Beyond Compliance: Mastering Materiality Assessment for Strategic Sustainability Success

What is a Materiality Assessment?

A materiality assessment is the cornerstone of any organization's sustainability strategy, serving as a foundational reference point. It is a critical process that identifies and prioritizes key environmental, social, and governance (ESG) issues pertinent to an organization’s operations and stakeholder interests. By engaging stakeholders and assessing the significance of various sustainability concerns, this assessment aligns with the company's goals and values. The insights gained from a materiality assessment are instrumental in guiding decision-making, shaping ESG strategies, and informing sustainability reporting. This ensures that the organization focuses its efforts on areas of greatest impact and significance, both for its stakeholders and its long-term success.

What is a double materiality?

Double materiality is a concept that reflects the dual perspective of an organization's impact on sustainability matters and how these matters, in turn, affect the organization financially. It's like looking through two different lenses at the same time.

Impact Materiality: This aspect focuses on how a company's activities and decisions impact people and the environment. It's about understanding and reporting the direct and indirect effects the company has on the world around it in terms of sustainability. This includes things like carbon emissions, labor practices, and community relations. It's like a company looking outward and asking, "What impact are we having on the world?"

Financial Materiality: On the flip side, this aspect is about how sustainability issues can influence the financial performance and value of a company. It's looking inward and considering questions like, "How could climate change, resource scarcity, or changes in social norms affect our profitability or business model?" This is about recognizing that sustainability issues aren't just ethical concerns; they can be crucial to a company's financial health and long-term success.

Indeed, some material impacts may evolve into material risks. For instance, deforestation is a material impact that could transition into a material risk if the cleared land becomes unsuitable for cultivation, presenting a clear material risk. Therefore, deforestation is identified as a material topic from both impact and risk perspectives and is positioned at the intersection in the Venn diagram below. The materiality of a matter is discerned through its material impacts or material risks and opportunities, with the possibility of a matter being material from both angles. A matter recognized for its impact materiality may or may not generate material risks and/or opportunities. Moreover, it's common for material matters to entail financial risks and/or opportunities, highlighting the importance of double materiality to ensure a thorough inclusion of all potential material matters.

The CSRD (Corporate Sustainability Reporting Directive) has formally integrated the principle of double materiality into its reporting framework. This requires companies to disclose not only the influence of sustainability issues on their financial performance (financial materiality) but also the effects of their operations and strategies on the environment and society (impact materiality). Previously, companies primarily focused on financial materiality in their reporting, identifying potential risks and opportunities presented to the company by environmental, social, and governance (ESG) topics. For instance, they would assess how climate change could present both opportunities and risks to their business, leading to the identification of material topics for disclosure.

Materiality Assessment & Sustainability Strategy

The Corporate Sustainability Reporting Directive (CSRD) marks a significant advancement by insisting on a strategic level of consideration for integrating sustainability into the very core of business operations and disclosures. Achieving this integration demands a deliberate and meticulous execution of the materiality assessment process, which aligns the company's vision and objectives with the establishment of clear, actionable goals, and a thorough monitoring and evaluation mechanism.

According to the Materiality Assessment Implementation Guidance published in December 2023, further elaboration can be found in the referenced article. The guidance illustrate the process of materiality assessment as depicted below: it starts by identifying impacts, risks, and opportunities, This leads to the identification of material impacts, as well as significant risks and opportunities. Consequently, this process feed the selecting disclosure requirement (DR) from the dataset provided by EFRAG, also published in the December 2023. This step is not limited to the selection of relevant data points but also plays a pivotal role in defining a company's sustainability statement, strategy, and decision-making process.

At the heart of this process is the intrinsic value of the materiality assessment, which empowers companies to identify and prioritize sustainability issues of paramount importance to both their operations and their stakeholders. The valuable insights derived from this assessment serve as a cornerstone, shaping the business model, guiding the overarching business strategy, and influencing critical management decisions. This process paves the way for the formulation of pertinent sustainability goals that are intricately woven into the company's core objectives.

Implementing a comprehensive materiality assessment and integrating its outcomes into the company's strategy, business model, and decision-making processes ensures that sustainability efforts are directed towards areas of highest impact and relevance. This, in turn, enhances the company's performance across environmental, social, and economic dimensions. Such an approach cultivates a symbiotic relationship, embedding sustainability practices deep within the fabric of everyday business operations.

Materiality Assessment & The ESRS

For companies aiming to meet the rigorous standards of sustainability integration and reporting set by the CSRD, the materiality assessment is absolutely crucial. It provides a well-defined framework for identifying goals, aligning sustainability efforts with business strategies, and ensuring that these initiatives are thoughtfully planned, executed, and monitored. Every company must be reviewing the 12 standards “ESRS” that provides guidance of the reporting expectations, then your materility assessment outcomes serve as an input to these 12 standards or to be exact 10 standards as the ESRS 1 & 2 do not depend on the outcomes of your assessment.

The European Sustainability Reporting Standards (ESRS) offer a comprehensive framework for sustainability reporting, detailing the necessary disclosures for organizations to accurately report on their sustainability performance. These standards encompass a broad spectrum of environmental, social, and governance (ESG) dimensions, including impacts, risks, and opportunities. Topics covered by the ESRS range from climate change, pollution, and water and marine resources to biodiversity and ecosystems, resource utilization and circular economy, community impact, workforce considerations, value chain labor, consumer relations, and ethical business practices, encompassing over 1,000 potential data points for reporting.

The 4 Step Approach

Step 1: Understanding The Context

First and foremost, the initial step involves assembling a dedicated team tasked with conducting the assessment. Recognizing the magnitude of this responsibility is crucial; the team must be ready to undertake a comprehensive mapping of all business sectors and operations, ensuring that every aspect is incorporated into the assessment's scope. Each operation, department, or position in the value chain may present a unique set of impacts, risks, and opportunities (IROs) that necessitate engagement with the appropriate stakeholders. Consequently, understanding the landscape of stakeholders becomes a critical component of the process. Including the right stakeholders is instrumental in significantly influencing the outcome of the assessment.

Step 2: Identification of Actual & Potential IROs

Review the European Sustainability Reporting Standards (ESRS) and internally assess potential impacts, risks, and opportunities (IROs) for each sustainability matter. This step necessitates a thorough examination of ESRS mandates, industry norms, geographical limitations, operational facets, and the risk landscape. It's vital to note that "risks and opportunities" pertain to financial implications stemming from environmental (E), social (S), or governance (G) issues, while "impact" denotes any potential effect on E, S, or G resulting from company actions. Each business function, along with the value chain, must undergo evaluation concerning relevant sustainability matters to identify possible IROs, laying the groundwork for subsequent steps.

• Engagement and Research: Engage with relevant stakeholders and experts to identify actual and potential impacts (both negative and positive) of the undertaking's activities and business relationships. Utilize scientific and analytical research to understand the impacts on sustainability matters thoroughly.

• Documentation: Document all identified impacts, categorizing them as either negative or positive and noting their direct and indirect nature.

Step 3: Assessment and Determination of Material IROs

This phase encompasses multiple sub-steps and is the most demanding in terms of time and resources within the process. It involves a comprehensive assessment of impact materiality (evaluation of impacts) and financial materiality (analysis of risks and opportunities), followed by consolidation of results and data points selection ready for disclosure. The "double materiality funnel," depicted below, systematically describes this approach. Potential and actual Impacts, Risks, and Opportunities (IROs) identified from the review of the ESRS and, where relevant, from prior materiality assessments, are directed into this critical phase.

1) Impact assessment: Develop criteria for gauging the materiality of identified impacts, focusing primarily on severity and likelihood. Consider the characteristics of severity, such as scale, scope, and the potential for remediation. Proceed to rigorously evaluate each identified impact against these criteria to determine its materiality. This involves an in-depth analysis of the impact's scale (severity), scope (extent of effect on people or the environment), and irremediable character (ability to reverse the impact). Through this meticulous process, it's possible to systematically pinpoint and prioritize the most significant impacts for targeted sustainability initiatives.

2) Financial assessment: Identify risks and opportunities that could affect the organization's financial health. This involves considering dependencies on natural and social resources and the materiality of these dependencies as sources of financial effects. These are classified as either risks (which could lead to negative financial deviations) or opportunities (leading to positive financial deviations).

The financial assessment focuses on identifying how impacts and dependencies can be sources of financial risks or opportunities for an organization. Key points include:

1. Dependencies on Natural Resources: Organizations reliant on natural resources, like water, may face financial risks due to changes in resource quality, availability, and pricing.

2. Negative Impacts on Communities: Activities causing negative impacts on local communities could lead to stricter government regulations or reputational damage, increasing costs such as recruitment expenses.

3. Business Partners' Risks: Sustainability-related risks faced by business partners can also impact the organization.

For reporting purposes, material risks and opportunities are determined based on their likelihood and the potential size of their financial effects, using appropriate thresholds. The assessment also considers the short-, medium-, and long-term financial impacts based on likely scenarios or forecasts and potential material financial effects. This includes situations not yet reflected in financial statements, such as impacts on cash flow generation and the influence of capitals (natural, intellectual, human, social, and relationship) not recognized as assets but significant to financial performance.

3) Consolidation of the outcomes

Consolidating the outcomes of both impact and financial materiality hinges not just on predefined thresholds but also takes into account the company's strategy and future objectives. It is crucial to ensure that the prioritization of material topics aligns with the company's aspirations. These significant topics should be prominently incorporated into the company's sustainability statements, overarching strategy, and decision-making processes.

4) Data points selection

Given the constraints of time and resources, the materiality assessment serves as an indispensable filtering mechanism. This process empowers companies to identify and focus on areas of significant impact, thereby streamlining the extensive list of potential data points to those most critical for reporting. The CSRD (Corporate Sustainability Reporting Directive) specifies 42 mandatory environmental indicators, highlighting the necessity of prioritizing reporting efforts. Additionally, based on the outcomes of the materiality assessment, companies typically select an additional 647 data points for inclusion in their reports.

The ESRS 2 further delineates 146 mandatory data points, alongside the possibility for companies to voluntarily report on more than 270 additional data points. An accompanying graph provides a visual breakdown of the data points required under each ESRS standard, underscoring the pivotal role of materiality assessment in directing reporting focus towards the most pertinent issues. The distinction between mandatory data points, which must be reported regardless of materiality assessment outcomes, and voluntary data points, which companies may choose to report on, is crucial. Furthermore, the materiality-driven data points underscore that the disclosure of these specific data depends on the results of the materiality assessment, tailoring reporting to reflect the company's most material sustainability impacts, risks, and opportunities.

Step 4: Close The Loop

Materiality assessment is not merely a one-time checkpoint; rather, it represents a continuous cycle of improvement and reflection. As such, it should be an ongoing process aimed at enhancing a company's sustainability strategy, ensuring it addresses the most impactful topics from both an impact and financial perspective.

In Conclusion

Materiality assessment marks the initial phase of the journey towards CSRD compliance, acting as a mechanism to funnel, screen, and prioritize diverse sustainability-related matters. Beyond compliance, it serves as a strategic tool for the development of sustainability strategies. Consequently, it's crucial to recognize two key points: First, materiality assessment should be institutionalized as a recurring process within your company. Second, there is no singular correct method for conducting a materiality assessment; instead, there are frameworks available that facilitate the implementation process and ensure comprehensive coverage of all necessary aspects.