What is financial materiality for sustainability reporting?
This article is the fifth in a series exploring the role of trustworthy AI in mainstreaming sustainable investing.
The purpose of financial materiality is to tell investors the relevant sustainability risks and opportunities before they allocate capital.
Specifically, the standard IFRS S1 requires an entity to "disclose information about all sustainability-related risks and opportunities that could reasonably be expected to affect the entity’s cash flows, its access to finance or cost of capital over the short, medium or long term".
This seemingly straightforward concept is surprisingly hard to put into practice with sustainability matters. Five issues are regularly cited by investors and other users of the reports
Subjectivity. Deciding what is "material" requires significant management judgement, making it difficult to defend and to compare across companies.
Ambiguous thresholds. The lack of standardised quantitative metrics or weighting leads to inconsistency and lack of trust.
Timeliness. Annual reporting cycles mean that a determination of which topics are financially material can take up to 9 months to be published.
Short-term Focus. Assessments naturally favour the known over the unknown so struggle with longer-term risks inherent in environmental, social and governance factors.
Over-disclosure. As seen from the first wave of CSRD reporting, too much noise buries the signal.
As more and more corporate reporters, institutional and retail investors, and assurance providers are realising, the traditional approach to materiality doesn't work well here. We need to find a better way to fulfil the purpose of financial materiality, not just to meet the regulation but because sustainable investing is increasingly just called investing.
Which risks and opportunities are relevant?
The standard is clear about what "financial" means in this context. It relates to the entity's cash flows, access to finance or cost of capital. These are well-known concepts in accounting and are monitored, reported, analyzed using standard methods by the entity's finance function, its auditors and investors.
However, there aren't any standard methods yet when it comes to sustainability matters. Even within the best-known risk area of carbon accounting to measure greenhouse gas emissions, there are multiple methodologies that give significantly different results. Activity-based vs spend-based methods vs direct measurement for example. Once we get into social or governance issues, there's isn't even agreement on available methodologies.
So, as an investor looking to allocate capital, what can I do? Should I just trust corporate reporters to correctly identify financially material matters? According to Deloitte, "more than two thirds (69) of the FTSE 100 made restatements on their sustainability metrics in 2025, rising for the third consecutive year". Interestingly, Deloitte also reports that 86 of the FTSE 100 are obtaining sustainability assurance. In other words, the reporters realise their reporting isn't trusted prima facie and are paying substantial fees to demonstrate the trustworthiness of their reporting.
To make progress here, one option is to take a data-driven approach to financial materiality. That is, can we build a robust and reliable data pipeline that can analyze the relative significance of sustainability matters as they impact the financial performance of an entity?
In the first instance, we need a Dependent Variable highly related to financial performance against which we can correlate a large number of sustainability Independent Variables. While not perfect, the least worst option here is closing day share price. This is because it is a widely-known and widely-available metric that quantifies all the publicly-available information (including on sustainability matters) known about a listed entity.
Share price as Dependent Variable
To justify our choice of share price as the Dependent Variable, we need to substantiate the relationship between share price and the three measures of financial performance highlighted by IFRS S1, as well as the important issue of timeframe.
An entity’s cash flows
A company’s share price is fundamentally tied to its cash flow, as higher per-share cash generation increases a firm's intrinsic value, funds dividends, and drives long-term stock appreciation. Analysts measure this core relationship using the Price to Cash Flow Ratio (P/CF), which compares a stock's market price to its operating cash flow per share.
Access to finance
Access to finance and a company's share price share a two-way relationship: easy and cheap credit lets firms grow and boosts stock values, while a higher share price makes raising new equity or borrowing money cheaper and easier.
Cost of capital
The cost of capital and a company's share price share an inverse relationship: when the cost of capital rises, the share price tends to fall, and vice versa. This happens because a higher cost of capital reduces the present value of future cash flows used in stock valuation.
Short, medium or long term
In the short term, share prices move based on supply, demand, and market flows driven by news, sentiment, and trading volume. In the long term, share prices are driven by a company's underlying fundamentals, such as revenue growth, profit margins, and overall business performance.
Informed investors
We can calculate which sustainability topics, and to what extent, move the share price up or down each day. The data-driven methodology is here. These daily scores need to be put into context by solving for materiality's 'three body problem'. This methodology is forthcoming.
This data-driven approach offers significant progress against the five issues regularly cited as frustrating to investors and other users of the reports.
Subjectivity. Using share price as a Dependent Variable provides an objective approach to deciding what is "material". Contextualizing these scores by solving the three body problem makes it simple to defend and to compare across companies.
Ambiguous thresholds. The standardization of materiality assessment enables consistency and trustworthiness of financial materiality determinations. However, inconsistencies can emerge further down the line with different methodologies for reporting quantitative metrics on each material topic.
Timeliness. A data-driven approach can be reported weekly, something that is required by investors who need to monitor the performance of their portfolios.
Short-term Focus. Using the context provided by the three body problem, analysts can understand the timeframe of the impact of the material topic on share price.
Over-disclosure. As IFSR S1 specifies, only report what is material and don't report what isn't material. So a data-driven approach saves time, effort and resource by isolating what needs to be reported quickly and with low effort.
An industry standard?
Maxwell Data and the Department of Mathematics at Brunel University of London are currently working with corporate reporters, institutional investors and assurance providers on proof-of-concepts of the data-driven approach to financial materiality. We will present the findings at an industry workshop at UCL Centre for Sustainable Business on 18th September. If there is consensus, we will work with stakeholders to roll out a data-driven approach to financial materiality for sustainability matters as an industry standard ahead of reporting season in Q1 2027.