There are a myriad of sustainability assessments companies can undertake to evaluate their environmental impact. One such crucial test is the materiality assessment, a cornerstone in ESG (Environmental, Social, and Governance) operations. So, why are materiality assessments becoming indispensable for organisations striving towards sustainability?
What is a materiality assessment?
By definition, a materiality assessment is a formal exercise aimed at engaging external stakeholders to find out how important Environmental, Social and Governance (ESG) issues are to them. The insights from material assessments can be used to guide strategies and communication and tell a more meaningful sustainable story to stakeholders.
In other words, a materiality assessment is a method that allows companies to understand and prioritise their sustainability issues better, incorporating stakeholder views on their products or services. The primary objective of this assessment is to identify the social and environmental areas that hold the most significance for your company, investors, and stakeholders.
Why is a materiality assessment important in ESG?
Materiality assessment is the bedrock for companies to formulate efficient sustainability strategies. With the world increasingly striving for net-zero emissions, the relevance of this assessment has skyrocketed. It illuminates various ESG challenges that could potentially derail a company's journey towards environmental and economic prosperity.
Research reveals that companies that address material ESG factors pertinent to their industry may have a performance advantage over the long term. Simultaneously, there's a potential opportunity cost for businesses emphasising immaterial factors. Although it's not a direct causation, there's a clear correlation between material ESG issues and financial performance, underlining the importance of materiality assessments.
Regulatory developments such as the SEC disclosure rule in the U.S. and the Non-Financial Reporting Directive (NFRD) in Europe. Companies adopting materiality assessments now will be better equipped to meet future environmental regulations.
How to conduct a materiality assessment?
Materiality assessment is an essential practice for organisations seeking to identify and manage the environmental, social, and governance (ESG) topics that matter most to their business and stakeholders. Here is a step-by-step breakdown of how to carry out this process:
PHASE 1: Define objectives, scope, and audience
1. Set clear objectives: Understand what you intend to achieve with the materiality assessment. This may include identifying key ESG risks and opportunities, refining sustainability strategy, or informing wider business strategy, among others.
2. Identify your audience: Determine who will benefit from the outcomes of your materiality process. It could be the board of directors, sustainability report readers, or others.
3. Define 'materiality': Materiality, in this context, refers to the significance of a topic to your stakeholders, its socio-economic or environmental impact, and its strategic relevance to your business.
4. Outline the organisational scope: Define the regions or business units to be assessed and decide how the outcomes will feed into your reporting, whether it be standalone sustainability reporting or integrated reporting.
PHASE 2: Identify potential topics
- Compile a list of material topics: Gather data from multiple sources like media reports, internal data, sector-specific regulations, ratings, and research on wider social and environmental trends.
- Involve key individuals: Ensure that the list of material topics is compiled in consultation with relevant individuals beyond the sustainability team, like the enterprise risk management team or senior management.
- Consider external stakeholder engagement: Identify which external stakeholders you should consult for valuable feedback.
PHASE 3: Categorise
- Cluster topics into categories: Refine the list of potential material topics by grouping them into relevant categories.
- Use company-specific language: Align topic names with the existing terminology, strategy, and policies used by your organisation.
- Ensure understanding: Make sure that everyone involved in the process understands the specific risk or opportunity for each material topic.
PHASE 4: Gather information
- Gather relevant information: Collect data about the importance of each material topic to your stakeholders and assess the strategic significance of each topic to the business.
- Assess impact: Evaluate the actual and potential economic, social, and environmental impacts of each topic.
PHASE 5: Prioritise
- Prioritise material topics: Decide which internal stakeholders should be involved in prioritising topics, develop a scoring methodology for each topic, and set a threshold for defining which topics will be considered material.
- Integrate with risk management: Work closely with enterprise risk management to integrate material social and environmental topics into company-wide risk management.
PHASE 6: Seek approval
- Get approval from senior management: Ensure that the materiality assessment is accepted and signed off by senior business management.
- Present outcomes to the board: Recommend actions for the board based on the outcomes of the materiality assessment.
PHASE 7: Review and integrate
- Review with stakeholders: Invite stakeholders to review the material topics published and evaluate the outcome of your materiality assessment before you repeat the process.
- Document and integrate results: Record results from stakeholder input and describe the impact this will have on future reporting. Also, work towards integrating the results of the materiality assessment into company strategy, governance, operations, and reporting.
Undertaking a materiality assessment enables organisations to focus their sustainability efforts on the areas that matter most to their business and stakeholders, creating a more impactful and targeted approach to sustainability.
At the end of the process, a materiality matrix is often created to provide a visual representation of the key learnings, helping stakeholders decide the next steps based on the findings.
Advantages and challenges of materiality assessments
A materiality assessment provides a wealth of benefits. It enables companies to define a long-term emissions reduction plan, evaluate risks, and take advantage of available opportunities. The process also enhances stakeholder engagement and allows a company to improve its transparency, thereby boosting its reputation.
Moreover, a materiality assessment can enhance sustainability reporting, facilitate progress tracking, and ensure better resource allocation. A 2021 MIT study found that sustainability reporting can lead to a 4.6% increase in market value, underlining the economic advantages of conducting materiality assessments.
Materiality assessments, while crucial, are not without their challenges. One of the foremost complexities is the integration and prioritisation of every stakeholder's perspective. In addition to this, a thorough materiality assessment demands scrutiny of a company's full value chain, extending beyond mere operations. Notably, another significant challenge is the substantial amount of time required to conduct a complete Materiality Assessment.
1- Don't detach the materiality assessment from the core business
There can be a tendency to view materiality merely as an obligatory exercise to generate a materiality matrix for your sustainability report. To truly harness the value of your materiality assessment process, it's crucial to go beyond the confines of the sustainability team and engage individuals from all parts of the organisation.
Guidance: A segregated process has restricted potential for safeguarding and increasing company value.
The materiality assessment process can provide you with insights that are too precious to be confined to just the sustainability team – understanding current and future risks and opportunities should be the foundational step for any sustainable business strategy. Think about broadening the responsibility for the materiality assessment process throughout the organisation as a medium-term goal. In the interim, begin by involving managers from various departments (such as tax, human resources, and sales) through interviews. Gradually, progress to engaging them in monitoring material topics, eventually shifting ownership to them for related topics.
2- Ensure active involvement from senior management in the materiality assessment process
Gaining senior management's buy-in in the materiality assessment process or making them aware of the results can be a challenge, yet their engagement can substantially enhance the outcome. It can also deter the materiality assessment from being confined to just the sustainability team.
Guidance: Frame the materiality assessment process in terms of business value.
We recommend portraying materiality in terms of its impact on corporate value creation: revenues, cost, and risks. Gradually establish top-tier management engagement, first by involving them in the process from the beginning, via interviews or a workshop, to discuss trends impacting the business. Later, before making the results of your materiality assessment public, obtain an official management-level endorsement on material topics to ensure widespread support for the process and its outcomes.
3- Conduct a meaningful materiality assessment despite business complexity
The GRI’s G4 Guidelines have led many firms to broaden the boundary of their materiality assessment beyond operational control to examine the significance and impact of issues across the value chain, from upstream in the supply chain to downstream product use and disposal. Large multinational corporations face the additional complexity of operating in multiple countries and across distinct business units with vastly different supply chains, products, and customers. Generating a single list of material topics that reflects viewpoints and interests across diverse segments of the business may seem impossible.
Guidance: Make sure your materiality assessment scope aligns with the realities of your business.
There are several ways to dissect a materiality assessment. Ensure your assessment's scope aligns with your business's realities by concentrating on the primary business processes and activities, or the most impactful geographies. Do not attempt to encompass the entire value chain for every business unit in every country initially. Another strategy is to establish a group-level framework for materiality assessment at the corporate centre while identifying material topics at the business unit level. A group-level framework provides consistency in the materiality approach but can be adapted to different operational environments.
4- Engage stakeholders in a time and cost-efficient manner
For large multinational firms, the list of potential stakeholder groups can be extensive, as your business interacts with hundreds of groups each year, both inside and outside the organisation. It can seem like a monumental task to involve these stakeholders in your materiality process to ensure their views and opinions are considered.
Guidance: Concentrate on your business's current stakeholder interactions.
Stakeholder engagement enhances the quality and credibility of your materiality process. While specific engagement activities can assist you in identifying material issues, a significant amount of valuable input can also be derived from existing sources and engagement channels such as employee or client satisfaction surveys or interviews. Your company's day-to-day stakeholder interactions as part of the regular business are just as valuable as one-off stakeholder activities. Asking external stakeholders to rate the importance of topics to them will provide you useful insights into their concerns and priorities, but don't depend solely on external views to shape your assessment. Also, consider the views of internal stakeholders by asking them to rate and prioritise the importance of topics to the business.
5- Prioritise topics when stakeholders show interest in every aspect
Your stakeholders may expect you to treat all opinions equally, but in practice, there are too many views and issues raised by internal and external stakeholders, necessitating some level of prioritisation.
Guidance: Rank stakeholder views using a straightforward and uncomplicated approach.
A simple process for weighing different stakeholder views will assist you in refining a long list of material topics into something meaningful that accurately reflects views. One method could be to rank stakeholder views as high, medium, or low against set criteria, such as the stakeholder's ability to significantly impact your business's value creation, the stakeholder representing a large group with a legitimate concern based on the societal impact of the issue, or the ability to reasonably assess the impact of the topic (either quantitatively or qualitatively).
6- What if material topics are too broad?
Many firms define material topics in broad terms, sometimes with overlapping subject areas, or fail to define an issue adequately. This makes it hard for stakeholders to determine whether your business is addressing the right issues or not.
Guidance: Define topics at a level that reflects your organisation and your communication objectives.
Strive to define material topics at a level that is relevant to your organisation and serves the purpose of your materiality assessment. Avoid combining different levels of topics, e.g. broad topics (environment), with specific sub-topics (improving energy efficiency of products). Different levels of definition could be social and environmental mega forces, topics, sub-topics, and metrics.
We suggest using different levels to communicate your priorities for different purposes. For instance, in an internal stakeholder engagement workshop, you may receive more meaningful responses to specific sub-topics. When discussing your business strategy with senior management, it may be more relevant to discuss social and environmental changes with implications for the broader business. For an external audience, you might choose to organise information for your sustainability report readers in chapters for each topic. Regardless of the level you choose, consistency is key when communicating your material topics.
Double materiality VS single materiality
Double materiality is a concept in the field of corporate sustainability that represents two complementary perspectives of environmental, social, and governance (ESG) impacts:
Outside-in or financial materiality: This perspective considers the impacts of external ESG factors on a company's financial performance, business operations, and competitive positioning. These factors can be social, environmental, or regulatory, and their materiality is determined by the extent to which they can affect a company's financial health. For example, changes in climate regulations could pose risks or opportunities for a company, affecting its profitability and sustainability in the long term.
Inside-out or impact materiality: This perspective focuses on a company's impact on society and the environment, irrespective of whether these impacts have immediate financial implications. It highlights a company's responsibilities towards stakeholders including employees, communities, customers, and the environment. For instance, a company's waste management practices or community engagement efforts would be evaluated under this perspective, even if these practices do not have an immediate financial impact.
The principle of 'double materiality' in corporate sustainability reporting, currently a major point of consideration in new European Commission standards, extends the concept of 'single' materiality. Traditionally, single materiality emphasises the impact of sustainability issues on the firm and its prospective future. Double materiality, however, necessitates that companies also disclose their effect on broader systems, like climate, biodiversity, and society.
The current situation and future trends of double materiality
Admittedly, the adoption of double materiality has been gradual in the US, where the GAAP (Generally Accepted Accounting Principles) still primarily focus on single (financial) materiality. However, American companies that abide by the GRI will inevitably need to shift towards defining materiality grounded in comprehension of real and potential impacts. This transformative notion will constitute a critical aspect of EU standards, but it has stimulated various conversations about its implementation in other contexts. Presently, the International Sustainability Standards Board (ISSB) does not incorporate double materiality in its international sustainability standards. However, this is likely to change soon due to significant market players pushing the organisation towards its inclusion.
Regardless of these differing viewpoints, the EU intends to progressively incorporate double materiality starting in 2024, notably through the CSRD and EU Taxonomy. Therefore, the companies under its jurisdiction must initiate data collection from this year onward, in preparation for this shift.
Why should your company conduct a materiality assessment?
When properly conducted, a Materiality Assessment can validate a business strategy's efforts to incorporate social and environmental needs. It also provides insights on strategies for long-term sustainability success and reveals the topics most relevant to stakeholders. Moreover, it can help identify neglected sustainability issues and assess a company's standing in an increasingly sustainable society.
As per a study by McKinsey, companies that lead in ESG had a valuation premium of up to 20% and showed superior profitability, reinforcing the argument for a Materiality Assessment's worth for any company. As sustainability becomes a mandatory aspect of successful businesses, a Materiality Assessment emerges as a worthy investment.
Materiality Assessments are a gateway for staying informed, actionable sustainability initiatives for companies. They enable businesses to prioritise, strategise, and communicate their sustainability efforts effectively, thereby playing a pivotal role in an increasingly ESG-driven corporate world. If you're looking to improve your ESG performance and sustainability factors, a Materiality Assessment is an excellent first step in your fight against climate change.
At Plan A, we understand the intricacies of Materiality Assessments and the unique challenges and opportunities they present. We're here to guide and assist your business in its transition to sustainable practices. Get in touch with us to learn more about how we can support your sustainability journey.