In this blog article, we will explore the meaning of Double Materiality and discuss how organisations can approach it in their ESG strategies.
Double Materiality in ESG expands the traditional view of materiality, considering both the financial impact of ESG issues on companies and the effects of companies' actions on the broader economy and society. It involves assessing the financial risks and opportunities related to ESG factors while also recognising the impacts of corporate practices on stakeholders and the environment. This approach acknowledges the interconnectedness of business and sustainability, fostering a more holistic understanding of ESG considerations for informed decision-making and responsible investing.
Financial materiality helps companies prioritise ESG issues based on their potential influence on financial performance and shareholder value. By focusing on ESG factors that directly impact revenue, costs, and profitability, companies can make informed decisions to mitigate risks, capitalise on opportunities, and enhance long-term financial sustainability. Recognising the financial implications of ESG issues allows companies to align their strategies with responsible practices, foster stakeholder trust, and drive value creation for both the organisation and its investors. For example, a major food processor will identify climate change as financially material due to its potential impact on agricultural supply chains and production costs. To address this, they invest in renewable energy sources, enhance supply chain resilience, and explore alternative sourcing options to safeguard revenue and shareholder value in the face of climate-related challenges.
Societal materiality expands the scope of materiality beyond a company's financial performance to encompass the broader impact of its activities on society, the environment, and the economy. It involves considering how a company's operations, products, and services contribute to or detract from sustainable development goals, societal well-being, and environmental preservation. For instance, a global fashion retailer may recognise the societal materiality of its supply chain practices. Through its ESG analysis, the company identifies labor conditions and human rights as critical aspects. To address this, it strengthens supplier engagement, implements fair labor practices, and ensures transparent sourcing. By considering the societal impacts of its supply chain, the company seeks to support the well-being of workers, foster community development, and contribute positively to sustainable fashion practices.
To effectively incorporate Double Materiality into their ESG strategies, organisations can follow these steps:
Engaging stakeholders is a critical aspect of conducting a double materiality assessment, as per the European Sustainability Reporting Standards (ESRS) related to the CSRD. The assessment involves identifying stakeholders impacted by the organisation and those who can affect it. Utilising stakeholder mapping can help determine the relevant groups to involve directly in the materiality assessment.
The purpose of stakeholder engagement is to gain insights into how the organisation's actions may impact people and the environment, and to receive input on material sustainability matters. This engagement can reveal new sustainability concerns to be considered during the assessment process. In subsequent steps, qualitative and quantitative stakeholder input informs the assessment of impacts, risks, and opportunities.
Under CSRD, the approach to stakeholder input has changed. Instead of asking stakeholders to identify important topics, they are now requested to highlight the organisation's most significant impacts and sustainability risks and opportunities. This can be challenging for stakeholders, given the diverse range of ESG topics to consider from these perspectives.
To address this challenge, conducting part of the assessment with internal and external experts on various sustainability matters can provide valuable insights into the organisation's impact. Additionally, this approach allows stakeholder dialogues to focus on improvement areas for the organisation. Stakeholder engagement should not only serve as input for the materiality assessment but should also include discussions on strategy, policies, and action plans related to these topics.
As part of the double materiality assessment, organisations should create a comprehensive list of sustainability matters to consider. The European Sustainability Reporting Standards (ESRS) provide a sector-agnostic list of such matters, serving as a starting point. EFRAG has also published Guidelines for Double Materiality.
In addition to the ESRS list, organisations must identify entity-specific sustainability matters that may not be explicitly mentioned in the standards. For example, a company's tax policy can significantly impact society and pose risks and opportunities concerning tax transparency regulations.
Furthermore, organisations should be prepared to address sector-specific sustainability matters based on sector-specific ESRS, currently in development. When identifying these matters, factors such as the organisation's sector of activities, geographical scope, and value chain stages should be taken into account.
To avoid overwhelming themselves with an extensive list of topics, organisations can collaborate with internal specialists and utilise internal resources, such as strategy documents and risk assessments. These actions help create a concise and actionable shortlist of topics for further assessment. Previous materiality assessments, external documentation, and insights from stakeholder engagement can also serve as valuable sources of input.
After identifying the relevant sustainability matters, the next critical step is to define them in terms of their impacts, risks, and opportunities, as required by the ESRS.
Defining these aspects can be complex, considering the multifaceted nature of impacts on people and the environment, which can be positive or negative, actual or potential, and interconnected with other topics. Moreover, the impacts, risks, and opportunities can manifest in the short, medium, or long term, across the entire value chain.
To ensure comprehensive assessments and avoid duplicative efforts, organisations should involve all relevant units within the organisation. Given that these assessments must encompass the entire value chain, stakeholder engagement and input from subject matter experts are crucial. For instance, expert consultation may be needed for topics like biodiversity-related impacts and human rights in the supply chain.
Once sustainability matters have been described in terms of impacts, risks, and opportunities (step 3), the next crucial step is to quantify these impacts (step 4) along with the risks and opportunities (step 5). This involves assessing the extent of damage caused by certain activities, the number of affected individuals, and the cost of mitigating negative impacts.
To ensure compliance with ESRS parameters and facilitate future disclosures, a detailed and granular assessment is necessary. This level of detail helps determine which disclosure requirements and data points are material, and it sheds light on how organisations manage impacts, risks, and opportunities related to each topic, thus clarifying strategic implications.
To gather input for quantitative assessments, engaging with stakeholders and experts, both internally and externally, through interviews, surveys, and workshops is essential. Moreover, a holistic, top-down review of the outcomes is advised to address the challenge of comparing impacts that vary significantly in nature. For instance, comparing the materiality of biodiversity with corruption requires careful consideration.
The subsequent step involves evaluating the impact of sustainability risks and opportunities on a company's enterprise value—assessing the financial effects that have not yet been reflected in the financial statements. The CSRD urges organisations to analyse this from two angles:
This assessment poses its own complexities, demanding an understanding of the value chain and insights into sustainability trends that could impact business operations. Will polluting activities face increased taxation? Will customers demand more sustainable products and services? What financial implications might arise from reputation risks linked to human rights violations?
To carry out this assessment effectively, input from a diverse set of experts is required. Sustainability teams can identify events triggering risks or opportunities, such as new regulations or shifting stakeholder expectations. Risk experts ensure alignment with enterprise risk management strategies, while financial experts help gauge the magnitude of financial effects, such as R&D expenses, revenue loss, or operational costs. Conducting a workshop with these experts can encourage dynamic discussion and enable a comprehensive evaluation of each topic's relative score within the broader context.
With all impacts, risks, and opportunities assessed, the organisation can generate separate ranked lists, ordered from high to low materiality scores, for negative impacts, positive impacts, risks, and opportunities. By applying a threshold or cut-off point, these lists can be categorised into material (top) and non-material (bottom) impacts, risks, and opportunities.
The challenge lies in establishing appropriate thresholds, as the ESRS offer limited guidance on this aspect. It is essential to include all significant matters, but an excessive number of entries could dilute the focus of sustainability statements and strategies. A collaborative dialogue involving senior management and experts is crucial to develop a comprehensive perspective on the most material issues.
To visualise the outcomes for both sustainability statements and internal discussions, a materiality matrix can be considered, though it is not mandated by the CSRD. While matrices offer a consolidated overview, some information may be lost, as consolidating positive and negative impacts, risks, and opportunities into a single dot necessitates assumptions. Alternatively, some organisations opt for a detailed table that provides a more granular representation of the results.
The CSRD mandates that companies disclose their measures for managing environmental and societal impacts related to each material sustainability matter. This entails divulging metrics, targets, policies, and action plans to achieve their goals. Essentially, companies must outline what they aim to achieve and how they plan to do so.
Furthermore, the CSRD requires companies to disclose how they integrate sustainability matters into their strategic planning processes. This involves addressing material impacts, risks, and opportunities and how they shape the business model, market position, and value chain in both current and future contexts.
Overall, these requirements underscore the growing importance of considering sustainability impacts and adopting a long-term outlook when formulating corporate strategies. Additionally, the disclosure of action plans necessitates credible formulations of how organisations will address sustainability matters and involve different parts of the organisation.
In the realm of corporate sustainability reporting, the "double materiality" concept holds immense significance. The latest guidelines of the Corporate Sustainability Reporting Directive (CSRD) require companies to provide general disclosures in their reports while reporting on specific standards only for those deemed material. The process of determining materiality must be transparently outlined and validated in the general disclosures.
To ascertain materiality, companies conduct a "double materiality" assessment, which involves evaluating two crucial aspects. Firstly, they assess how their operations impact both people and the environment, considering the social and environmental consequences. Secondly, they examine how sustainability-related developments affect the company itself. If an impact is deemed material from either or both perspectives, the topic is classified as material.
These assessments involve actively engaging diverse stakeholders, such as scientific experts, customers, employees, and investors. Stakeholders provide valuable input, evaluating risks and opportunities related to the topics covered by the CSRD. Moreover, metrics-based measurements are employed to augment the understanding of potential impacts.
Through a combination of qualitative and quantitative insights from stakeholders, companies can identify the truly material topics. These materiality assessments significantly influence which specific standards of the CSRD must be included in a company's reporting. This ensures that reporting efforts focus on the topics that hold significance for both the organisation and society as a whole, promoting transparency and accountability in environmental and social responsibilities.
Double Materiality represents an evolving paradigm in the world of ESG, urging organisations to consider not only the financial impact of ESG issues on their performance but also their broader societal and environmental impacts. By conducting comprehensive materiality assessments, integrating ESG considerations into decision-making processes, adopting transparent reporting practices, and fostering collaborations, organisations can navigate the complexities of Double Materiality and contribute to sustainable development.