The Essence of Double Materiality

Materiality vs Significance?

The term "Materiality" has a specific history in both accounting and corporate sustainability contexts:

1. Accounting Context: In accounting and financial reporting, the concept of "materiality" is well-established. It refers to the significance of an item to users of a company's financial statements. If something is left out or incorrectly stated and it can affect financial choices, it's considered material.
   
   
2. Sustainability Context: In the realm of corporate sustainability reporting, "materiality" has been used to determine which environmental, social, and governance (ESG) topics are most relevant to a company and its stakeholders. Material topics in this context are those that reflect significant economic, environmental, and social impacts or those that would substantively influence the assessments and decisions of stakeholders.

So, the word "Materiality" was chosen because of its existing usage and significance in both financial and sustainability contexts, making it easier for professionals from these fields to grasp the dual nature of the concept. Using the term "significance" might have made the concept more ambiguous, given that "materiality" already encapsulates the idea of "significance" in financial reporting.

Double Materiality Initiated by EU for Reporting

The European Commission was the first official body to define double materiality in its 2019 guidelines on non-financial reporting. It emphasizes that sustainability matters are not just about corporate social responsibility but are intrinsically linked to a company's long-term viability and success.

In essence, Double Materiality is a comprehensive approach that requires companies to evaluate and report on:

• How they impact the environment and society (their externalities).
• How environmental and social issues might impact them (risks and opportunities).

Impact Materiality and Financial Materiality

According to the European Sustainability Reporting Standard (ESRS), "Double Materiality" refers to the dual perspective of assessing materiality in the context of sustainability reporting:

1. Impact Materiality (Outward Impact): This perspective considers the impacts of the company's activities on environmental and social factors. It assesses how the company's operations, products, or services affect the environment, society, and stakeholders. This is about understanding the company's footprint on the world.
   
2. Financial Materiality (Inward Impact): This perspective looks at how environmental and social factors impact the company's ability to create value in the short, medium, and long term. It's about understanding how sustainability issues might affect the company's financial performance, operational efficiency, and overall value proposition.
   

Specific consideration is given to the definition of financial materiality, particularly in ESRS 1 paragraph 48 of the Delegated Act. It was stated by EFRAG on 23th of August 2023 that material financial information under ESRS is now focused on the needs of primary users (investors), assuming that the needs of other stakeholders are satisfied either through impact materiality information or through the information needed by investors.

Double Materiality Outside of European Union

While the concept of double materiality originated in the European Union, it is gaining recognition and is being adopted outside the EU, especially in the U.S. and by major global sustainability reporting frameworks:

• U.S. companies are getting to know the concept of double materiality, especially among U.S. companies with European subsidiaries.
•  International Sustainability Standards Board is working on a global guide for sustainability reporting, which will incorporate double materiality.
• Popular sustainability reporting guidelines, such as the GRI or the SASB standards, which initially focused on the “outside-in” approach, are now moving towards double materiality by incorporating the “inside-out” perspective.

Why put effort into Double Materiality Assessment?

Companies conduct a Double Materiality Assessment for various reasons:

1. Regulatory Compliance: Many jurisdictions are introducing or have introduced regulations that mandate certain companies to disclose their environmental and social impacts. Double materiality helps ensure compliance with these regulations.
2. Stakeholder Expectations: Stakeholders, including investors, customers, employees, and communities, increasingly expect companies to understand and manage their broader impacts on society and the environment.
3. Risk Management: Understanding both the external impacts a company might have and the external factors it depends on allows for better risk identification and management.
4. Strategic Decision-making: Insights from the assessment can inform a company's strategy, helping it pivot or refine its business model in anticipation of future challenges or opportunities.
5. Financial Performance: Addressing material environmental and social factors can potentially lead to better long-term financial performance. Identifying and acting on sustainability-related opportunities can open new revenue streams and improve operational efficiency.
6. Reputation Management: Demonstrating a commitment to understanding and managing societal and environmental impacts can enhance a company's reputation, which can lead to increased brand loyalty, customer retention, and a competitive edge.
7. Access to Capital: Investors are increasingly considering environmental, social, and governance (ESG) factors in their decision-making processes. Companies that can demonstrate a robust approach to materiality are often more attractive to these investors.
8. Operational Efficiency: By identifying material issues and addressing them, companies can often find ways to operate more efficiently, reducing waste and optimizing resource use.
9. Innovation: Addressing material challenges can spark innovation, leading to the development of new products, services, or processes.
10. Long-term Viability: For a company to thrive in the long-term, it must understand and navigate the broader systemic challenges it faces. Double materiality provides a framework for this.
11. Employee Engagement and Retention: Employees increasingly want to work for responsible companies. By addressing material issues, companies can increase employee satisfaction and retention.
12. Supply Chain Resilience: Understanding dependencies and impacts can also aid in building a more resilient supply chain, as companies can work collaboratively with suppliers to address shared challenges.