As a child of the 80s, any time I hear the words material or materiality I automatically default to Madonna, as any self-respecting child of the 80s would do. This is fortunate or unfortunate, depending on your view of Madonna, given that materiality is such a central tenet of enterprise sustainability and responsible business conduct (RBC).
When it comes to materiality, in accordance with Madonna’s demands, companies have for many years been primed to think about what’s important to their business in terms of money and wealth. What will make them grow? What will earn them more revenue? What will make more profit? What will protect what they already have? What might endanger their revenue or profitability?
While thinking in this way is of course a fundamental requirement of all business owners to ensure they remain viable, I think it’s fair to say that left unchecked, it can run amok.
For example, we all know people who have been impacted by redundancy at some stage in their career. In many cases, this happens because company profits have fallen from the previous year. This may be a fall from a 50% profit to a 35% one, which although still significant, is for some reason deemed insufficient by shareholders.
This can happen where companies operate in accordance with a model of corporate governance known as shareholder primacy. According to this model of governance, the primary purpose of the company is to generate returns for shareholders and to maximise shareholder value. This requirement is built into corporate law in the United States where companies have a fiduciary duty to shareholders. This means that US companies must operate and make decisions in a way that maximises value for shareholders, regardless of the impact this may have on employees, suppliers, customers or the planet.
If a company operating in accordance with this governance model for example has to choose between two suppliers, one of whom has known or suspected links to deforestation or one with verified sustainability credentials who is significantly more expensive, which will will it choose? If a decision needs to be made to take a small hit on profits to ride out a short-term storm or to let people go to be seen to be tackling the issue, which one will the company managing for shareholders choose? Don’t forget, they can always re-hire when things bounce back. Fresh blood, fresh faces. When faced with these decisions, management teams in these shareholder primacy companies very often have their hands tied.
Recognising this, the OECD-led, European supported, international Responsible Business Conduct (RBC) movement which is a much firmer, more directive version of its Corporate Social Responsibility (CSR) predecessor pushes companies to adopt a stakeholder model of governance rather than a shareholder-only model. This requires companies to operate their businesses with all stakeholders in mind.
Note: When it comes to stakeholders, while there are plenty of robust discussions as to whether Mother Earth should be a stakeholder or even on a company’s board of directors (see Apple’s take here), there is no denying that everyone is dependent on a healthy planet for their well-being and survival. This means that regardless of whether you view the environment as a stakeholder or not, we cannot ignore the science. Planetary harm is human harm, or in the language of business, planetary harm is stakeholder harm and planetary harm is shareholder harm.
RBC therefore requires companies to adopt a double materiality approach when it comes to running their business. This means, companies must assess what’s important from two lenses. An impact materiality lens and a financial materiality lens.
Impact Materiality
Impact materiality requires companies to assess the impact they have on people, the environment and the economy, either directly, where they cause or contribute to the impact, or indirectly, where they are linked to the impact through suppliers or partners, who themselves directly cause or contribute to the impact.
This means companies must ensure they do not adversely impact their employees, suppliers, customers, the local communities they operate in, the general public, the environment or society in general, through for example tax avoidance or creative tax practices that lessen the amount of public money available for social services.
Questions companies should ask themselves when assessing their impact include whether they pay everyone a living wage? Do they have health and safety procedures in place? Do they have mechanisms in place to allow people, both inside and outside the company raise concerns without fear of reprisal or recrimination? How aware are they of what’s happening in their supply chain? What are their investments being used for? What do their pensions fund? Do they pollute or contribute to environmental damage? etc.
Financial Materiality
Financial materiality assessment on the other hand is already a well-established practice in business, as each company already formally or informally assesses impact and risk from the perspective of their financial position and performance. What may be different for some companies in this case though is that they must now extend this view of financial impact and risk to include sustainability and ESG matters. So for example, what impact does climate change have on the business’s financial position and performance? Will the public policies designed to support an energy transition result in stranded assets for example? Will the risk of increased flooding drive up insurance costs? Will weather events disrupt supply chains? From a human rights perspective, will association with a supplier found to be engaging in forced labour damage the company’s reputation and thus impact revenue? And so on…
Double Materiality
When companies apply a double materiality perspective, they assess both their impact on people and planet and the impact of ESG topics on their financial position and performance. More importantly they are required to prioritise their response to this impact based on set criteria which includes how grave their impact on people and planet is (scale), how widespread it is (scope) and how difficult it is to counteract (irremediable character).
Those in scope for the EU Corporate Sustainability Reporting Directive (CSRD) are required to apply a double materiality assessment perspective when assessing their impact and risk and are required to describe how this was carried out in their organisation. This information is also required of those reporting in accordance with the GRI Standards.
While other international reporting standards such as the IFRS Foundation’s Sustainability Disclosure Standards S1 and S2 (developed by the ISSB) and the Recommendations from the Task Force on Climate-related Disclosures (TCFD), only require companies to report from a financial materiality perspective we would always recommend companies apply a double materiality assessment perspective.
Applying both perspectives not only gives companies a more holistic view of their impact, it also future-proofs them against changes to materiality assessment scope that may be applied to those financial materiality-only disclosure standards once investors and assessors start seeing the insights a richer double materiality dataset can deliver on each business.
I’m not saying all investors think like Madonna but once they see the art of the possible, those that do are going to want everything material you can give them.
