The Importance of Materiality Assessments
In today's complex and rapidly changing business environment, companies are under increasing pressure to deliver financial results and demonstrate their commitment to environmental, social, and governance (ESG) factors. A powerful tool to determine which factors are most meaningful to a company’s operations and long-term success is a materiality assessment. What is a materiality assessment, and why should companies invest in conducting one?
A materiality assessment is a strategic process used to identify and prioritize the ESG issues that matter most to a company. Single materiality focuses on how ESG factors affect a company's financial performance, such as the impact of DEI initiatives on the rate of attrition–a well-known driver of costs. Double materiality, however, considers how ESG factors impact companies’ financial performance as well as the impact on the environment and society. For example, if a company was assessing the impact of a carbon reduction initiative in a double materiality assessment they would report the impact of this initiative on the company’s financials as well as the impact on the environment or the community, such as air quality or health outcomes. By focusing on the factors that have the most significant impact, companies can ensure they are addressing the most critical aspects of their operations and value chain.
The Importance of Double Materiality Assessments
Conducting a double materiality assessment is beneficial for companies for the following reasons:
1. Risk Management
Conducting a double materiality assessment enhances risk management by identifying and prioritizing the most significant risks and opportunities related to environmental, social, and governance (ESG) factors, allowing the company to allocate resources effectively to mitigate critical risks and manage potential impacts.
2. Improved Environmental and Social Impact
A double materiality assessment enables companies to take an evidence-based approach to improving their environmental and social impact. By identifying and prioritizing the most significant ESG issues, managers can develop strategies that maximize positive outcomes in the most financially efficient way.
3. Regulatory Compliance
Evolving accounting and reporting requirements are placing an increased emphasis on materiality. Leading frameworks such as the Global Reporting Initiative's G4 guidelines, the International Integrated Reporting Framework, and the Sustainability Accounting Standards Board (SASB) emphasize materiality in their reporting standards. Additionally, new SEC disclosure rules and the European Directive on Non-Financial Reporting indicate a growing focus on materiality in ESG disclosures. As regulations around materiality continue to proliferate, companies must remain in compliance in countries that they do business in or plan to expand into.
“Businesses that want to be here for the long term need to understand the impact of their business on people and planet, and how social and environmental issues present financial risks and opportunities. Looking at both these perspectives – so-called ‘double materiality’ – is necessary so leaders can review their current business model, stay relevant, and ultimately thrive in these uncertain times.”
Conducting a Double Materiality Assessment
While there is no single agreed-upon methodology for conducting a double materiality assessment, the following steps from the GRI G3 reporting standards, and suggested by B Lab, provide a solid framework:
Understand Company context: Create an inventory of business activities, relationships and stakeholder groups.
To do this, the company takes inventory of products or services offered and relationships with other businesses throughout the company’s value chain, as well as subsidiaries or parent organizations. Next the company determines what stakeholder groups are affected by these activities. Finally, the company must determine what sustainability and human rights considerations are most relevant to their operations based on the geographic location of the bulk of the company’s operations (e.g. water scarcity, climate justice, air pollution, etc…)
Determine actual and potential impacts: The company should determine actual and potential positive and negative impacts of their operations on key stakeholders.
To determine actual and potential impacts on the environment, financials, society and workers, companies use a combination of financial audits, third-party assessments and stakeholder engagement. Actual impacts are those that have already occurred, while potential impacts could occur in the short or long term, but haven't yet.
Assess the significance of these impacts based on both severity and likelihood: The severity of negative impacts can be determined by its scale, scope and the level of difficulty to remediate the impact. The significance of positive impacts is determined by the scale, scope and likelihood of the impact.
By determining the significance of the potential negative and positive impacts ascertained in the previous step, the company can set priorities to efficiently improve operations and reduce the risks posed by potential negative impacts.
Prioritize the most significant impacts for reporting: Prioritize the most material topics using the severity or significance of the impacts determined in the previous step.
Companies need to justify why some impacts are considered material and others are not. Significance must be the only factor that determines whether a given impact is reported, not the difficulty level of reporting it.
Double Materiality Assessments and B Lab’s New Performance Standards
B Lab’s new standards require companies to conduct a double materiality assessment every three years. Companies must follow GRI G3 standards to determine which topics are material and the best practices for reporting on them. The results, whether in the form of a materiality matrix or a list of material issues, must be publicly available. Companies are also required to represent a minimum of two stakeholders and one other external stakeholder in their assessment. Conducting the assessment with or by a reputable third party ensures unbiased results and adherence to best practices.
The organization's highest governing body must review and approve the list of material topics, therefore it is essential that this team is provided with training and education about the materiality assessment to ensure its successful implementation.
Taking Action
Conducting a double materiality assessment is not just about compliance; it is about strategically positioning your company to thrive in a changing world. By identifying and addressing the most significant ESG issues, companies can improve their sustainability performance, manage risks more effectively, and build stronger relationships with stakeholders.
If your company has not yet undertaken a double materiality assessment, now is the time to start. Engage with experts, collaborate with stakeholders, and take proactive steps to ensure your business is prepared for the future. The benefits of a double materiality assessment are clear: improved risk management, better regulatory compliance, and a stronger, more sustainable business.
Are you interested in learning more about how to conduct a materiality assessment? Schedule a free consultation with one of our consultants.