Risk, impact and responsibility: It’s time to double down on materiality.
‘Double materiality’ will become an increasingly important concept thanks to new EU rules on corporate sustainability reporting.
In the near future, social risks will be treated with the same seriousness as climate risks are today.
Materiality is a familiar concept in financial reporting: a piece of information is material if omitting it could influence decisions made by investors based on those financial reports.
In ESG, the definition is similar. In essence, we must ask, ‘does it matter?’ The threat of sea-level rises is a material issue for a hotel chain with beachside properties on low-lying islands, but is not as business-critical to a consulting firm with offices in high-rise buildings well away from the coast. An ESG issue is material if it causes a real risk to a business.
Double materiality means understanding what material risks a company faces from environmental and social changes and its material impact on the world around it. A soft-drink manufacturer’s decision to use recycled or non-recycled plastic, or a delivery company’s policies on its gig-economy workforce, have a material impact on the world around those organisations. An accounting firm’s plan to ban plastic straws in the company canteen probably doesn’t, well-intentioned as it may be.
Shareholders, investors, creditors and regulators are likely to be concerned about the financial risks that social and environmental changes pose to a business. So far, most serious thinking about risk is related to climate change—and the Biden administration’s executive order on climate-related risk means this will only intensify in the coming years. Yet the pandemic and the #MeToo movement have demonstrated that companies can face real financial, regulatory and legal risks from social upheaval.
Key takeaway: distinctions between risks to your business and the impact your business has on social and environmental issues are becoming increasingly blurred.
Securities regulators have thus far been chiefly concerned that companies disclose material ESG risks. However, the next wave of regulation—driven by the EU’s new rules—will include increasingly demanding requirements for companies to disclose information about their impact on the world.
Changes to the EU’s Non-Financial Reporting Directive are not likely to bite until 2024, but many businesses will likely fall into line well before then. Even those outside the EU will need to take note if they want to attract European funding, thanks to the new Sustainable Finance Disclosure Regulation.
What’s on the horizon?
The direction of travel is clear: while ESG will continue to be about risks to your company, expect investors—and increasingly regulators—to ask more detailed questions about the contribution you are making to solving big global environmental and social problems.
