In the dynamic Environmental, Social, and Governance (ESG) landscape, understanding materiality is essential. It not only provides businesses with insights into why ESG matters but also narrows down the scope for identifying which specific ESG issues should be addressed, along with their potential risks and opportunities. However, the surge in jargon - double materiality, financial materiality, impact materiality - has led to confusion. What do these terms mean, and what should businesses do about them?
In its simplest form, materiality encompasses selecting ESG issues that are relevant to companies and what they should disclose and progress on accordingly. For example, if we consider an apparel organization that produces T-shirts, we think about material issues such as the product life cycle, fair labour conditions, and supply chain control. Although other issues, such as data privacy and employee health and safety, are also important topics, they do not directly impact the core operations and sustainability of the apparel value chain activities. Therefore, they might be considered less material in this specific context. Materiality thus helps organizations focus on the most critical ESG issues that can influence their long-term success and sustainability. By prioritizing these key issues, companies can better allocate resources, improve transparency, and meet stakeholder expectations.
The rise of double materiality
Over the past years, there has been a significant rise in ESG-related regulations and standard setting. The concept of materiality has been a core component of these developments, helping businesses identify which ESG issues they need to report on and the scope of the regulations they need to abide by. One such regulation is the European Union's Corporate Sustainability Reporting Directive (CSRD). The CSRD has introduced a unique definition of materiality, combining the perspectives of financial and impact materiality into an encompassing concept known as "double materiality."
Figure 1. Double materiality explained
As part of double materiality, impact materiality involves identifying the positive and negative external impacts a business has on the economy, environment, and society. Besides the EU CSRD, standard setters heavily rely on impact materiality, including the Global Reporting Initiative (GRI) and the United Nations (UN). These regulatory bodies and standard setters aim to target a broad range of stakeholders from a sustainability perspective by emphasizing impact materiality.
Financial materiality, the other component of double materiality, looks at the internal impacts suffered by the business from the effects of people or the environment. Standard setters, including the Taskforce on Climate-related Financial Disclosures (TCFD) and the IFRS Foundation - which recently incorporated the Climate Disclosure Standards Board (CDSB), International Integrated Reporting Council (IIRC), and Sustainability Accounting Standards Board (SASB) - primarily target investors, emphasizing financial materiality. The EU CSRD, however, adopts financial materiality alongside impact materiality and mandates that organizations consider both lenses when narrowing down the key ESG issues for their business and value chain activities.
Based on the above, it is safe to say there has always been a selection of either financial or impact materiality among standard setters, stirring confusion in the sustainability landscape. However, the introduction of the EU CSRD, considering both impact and financial materiality, aims to drive a holistic approach to materiality and settle the discussion.
The why behind double materiality
Adopting a double materiality approach offers several benefits. Firstly, it provides a comprehensive view of a business's sustainability performance by addressing both internal operations and external impacts. This approach also helps businesses align their sustainability efforts with stakeholders' expectations, fostering trust and contributing positively to society.
Moreover, double materiality enhances risk management. By understanding how sustainability issues affect the broader world, companies can proactively mitigate risks and seize opportunities. This holistic perspective makes double materiality a robust framework that meets investor needs while addressing broader societal and environmental concerns.
In some cases, companies may feel compelled to adopt double materiality, especially those subject to the EU's Corporate Sustainability Reporting Directive (CSRD), which mandates reporting on both financial and non-financial sustainability impacts starting in 2024.
It's important to note that while the CSRD requires double materiality reporting, other frameworks like the ISSB's IFRS S1 and S2 standards currently do not. Companies should consider these evolving regulatory requirements and the specific demands of their operating jurisdictions when making decisions.
Performing a double materiality assessment
With the growing adoption of double materiality, now is the time for businesses to conduct an assessment. While each business may approach double materiality differently, there are general steps to begin the process:
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Highlight key regulations: Understand the varying disclosure requirements based on geographical presence, industry sector, and business size. Start by clearly comprehending the regulations governing your reporting obligations for both financial and non-financial data.
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Engage stakeholders and understand peer/competitor landscape: Actively involve internal and external stakeholders to understand their perspectives on ESG issues relevant to your business. Assess how competitors and peers approach ESG reporting and sustainability practices. This engagement provides insights into industry norms, best practices, and stakeholder expectations.
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Map key ESG areas on double materiality matrix: Utilize a double materiality framework, such as &BLOOM’s, to prioritize key ESG areas. Based on regulatory insights and stakeholder assessments, identify the most impactful ESG factors from both financial and impact perspectives. This strategic mapping guides businesses in setting ESG goals, managing risks, and making informed decisions to enhance sustainability performance on topics that are relevant.
Figure 2: &BLOOM double materiality matrix
At &BLOOM, we serve as your partner in this journey, offering expertise and support to help you navigate the evolving landscape of ESG materiality. Together, let's unlock the potential of sustainable and responsible business practices.