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Sustainability
Materiality: from reporting requirement to strategic insight
SUSTAINABILITY TOOLKIT no.5
In the fifth of a series of practical guides for organizations on sustainability, Julia Binder, IMD’s Professor of Sustainable Innovation and Business Transformation, explains how to carry out a materiality assessment – and how the insights it provides can be used to drive a company’s entire business strategy.
A buzzword that often crops up in conversations about corporate sustainability and ESG is materiality. This is a topic that has gained so much traction in recent years that it may even come up at a casual dinner party these days. Yet in reality, very few business leaders have their most material issues uppermost in their minds, and most employees are not aware of their company’s materiality assessment, even if it has been conducted for many years. The reason for this is that, to date, materiality assessments have primarily been seen as a communications and reporting exercise. But they can be used much more strategically than that. A materiality assessment, if used well, can be a key tool in prioritizing strategic topics for the whole business.
Before we talk about strategy, let’s talk about the basics. What do we mean by materiality? In general, materiality is defined as the information that a reasonable investor would want to have before making an investment decision, or information that might have a substantial effect on the financial value of a company. And in the context of ESG (environmental, social, and governance considerations) or corporate sustainability, a materiality assessment is a process by which a company identifies the ESG issues that are most significant given the operating context of their business.
There are currently two different approaches to this.
You can assess ESG factors in terms of their financial materiality. This means that you consider materiality from the perspective of investors and other providers of financial capital and focus on the issues that influence a company’s financial performance and enterprise value, also referred to as inward impact.
The leading standards for assessing financial materiality have been developed by the Sustainability Accounting Standards Board (SASB), now part of the IFRS Foundation. The SASB Standards vary by industry, reflecting the different sustainability risks and opportunities affecting the financial performance and value creation models of particular sectors over the short, medium, and long term. The SASB’s Materiality Map illustrates the relevance of 26 sustainability issues for 77 different industries.
Alternatively, you can consider sustainability issues in terms of impact materiality. Such an analysis relies on a multi-stakeholder approach to identify the areas where a company has the greatest economic, social, and environmental impact on the planet and society, also referred to as outward impact.
Most companies now conduct a materiality assessment to identify their most significant ESG issues, but they too often just see this as a communications and reporting exerciseAn impact materiality assessment will provide clarity on the most important social and environmental issues that your company should address. You may want to relate the outcome of this analysis to the 17 UN Sustainable Development Goals, each of which has several sub-targets. Nobody is expecting your company to tackle all of these, but your stakeholders will demand that you focus on those issues that you can influence.
One of the leading organizations monitoring impact materiality is the Global Reporting Initiative (GRI). The GRI Standards enable any organization to understand and report on the effects of its activities on the economy, environment, and people, and to prioritize the most important areas. Rather than looking at matters just from a financial or shareholder perspective, the GRI considers the interests of a broad range of stakeholders, which it defines as all individuals or groups that are – or could be – affected by the company’s activities and decisions. Think about your suppliers, employees, customers, partners, local communities and so on. Intensive stakeholder engagement, therefore, lies at the heart of an impact materiality assessment.
A holistic view of sustainability requires a double materiality assessment
It is already clear that the two approaches are highly complementary. If you want to gain a holistic understanding of your company’s overall sustainability performance, you need to conduct both financial and impact materiality assessments. This combination has more recently been referred to as double materiality.
A few companies already carry out double materiality assessments, and the GRI and SASB are cooperating to harmonize their disclosure frameworks and create a comprehensive regime for the sustainability reporting landscape.
In any case, double materiality will soon be a mandatory disclosure requirement for many organizations. From 2024, large companies based in the European Union (or with an annual turnover in the EU of more than €150m) will be required to conduct double materiality assessments as part of the EU’s new Corporate Sustainability Reporting Directive.
But don’t fall into the trap of just performing your materiality assessment as a box-ticking exercise to meet regulatory requirements.
Leveraging the insights of your materiality assessment strategically
Extending your single or double materiality approach to one of strategic materiality can offer great benefits to a business.
While the true value of a thorough materiality assessment lies in utilizing the insights gained to future-proof the company’s strategy, most companies conducting a materiality assessment fail to use its insights in this way. .
Businesses should go beyond this double materiality method and adopt a strategic materiality approach.
A materiality assessment brings together in-depth data from the company’s most important stakeholders with an analysis of industry and market trends, sustainability reports, and regulatory changes, and this information provides a multitude of opportunities for strategic foresight. It also offers a terrific opportunity to actively engage your stakeholders in your sustainability journey.
Insights into your company’s most material sustainability issues might be used to:
- Identify blind spots and risks: Analyze changing market conditions, stakeholder expectations, and regulatory requirements to identify potential blind spots in your current strategy and better manage risks that may become more significant in the future.
- Develop a sustainability strategy: Ensure that your sustainability strategy closely aligns with your business objectives and meets your stakeholders’ expectations. This involves prioritizing your company’s most relevant sustainability topics as well as determining the most relevant sustainability KPIs. It can also provide you with important insights for exploring and assessing your strategic impact opportunities.
- Drive innovation and differentiation: Identify new markets and customer segments that prioritize sustainability and create opportunities for innovation in products, processes, or business models. This can help you to develop innovative solutions that truly meet the needs of your stakeholders and differentiate your company from its competitors.
- Prioritize investments and resource allocation: Prioritize investments in sustainability initiatives that address your most material issues and thereby maximize your company’s impact and improve your sustainability performance more efficiently.
- Report on sustainability performance and progress: Enhance transparency and accountability by reporting on your company’s sustainability performance and the progress made towards addressing your most material issues. This will also help to demonstrate your company’s commitment to sustainability and improve stakeholder trust.
- Engage stakeholders: Build loyalty and enhance your company’s reputation by engaging stakeholders in the process of identifying and prioritizing material sustainability issues. Additionally, this will help to ensure that the sustainability initiatives the company undertakes are aligned with your stakeholders’ expectations.
- Strengthen future readiness: Spot emerging trends and issues that may become more significant in the future. You can also develop a more resilient business strategy by stress testing your materiality assessment against a set of plausible scenarios for the future, which will help you to stay ahead of the curve and better navigate future risks and opportunities.
As you can see, materiality assessments can offer you a multitude of strategic insights that may be going largely unnoticed. Ask yourself how you can use these insights to inform your strategy, your R&D activities, or your partnerships. And most importantly, disseminate the results across your company to empower and encourage all your employees to come up with suggestions to address your company’s most material issues.
This is the fifth article in our Sustainability Toolkit series. To read the previous articles click here (n.4), here (n.3), here (n.2), and here (n.1).
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