I used to think the concept of materiality in sustainability-speak was rather hard to understand until I came across the concept of “double materiality” in the EU proposal for improvements to company reporting.
Is double-materiality significant or merely a bureaucratic oxymoron?
The answer lies in your point of view.
- If you are an unreconstructed financial traditionalist, then the concept is something quite new and potentially disruptive.
- If you’re a sustainability advocate, it’s heartwarming because the concept accelerates the cause for greater corporate responsibility, transparency and positive action.
Before understanding double materiality, it helps to know what single materiality is.
Traditional view
The Securities and Exchange Commission (SEC) is the US government regulatory agency that, among other duties, specifies what listed companies should report to investors. It defines materiality as the information “a reasonable person would consider important” when valuing an enterprise.
In practice, information is deemed material to a company’s financial stability and therefore its value to investors. For example, if the share price drops alarmingly because of, say, revelations of widespread corruption or a major accident. When BP’s Deepwater Horizon oil rig blew up in the Gulf of Mexico, the financial and reputational impact of the resulting oil spill had a material affect on the value of the business.
Small accidents or “traffic ticket” fines for pollution would not have the same commercial impact and would not be considered financially material. And until quite recently, the nature of BP’s core business – producing and marketing oil and gas – was not considered a material issue because it contributed to the prosperity of society and BP’s shareholders.
Sustainability view
Sustainability advocates have long argued that the negative impact of an enterprise on the planet and society should influence its value. To make their point, they borrowed the materiality term and devised ways to determine a new set of material issues that the financial community had long ignored as “externalities” (and mostly still do). For example, long before carbon began rising up the financial agenda, it was of great concern to other stakeholders worried about climate change. Stakeholders also fretted about other issues that the financial community ignored, such as human rights, diversity and impacts on nature.
The inclusion of “stakeholder” concerns resulted in the materiality matrix commonly found in sustainability reports. The matrix is plotted by establishing the relative importance of an issue to:
- The company’s management
- The company’s stakeholders
Plotting the matrix is more of an art than a science. It is usually done by consultants who (should) take a neutral view. Their process goes something like this (there are many variations on a theme):
- Step 1. Stakeholders are asked what sustainability issues the company should be managing, and then to rate the relative importance of each issue. For example, on a scale of 1-10, encouraging diversity could be, for arguments sake, rated 9 while protecting biodiversity could be rated 5 by the stakeholders.
- Step 2. The consultant (knowing the company), then rates the issues according to their potential importance to the company.
- Step 3. Using two axes (importance to the company; importance to stakeholders) the issues are plotted. The top right quadrant contains the issues that are the most important to the company and its stakeholders. It is those topics that are considered material and which define the contents of the sustainability report.
What’s the double fuss?
Sustainability reporters rightly ask what the fuss is about because their concept of materiality broadly accounts for impacts on stakeholders (proxy for the planet) and impacts on the company. Is this not already double materiality, they ask?
Partly. But the important point here is that the concept of double materiality is aimed at the financial community, not the Sustainerati.
The regulators are saying that the traditional financial definition of materiality is pertinent but too narrow. They want reporters to acknowledge that longer-term issues, such as the impact of climate change on a company, are material to the value of an enterprise.
By promoting “double” materiality the regulators are asking companies and the financial community to acknowledge that a much broader range of issues and events affect an enterprise. The regulators are siding with sustainability advocates who have long argued this case. And what’s more, the actions of companies affect society and the environment too. The concept of double materiality acknowledges that interconnection – hence double.
Phew! What a long explanation, say the Sustainerati: that’s what we’ve been arguing for all along!
Sustainability advocates have got their way. Their view of materiality is (largely) being enshrined in regulations and will dictate what large companies are required to report to an increasingly interested financial community.
It may take a little while. But materiality is about to double.
