Navigating the Dynamic Landscape of ESG/Sustainability: The Significance of Materiality
The ESG (Environmental, Social, and Governance) landscape is in a constant state of evolution, presenting professionals in the field with a myriad of challenges and opportunities. From the proliferation of regulations to the emergence of new terminology, the realm of ESG/Sustainability offers an intriguing career path.
Amidst the array of new terms, standards, and regulations, there exists a common consensus among professionals: the paramount importance of materiality. Materiality refers to what is deemed significant or relevant to an organization or its stakeholders. In essence, with numerous sustainability issues at play, how does an organization discern what matters most to them? This critical process is known as a materiality assessment.
Materiality stands as a fundamental prerequisite for effective sustainability or ESG functions. It serves as the cornerstone for strategy development, sustainability initiatives, and reporting endeavors. In the realm of reporting, organizations seek to divulge information regarding their progress toward sustainability goals, their commitments, and how they are integrating ESG principles into their operations. Hence, the gold standard lies in furnishing decision-useful information to users of the report.
However, this information can be viewed from two distinct perspectives. One angle pertains to impact materiality, focusing on how an organization’s operations affect the external environment or stakeholders. Notably, the Global Reporting Initiative (GRI) standards exemplify a global framework renowned for its alignment with impact material issues.
Conversely, external issues can profoundly impact an organization’s operations and activities, influencing its ability to create and sustain value. These issues, with the potential to affect financial returns, are termed financial materiality issues, as propagated by the Sustainability Accounting Standards Board (SASB) standards and its materiality map.
Traditionally, organizations have conducted single materiality assessments, focusing on either impact materiality or financial materiality. However, there’s a growing trend toward integrating these two concepts, known as a Double Materiality Assessment. This holistic approach considers both impact materiality and financial materiality, providing investors and other stakeholders with decision-useful information for making informed investment decisions. Moreover, it enables organizations to gain a comprehensive understanding of the significant ESG risks they face.
So, how does this process unfold? In determining the materiality of a topic, the definition provided by the International Financial Reporting Standards (IFRS) offers comprehensive guidance. Information is deemed material if its omission, misstatement, or obscuration could reasonably influence decisions made by primary users based on that information.
For instance, health and safety issues are material concerns for the upstream sector. Failure to disclose these critical issues could mislead investors and the risk manifestation could potentially lead to sanctions, loss of profits, and a compromised social license to operate, ultimately jeopardizing the organization’s long-term sustainability and profitability.
To identify these issues, organizations can consult legal requirements, industry standards, and benchmark across industries. Additionally, conducting financial models of similar cases within the industry can shed light on how these issues impact profitability. Ultimately what is financial material has some relationship with the risk appetite of the organization.
Impact materiality assessment, on the other hand, focuses on evaluating an organization’s operations and their interactions with the physical and social environment. For example, an organization releasing significant quantities of dust contributes to poor air quality, making air quality a material topic. Similarly, organizations with extensive supply chains must scrutinize the activities within their supply chain, ensuring alignment with legal requirements.
While this article provides general insights on identifying material issues, materiality assessment extends beyond identification to prioritization and alignment with stakeholders. Engaging both internal and external stakeholders through various tools facilitates this process, culminating in the generation of a materiality matrix. This matrix serves as a crucial input into sustainability strategy development and reporting processes, marking the inception of the organization’s ESG journey.
As professionals and organizations embark on this journey, it is imperative to recognize the evolving nature of the ESG landscape and the pivotal role of materiality in navigating it effectively. Should you require assistance on your ESG journey, do not hesitate to reach out to Parallelpoint Consult.
