can double materiality contribute to achievement of the EU’s objective of sustainable development?
Sustainable development is, however, an open concept in the TEU. Our claim is that it entails positioning corporate purpose and business value creation within the research-based concepts of planetary boundaries and social foundations. In reporting, information that is material from an impact perspective is fundamental for orienting businesses according to sustainability criteria and monitoring their contribution to the overarching EU’s objective of sustainable development. It becomes crucial to adopt an impact perspective on business operations in addition to a financial one.
What are the consequences for interoperability with other standards?
We argue that a single materiality perspective, focusing on the financial effect of sustainability factors, is inconsistent with the EU constitutional objective of sustainable development. That single materiality approach has, however, been adopted as part of EU law in financial accounting with the International Financial Reporting Standards (IFRS). There is therefore a discrepancy between financial and sustainability reporting. At a micro-level, an impact materiality approach to corporate reporting is essential for assessing the alignment of each single business with planetary boundaries and social foundations. At a macro-level, it is key for evaluating the contribution of the economic system to sustainable development.
From a legal viewpoint, a materiality perspective that disregards the impact dimension of businesses fails to ensure a high level of protection for the environment, which is established in Article 11 TFEU as the guiding principle for all EU policies and activities. For instance, the precautionary principle in Article 191(2) TFEU should apply also to materiality, to prevent EU policies and interpretations harmful to the public or the environment. Failing to consider the impact dimension of businesses' operations would also open to possible actions from interested and affected parties before courts, including the European Court of Justice, for violation of the Treaty obligations.
What does this mean for the European standards-setting process?
However, there are flaws in the EU standard-setting process, too. The Commission is relying on a private entity, the EFRAG, drawing its mandate from the ‘public interest’, the same concept as that used in the IFRS system to justify single materiality. We see that EFRAG’s nature and current structure, as well reference to the public interest, is in tension with the broader objective of an accounting system for the common good.
The Treaties contains provisions aimed at protecting a pluralist view of society, especially Article 9 TEU on equality between EU citizens and Article 15 TFEU on transparency in the EU decision-making. These requirements are not adequately reflected by EFRAG. To align with the European pluralist constitutional system of the Treaty, the ESRS standards-setting process must be safeguarded against special interests represented in EFRAG. Significant environmental and sustainability expertise is also needed to scrutinize and understand the corporate and investment impacts on the Earth system and on people to fulfil the requirements of double materiality.
Independence from private economic actors and organizations, along with an EU salaried staff and improved monitoring from the European Parliament, could represent one important step to ensure that the standard-setting process pursues the ‘common good’, in line with the EU constitutional setting, rather than merely serving the ‘public interest’ of private interests. Therefore, the substantial funds allocated for transitioning towards a green and just society should also been directed to transform the EFRAG into a public European agency for accounting standards.
Finally - a new explicit accounting law concept is necessary
Building on our analysis we propose to introduce an explicit EU accounting law concept of the common good in the EU Accounting Directive covering both financial and sustainability accounting and disclosure, directly referring to the goal of sustainable development established by the Lisbon Treaty. By doing so, sustainable development becomes legally binding in substantive accounting regulation, offering a clear objective that accounting standards within the EU must fulfil.
This explicit accounting law concept of common good should drive the entire accounting standards-setting process and organization, ensuring alignment with the EU constitutional framework. Double materiality would therefore become a constitutional concept in accounting regulation, extending to the field of financial reporting as well. Adopting an impact materiality perspective on the Accounting Directive, including both financial and sustainability accounting, and on standards adopted based on the Directive would also require a thorough reform of the financial reporting standards endorsement and adoption mechanisms. It would mean a critical political and legislative evaluation of the IFRS accounting standards as part of EU accounting law.