With the impending arrival of new regulations, there has been much written and talked about on the principle of ESG materiality. Double materiality, financial materiality, impact materiality, the influences of SASB and GRI, and the emerging reporting requirements of ISSB and CSRD are thrown around to add to the myriad of terminology and frameworks that already plague the ESG space. For Boards or companies that don’t have the internal resources or expertise at hand, this can sound like, or be sold as, an overly complex and expensive conundrum. It has no need to be.

In fact, the basis of ESG materiality, if approached properly and proportionately for your business, is a highly valuable management tool. The first important step is to break out of the mindset that it is primarily needed for compliance and as a reporting requirement. If a management team can treat ESG materiality as being part of their strategy, risk, and financial planning processes, then they are off to the right start in harnessing its value.

Let us address the regulatory element first and get that out of the way. Yes, materiality will become a regulatory and reporting requirement. The International Sustainability Standards Board (ISSB) and its standards of IFRS S1 and IFRS S2, if adopted by your regulator, will request the principle of financial materiality. This requires a company to look “outside in” to understand which environmental, social, or governance issues could have a financially material impact on the company from a risk or opportunity perspective. If you are a company listed or operating in Europe, then the Corporate Sustainability Reporting Directive (CSRD) through its standards ESRS 1 and ESRS 2 will, depending on your scale of operations and other criteria, require you from 2024 onwards to undertake an assessment of impact materiality in addition to financial materiality. This is where the term double materiality comes into play. Impact materiality looks at “inside out” and is a factor of sustainability and responsibility. It requires a management team to understand which of their organisation’s environmental, social or governance issues could have an impact on the planet or people.

So, while there have been attempts to claim that double materiality is a new concept, this is a smokescreen. Financial materiality is a practice familiar to any company’s finance function. In many cases, this exercise in relation to sustainability will already have been undertaken to a degree as part of the audit and risk management process. In addition, any company that has been measuring its carbon emissions, for example, should be comfortable with the concept of impact materiality.

Because of the smokescreen and the regulatory overlap between ISSB and ESRS, there is the possibility of confusion for companies about which materiality test they should undertake. There should be no confusion. If materiality is approached from a business decision-making perspective rather than an attempt to just comply, then a Board or management team will want to use it effectively and undertake a double materiality test. The key reason being that both impact and financial material issues will require management input and measurement.  Also, if you are looking over a strategic timeline, it doesn’t take long to realise that what could initially be recognised as impact materiality could become financially material in the future.  Again, a Board that is now looking at the capex requirements to reduce the carbon emissions of their operations has already faced this reality.

The final reason for approaching ESG materiality from a business decision-making perspective is that you will create a materiality assessment that is right for your business. If approached from a factor of compliance, it will be easy for the majority of mid and small cap companies, as well as private companies, to get distracted by pages and pages of recommendations on how to complete double materiality assessments that are wrapped in a banner claiming “best practice”. In most cases these have been designed for global large-scale businesses, operating in multiple jurisdictions with complex value chains and are inappropriate. Both ISSB and CSRD recognise that a materiality assessment must be undertaken that is fit for purpose without requiring undue resource or cost – often termed ‘proportionality.’  A decision-led materiality is more likely to achieve this. The basis of this, in our mind, is:

• Get Board support and buy-in at the start
• Drive the materiality process from a senior management position within the organisation.
• Involve as many departments as necessary to your business; do not delegate to one department and run the materiality assessment in silo.
• Integrate ESG materiality into the current risk, financial and operational programmes.
• Look to involve as many stakeholders in your value chain as possible.
• Maintain detailed records of the process and data – materiality will become part of a verification and /or audit process.

In all our work with companies that approach ESG from a management decision-making basis, the above list becomes obvious, which it is not if looked at purely from the basis of compliance and reporting.

If you would like guidance on implementing a double materiality assessment that is right for your business and budget; want to know more about the requirements of ISSB; or believe you could be subject to CSRD; please be in touch.

Note:  Accountancy Europe have provided a useful summary of the type of companies that will need to comply with CSRD, here.