Financial and ESG materiality (sometimes called impact materiality) have historically been carried out in silos. Or businesses have selected one approach over the other depending on their strategy, primary audience, and alignment with certain ESG reporting frameworks. While many focus on financial materiality, typically done at the request of investors, others prioritize external-facing ESG impact reports. If you’re wondering about the best approach to materiality, financial or ESG, you're not alone. There's been no real consensus in previous years.
However, that’s starting to change. Regulators and modern-day investors are seeking a more holistic view of business risks and impacts. They want to understand the broader implications of ESG issues, not just short-term financial performance.
In comes double materiality. Read on for a quick guide on everything you need to know about double materiality – what it is, why it’s gaining traction, and how to conduct a double materiality assessment for your organization.
Taking a Step Back: Materiality Defined
At its most basic level, materiality is about identifying which ESG issues matter most. In addition to helping you determine which disclosures to include in your reporting, materiality assessments ensure you’ve considered all the ESG issues that are relevant to your business and its key stakeholders.
Here’s a breakdown of the types of materiality assessments, including financial, ESG, and double materiality.
ESG reporting and regulation aside, double materiality offers an unparalleled look into business risks and opportunities that simply can’t be achieved with financial materiality alone.
Why Implement Double Materiality?
Double materiality helps your business and stakeholders look beyond immediate financial risk, providing a more comprehensive view of ESG performance. Here are just some of the many ways double materiality can contribute to the long-term success of your business:
- Increase Stakeholder Engagement: Stakeholder engagement is foundational to identifying material ESG issues. Double materiality requires you to engage a much broader set of stakeholders than financial materiality, such as local community groups, suppliers, and employees. This provides a more complete picture of your organization’s challenges and opportunities. For instance, working with suppliers to determine material ESG issues might uncover labor and human rights risks you weren’t aware of.
- Meet Demands for Transparency: Today’s consumers, citizens, and employees want complete transparency from the brands they buy from and work for. When done right, double materiality gives you full visibility into your impact on society and the environment, helping you stay ahead of stakeholder demands.
- Attract Investors: ESG is quickly becoming the cornerstone of modern-day investment. To attract or even retain investment, you’ll need to have clear information about your ESG-related impacts handy. Double materiality does just that.
- Identify Hidden Risks & Opportunities: Going beyond financial materiality and expanding your stakeholder base allows you to surface risks (and opportunities!) buried deep within your supply chain. Perhaps you discover that a certain certification scheme for ethically sourced cacao is adversely impacting the welfare of local suppliers. Or there’s an opportunity to partner with your suppliers and a local NGO to restore degraded forest land.
- Address Reputational Threats: Double materiality uncovers what negative impacts you’re having on the world, which often become reputational or even legal threats if left undetected. Proactively identifying them helps you put out fires before they start.
- Firm Up Your ESG Strategy: By identifying what issues matter most to a holistic range of stakeholders, double materiality helps you build the backbone of your ESG strategy. The process of uncovering impacts on people and the planet also encourages you to link your company’s ‘E’ and ‘S’ functions, driving efficiency and innovation and enabling you to meet your goals faster.
Materiality & ESG Reporting: Understanding the EU’s CSRD
The EU’s Corporate Sustainability Reporting Directive (CSRD), set to become active in the FY24 reporting season, is the first major legislation requiring double materiality reporting outright. And this won’t just impact EU-based businesses. In addition to EU companies, any non-EU company with €150M net turnover in the EU and one branch or subsidiary in the EU will be subject to the CSRD. That translates to around 50,000 EU-based companies and 10,000 non-EU companies.
Double Materiality in 6 Steps
Ready to conduct a double materiality assessment for your business? Follow these six steps to get started:
1- Define Scope & Organizational Boundary. Determine the scope of your assessment by defining what operations, products, and services you’ll include. Also define how far you’ll look up and down your value chain. For instance, will your organizational boundary encompass your entire supply chain down to the source? Will you consider how citizens use your goods after they’ve left your hands?
2- Engage Relevant Stakeholders & Identify ESG Issues. Gather input from a broad range of stakeholders to determine which social, environmental, and economic issues will have the greatest impact on your business and how your business affects people and the planet. At a minimum, your list of stakeholders should include consumers, employees, investors, suppliers, and local communities.
Remember that it’s not just about risks. As you talk to your stakeholders, look for opportunities to build business resilience and deliver community impact.
3-Assess Financial & Non-Financial Impacts.
Now that you have a list of ESG issues, quantify the potential impact of each on your company’s financial performance. Be sure to include the costs and benefits as well as the financial risks and opportunities associated with each issue. How will deforestation and species loss impact your business viability? What’s the financial benefit of partnering with suppliers to promote water stewardship and increase local accessibility?
Also assess the non-financial impacts your business has on each ESG issue, such as GHG emissions, water use, ecosystem loss, economic opportunity, and human rights. Again, these should include both positive and negative impacts. Are your sourcing activities inadvertently creating poor living conditions for local supplier populations? Or are you promoting economic opportunity and independence like Burt’s Bees’ partnership with women-led co-ops across West Africa?
4-Prioritize Issues Based on Impact.
Based on the financial, environmental, and social impacts of the issues you’ve identified, evaluate the significance of each and prioritize the issues that are most material to your business and stakeholders.
Issues that pose significant inward and outward impacts (they impact your business just as much as you impact them), like GHG emissions, will likely appear at the top of your list. However, this shouldn’t minimize the importance of issues your business negatively impacts, even if they don’t pose immediate financial risks.
5-Address the Most Material Issues.
Develop a strategy to address the most material ESG issues you uncovered, prioritizing actions that minimize adverse impacts and capitalize on potential opportunities. For instance, lobbying for clean energy policy where you do business and where your suppliers operate. Your action plan should include measurable, time-bound targets and be supported by the right governance and accountability structures to ensure successful implementation.
6-Report & Communicate Progress.
Incorporate the results of your double materiality assessment into your annual ESG reporting cycle, including your plans to address adverse impacts and financial risks. Communicate progress on your goals and don’t be afraid to admit it if you haven’t made as much progress as you would’ve liked.
The Future of Double Materiality
The EU has always been a leader in corporate ESG reporting, setting standards that have far-reaching implications and bring the rest of the world up to speed. While the EU is the only entity mandating double materiality reporting through its CSRD legislation, it may be only a matter of time before double materiality becomes the new standard, even if not required on a global scale. And as sustainability reporting standards unify, double materiality will only become more relevant.