Module 2 of the HSBC Sustainable Business accelerator explored “materiality in ESG”- the significance or importance of an Environmental, Social, or Governance issue or topic to an organisation/business and the process of conducting such an assessment for a business. Within the session case study examples where shared to assist participants understand it within the context of industry.
Effective Measures
Sustainability has become a key pillar of companies’ day-to-day operations. From increasing the share of renewables in the global energy mix to improving employees’ working conditions, corporations are laser-focused on improving Environmental, Social, and Governance (ESG) related issues. But how can firms be sure that they are implementing and reporting on measures most effectively? Materiality has become an increasingly familiar concept and answer to this question.
In the dynamic landscape of sustainable business practices, the concept of materiality, traditionally associated with legal and financial domains, has taken on a new role. Materiality signifies relevance and significance – qualities that have gained fresh resonance in ESG. It allows organizations to identify and address critical topics with substantial implications. This strategic focus ensures businesses prioritize areas that influence the bottom line and contribute to positive outcomes for our planet and society. For stakeholders, this approach translates into receiving insightful and pertinent information that paints a comprehensive picture of an organization’s commitment to sustainability. At the core of corporate decision-making, materiality supports leaders to allocate resources thoughtfully, manage ESG risks proactively, and seize opportunities that align with their organization’s ethos and values. The result? A solid foundation for developing transparent and meaningful sustainability reports, which in turn bolsters the credibility and utility of the shared information.
Prominent frameworks like the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB) embrace the concept of materiality, to focus on the most pertinent ESG subjects. GRI identifies measures that reflect an organization’s most influential impact on the economy, environment, and people – outward/impact materiality. For example, a company producing a lot of greenhouse gas (GHG) emissions has an outward negative influence on the environment (e.g., loss of biodiversity) and people (e.g., respiratory diseases due to air pollution). SASB by contrast takes a financial viewpoint, deeming information material if its absence or distortion could sway investment or lending decisions – inward/financial materiality. A company has an inward influence, for example, if it spends to offset emissions (such as investing in tree planting) or if it pays fines due to evolving regulations limiting GHG emissions.
Double Materiality: Bridging Impact and Financial Materiality?
Many companies will face the concept of double materiality. It refers to the idea that ESG topics can be material from the perspective of how a company impacts society and the environment (impact materiality) and how the world impacts a company and its ability to operate (financial materiality). Double materiality poses two overarching questions: How significantly does the company’s business model and activities affect ESG-related issues? How significantly do ESG-related issues affect the company’s ability to perform and grow enterprise value? For example, an energy-efficient company can positively impact the environment due to a reduced carbon footprint (impact materiality) and potentially save costs by reducing energy consumption (financial materiality).
Best Practices for Materiality Assessment
Materiality assessment is more an art than a science. Each company is unique and will conduct different types of materiality assessments. Five critical steps can be used as guidelines.
The first step is identifying the broad universe of potentially material ESG issues and topics relevant to the business - in other words, knowing what topics are essential to a company and which are not. Take Starbucks, for instance; responsible sourcing and waste management stand as material pillars, echoing their dedication to sustainability. In contrast, deep-sea drilling and heavy metal emissions stand sidelined, as they don’t resonate within Starbucks’ operations. Companies can complete this step through a combination of external and internal research. It involves analyzing country-specific regulatory frameworks, industry benchmarks focusing on topics reported by competitors, global ESG trends, etc. For companies with advanced ESG strategies, more profound research can be done by gathering detailed insights from department heads and employees, for example.
Secondly, a company can conduct two tests: evaluating the company’s significant impact on an ESG issue (e.g., human rights in the supply chain), and assessing the financial and operational implications of the issue (e.g., potential fines for GHG emissions). Positive and negative impacts on operations and the supply chain, both short and long-term, should be considered. If either test demonstrates materiality, the critical concerns shortlist will include the issue.
The third critical step is engaging with internal and external stakeholders affected by the organization’s reporting which in turn, can influence the ability of the organization to achieve objectives. These individuals or entities can be investors, board members, employees, customers, local communities, creditors, government entities, etc. Companies can better understand stakeholders’ needs and concerns through surveys, interviews, focus groups, and consultations while validating materiality assessments. Implementing an ongoing strategy using various techniques to engage different stakeholder groups is essential.
Fourthly, companies should report on the materiality assessment process and present the results in a way stakeholders and readers can understand - in a matrix or simply a list of crucial ESG topics. Aside from reporting results, regulations require companies to describe these fundamental processes in detail and have third party audits. Companies just starting, can focus on broadly explaining “How did you identify potentially material issues?” and “What data, sources, and evidence were analyzed to determine materiality?” For example, Majid Al Futtaim, the leading shopping mall, communities, retail, and leisure pioneer across the Middle East, Africa, and Asia, published their first ESG report in 2022 based on a simple materiality assessment including crucial stakeholder engagement, peer and investor review, and analysis of existing and emerging legislation.
Finally, materiality is dynamic – what is not material today could be tomorrow so reviewing and monitoring ESG topics over time is essential. Changes to materiality can stem from several sources – new regulations, shifting societal expectations, and changing industry trends. Corporations can review and monitor their materiality every two to three years, with minor updates in the interim periods.
