How Do Companies Determine What’s Material? And How Can Materiality Instigate Transformative Change?

By Ralph Thurm & Bill Baue

This is part 6 of the Reporting 3.0 series that highlights the ‘burning questions’ of Boards and Sustainability Professionals why we need Reporting 3.0 and what it aims to deliver with its Blueprints on Reporting, Accounting, Data and Integral Business Model Design.

What’s the issue?

The practice of companies determining what’s “material” to their businesses emerged in the financial accounting and reporting worlds to establish thresholds between what’s relevant, and thus obligatory to disclose to inform financiers’ decision-making, and what’s not. Intending to crystallize a more comprehensive approach, the sustainability accounting and reporting worlds broadened the definition of materiality to include social and environmental issues, in order to inform their stakeholders’ (or rightsholders’) decisions.

This has resulted in two unfortunate outcomes:

· First, this proliferation has created a definitional morass;

· What’s worse, sustainability accounting and reporting definitions of materiality neglect to link to sustainability thresholds in ecological and social systems.

As a global public good R&D function for the disclosure field, Reporting 3.0 is filling this gap by proposing an approach to materiality tied to sustainability thresholds in ecological, social, and economic systems, as well as links to business model viability and sustainable system value creation. In this way, we see materiality operating not simply at the micro level of companies, but also at the meso level of industries as well as the macro level economic, social, and ecological systems.

What can you do about it?

Say hello to the Reporting 3.0 Integral Materiality Process. Organized around a Plan-Do-Check-Act cycle (PDCA, or Deming Wheel) known from Quality Management Systems, this process applies across functions in the organization and can therefore align sustainable value creation at company as well as systems levels. Now, what makes the r3.0 Integral Materiality Process so different:

Figure 1: The r3.0 Integral Materiality Process

The PLAN phase, which is firmly grounded in a context-based approach linked to the carrying capacities of capitals, calls on companies to identify three key elements:

  • Rightsholders to whom companies owe legal duties and ethical obligations due to direct impacts on their wellbeing or, indirect impacts on vital capital resources that these rightsholders rely on for their wellbeing.
  • We assert this linguistic shift from stakeholders, which typically amounts to those who claim a stake in a company’s considerations, to rightsholders, which more clearly aligns to companies’ accountability for direct and indirect impacts on social, economic, and ecological resources.
  • Impacts companies have (both negative and positive) on vital capital resources that rightsholders rely on for their wellbeing.
  • These impacts can increase or decrease the amount (or “stocks”) of natural, social, human, built, financial, and intellectual capital (to name the six capitals in the International Integrated Reporting Council format), as well as the “flows” of these resources.
  • Thresholds that differentiate sustainable levels of these vital capital resources from unsustainable levels — also known as the carrying capacities of capitals; as well as allocations of companies’ fair, just, and proportionate shares of these resources.

The DO phase shifts into operationalization mode, which includes:

  • Collaborating with these rightsholders to validate and manage the above impact areas, thresholdsand allocations.
  • Setting context-based targets across the multiple capitals and dashboards for tracking performance on trajectory targets.
  • Integrating this context-based thinking and practice across all key elements of the enterprise, including risk management, governance, innovation and leadership (including performance and compensation metrics).

The CHECK phase controls and tracks performance towards set targets, but also evaluates the longer-term delivery status and correction measures. This phase calls for:

  • Tracking performance against trajectory targets, enabling redirection if necessary.
  • Testing against scenarios (particularly <2°C / net zero GHGs by 2050 climate scenarios) and creating transition plans that respond to this systemic (and indeed existential) risks.
  • Assessing the ongoing viability of business models to ensure current and future system value creation (which includes and transcends both shareholder value and shared value)

The ACT phase revisits elements of the DO phase, while also scaling up influence and advocacy from the micro to the meso and macro levels. This phase calls for:

  • Engaging rightsholders around the sustainability of business models to ensure ongoing future system value creation.
  • Transitioning to <2°C / net zero GHGs by 2050 business models.
  • Transforming the broader contexts within which companies operate, including their industries at the meso level, as well as the economic system that needs reform in order to support healthy social and ecological systems.

Why “Integral” as the moniker for this approach to materiality? We draw this term from Integral Theory, which advances a holistic approach, integrating considerations across the individual to the collective levels, and the internal / subjective to the external / objective realms.

Figure 2: The Four Quadrants of Integral Theory

What will you have achieved afterwards?

The Integral Materiality Process addresses the current shortcomings in materiality mentioned above, as a means of also resolving broader misalignments. It is the core implementation mechanism for ‘integral thinking’ and designing ‘integral materiality’. Not all of this can or even should be implemented in a short amount of time. This process also allows a step-by-step implementation, and we leave it up to each organization to design its own pace. On average we expect a full implementation to be possible within three years. We are convinced that this process allows enough flexibility and future-readiness that it can lead towards a full implementation of integral business models.

What question will we discuss next time?

The shift from stakeholders to rightsholders — why is it so important? Please find part 7 here.

Please add your feedback, the authors Ralph Thurm and Bill Baue of Reporting 3.0 will look at all responses. Don’t forget to ‘wave’ if the above resonated with you ;-).

[Context of this series: The sum of these articles form the basis of an Implementation Guide that summarizes the total value of Reporting 3.0 in implementing a future-ready sustainability strategy and disclosure approach, in line with the idea of a Green, Inclusive and Open Economy. By posting these articles here Reporting 3.0 seeks feedback in the writing process of the final document, to be released as Blueprint 5 at the 5th International Reporting 3.0 Conference in Amsterdam, The Netherlands, on June 12/13, hosted by KPMG, see www.2018.reporting.org]