What this means for environmental and social impact and for sustainability reporting

We love to read about companies that do great work to help the planet and people. Most of this information comes through case studies presented on an organisation’s website, via newsletters or in their annual impact and/or sustainability report.

However, sometimes it is unclear, in the eyes of both internal and external stakeholders (and even the casual observer), how an organisation came to identify its material topics – or those environmental and social initiatives in which it is investing its resources to improve its performance or impact outcomes. How is one topic prioritised over another?

The emerging global standard is to apply the double materiality concept, which means to consider both impact materiality and financial materiality. In practice, the approach is multi-dimensional and can utilise tools that already exist within an organisation, such as the risk management framework.

In this blog, we look at the characteristics of existing and new approaches and the need for synthesising this information to form a complete and transparent view of a company’s ESG, impact and sustainability performance.

Sustainability and double materiality

There are many dimensions to evaluating sustainability performance. This is one possible reason why capital markets have moved to the more specific description of ESG – environmental, social and governance – to evaluate investor risks or to identify superior risk-adjusted returns.

In addition, there is also a proliferation of interpretations around some of these terms (e.g., sustainability and materiality) and organisations may find it difficult to determine what data should be captured to enable strategic planning. From a science perspective, it is argued that “sustainability “should be assessed relative to planetary boundaries and tipping points - such as global surface temperature warming, biodiversity loss, pollution levels, human health, and equity. The Science Based Targets Initiative uses this approach.

A 2021 paper published by the Global Research Institute (GRI) – titled “The Double Materiality Concept: Application and Issues” (authored by Adams, C.A et al), gives several examples of current thinking about double materiality. These stem from the European Commission (2019) in its Guideline on Non-financial Reporting, which outlines two interconnected perspectives:

1.       “the extent necessary for an understanding of the company’s development, performance and position” and “in the broad sense of affecting the value of a company”

2.       the environmental and social impact of the company’s activities on a broad range of stakeholders.

This paper also notes a recent definition from the European Financial Reporting Advisory Group (EFRAG, 2021) which describes impact materiality based on the severity and likelihood of actual and potential impacts on people and the environment – which are terms that most businesses are accustomed to from their use in risk management frameworks. The EFRAG definition extends to the scale, scope, and likelihood of positive impacts on people and the environment across operations and value chains and introduces the dimension of urgency.

Focus on sustainable development

Adams et al, 2021, outlines why an organisation needs to undertake impact materiality to inform financial materiality and how both perspectives are important to provide a complete portrayal of sustainability performance.

This thinking is reiterated by RMIT University and GCNA (2021), which highlighted that to integrate the United Nations Sustainable Development Goals (SDGs) into strategic analysis, the initial step is to conduct an assessment of the current and potential, positive and negative impacts that the business activities have on the SDGs throughout the value chain.

To maintain and enhance its focus on sustainable development and reporting, organisations should:

• Identify its material impacts on sustainable development prior to assessing financial materiality

• Define materiality from the perspective of the impact of an organisation on sustainable development and stakeholders, thereby enhancing engagement with stakeholders

• Focus on ‘value for the organisation, society and the environment’ through engagement with the UN Sustainable Development Goals

• Implement robust methods for materiality analysis, to avoid falling back on financial materiality - noting that identification and disclosure of material sustainable development is value relevant and enhances financial performance

• Increase the credibility of sustainability reports by increased disclosure about materiality processes

• Extend quality assurance processes beyond checking data.

(adapted from Adams et al, 2021).

Non-converging perspectives

The GRI (Adams et al, 2021) believes each direction of the notion of materiality needs to be considered and it is not the convergence of the two perspectives that renders an issue as material “impacts on the environment and society cannot be deprioritised on the basis they are not financially material, or vice versa”.

The diagram below visualises these two directions as outward looking (impact materiality) and inward looking (financial materiality). Impact materiality considers the positive and negative impacts of a business’s activities on the environment and society. The burning of coal for electricity generation, for example, has significant negative impacts in terms of scale (industrial operation), scope (large quantities of greenhouse gas emissions), urgency (to keep surface temperature warming below 1.5 degrees increase) and effects on stakeholders (local air pollution, global climate warming).

Financial materiality as a second stream, looks at those risks that affect enterprise value and is most closely aligned with a typical risk assessment framework that categorises risks according to severity and likelihood, before and after control measures. Using the coal-fired electricity generation example, the financial materiality is also significant given the physical, transition and liability risks (such as reported under the Taskforce on Climate-related Financial Disclosures (TCFD) framework) of continuing to operate in the face of global warming.

The outcome of this analysis would be one source of information that makes apparent the line of sight between company priorities and imminent environmental and social issues. One should inform the other to ensure the prioritisation of risks and opportunities is responsive to decisions and changing conditions or expectations across the business and value chain. Metrics and targets are important to show improvement in impact performance.

Application of double materiality

We couldn’t find any recent Australian reports on double materiality through internet searches. However, one article in The Inside Adviser discusses the application of double materiality from an investor’s point of view, using a couple of high profile examples: Rio Tinto (RIO) and Cleanaway Waste Management (CWY).

In the first example, the investor sold their position in RIO following the destruction of the 46,000 year old Indigenous rock shelter at Juukan Gorge mine. Their view was that RIO not only damaged its reputation and social licence to operate, but its actions also led to increased environmental and regulatory costs for its business and the industry. This resulted in the investor downgrading aspects of their ESG performance (earnings quality, industry dynamics, management, valuation and ESG) and ultimately their overall assessment. In the CWY case, the CEO’s misconduct resulted in marking down some aspects (management/governance) but the overall assessment remained acceptable.

For a recent example of how an impact materiality assessment (as described in this article) is undertaken see this report by the Australian Beef Sustainability Framework – Materiality Assessment Report 2021. It describes the steps undertaken to review and confirm the topics material to this industry, maintain a consistent application of evolving sustainability-related standards and engage with stakeholders and seek their feedback.

Forward looking

Stakeholders are taking an active interest in company performance in terms of impacts on sustainable development and on enterprise value. This is driving the rise of the double materiality (impact and financial) analysis framework that encompasses both inward looking and outward looking perspectives on an organisation’s performance.

The framework recognises the bi-directional nature of an organisation’s activities. For example, activities causing biodiversity loss (impact materiality) can also result in reduced supply of natural resources (financial materiality). Similarly, an organisation may both directly impact on climate change (e.g. greenhouse gas emissions) and be affected by climate change (e.g. damage to assets and property).

There are few barriers to adopting double materiality, since most of the tools are at hand. Organisations are familiar with the risk assessment framework, and typically through the environmental impact assessment or planning approval processes, with their environmental and social impacts - both negative and positive. Technology has also made it possible to gather more granular reporting data and the state of knowledge is always increasing. It just remains for forward looking companies to maintain stakeholder engagement and keep up with the pace of change.

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Shelley Anderson is a freelance Certified Environment and Sustainability practitioner with experience in Australia and the UK. Her expertise includes environmental risk assessment and management, due diligence, and reporting across a broad range of industry sectors. Shelley was also a Director of the Cotswold Canals Trust (UK) where she led the Natural Environment team and applied her skills to charity governance and impact.

Written in consultation with Jenni Mulligan, Co-Founder and a Principal Consultant @ iSystain .

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