9 minutes04/05/2024
The term double materiality has received greater attention recently due to its inclusion as a reporting requirement in the EU’s Corporate Sustainability and Reporting Directive (CSRD). For those unaware of what double materiality entails we put together this guide to help you gain a better understanding of it.
In this article, we deep dive into what double materiality is, why it is important, why it’s a topic of debate, how it’s viewed by the EU, and how organizations can incorporate double materiality into their ESG and sustainability programs.
Let’s get started.
Double Materiality Defined
In essence, the concept of double materiality revolves around two key points: firstly, how environmental, social, and governance (ESG) issues, such as climate change, can significantly influence an organization's operations; and secondly, how the actions of an organization can materially impact ESG issues.
The notion of double materiality, although not universally defined within the realms of ESG and sustainability, is rooted in the financial sector's accepted notion of materiality. In the financial context, a matter is deemed 'material' if it is "reasonably likely to influence the decision-making of investors." Such information is critical and must be disclosed in detail, as omitting it could hinder an investor's decision-making capacity.
This principle of materiality highlights that what is considered significant can differ from one organization to another, depending on their size and scope. For example, a $20,000 expenditure may be critical for a small business with annual revenues of $200,000 but negligible for a corporation earning $2 billion annually.
The application of materiality has expanded to encourage the disclosure of both financial and non-financial data concerning a company's ESG and sustainability endeavors. Double materiality advances this by urging entities to evaluate the mutual impact between them and ESG issues, encompassing all aspects of ESG, especially as climate risks and regulatory demands heighten. Furthermore, double materiality acknowledges a broader range of stakeholders beyond investors, including the general public, emphasizing the accountability of organizations to these groups.
The Importance of Double Materiality
One significant criticism leveled against ESG and sustainability initiatives is their failure to implement rigorous reporting standards. This shortfall often led to organizations engaging in greenwashing, where their environmental efforts were overstated or misrepresented. In response to this issue, the concept of double materiality has been introduced as a corrective measure. This approach mandates that companies adopt a reporting framework that is transparent, dependable, and rooted in concrete data. According to double materiality principles, any factor within the ESG domain that significantly affects the company's operations or financial health must be disclosed to investors and other relevant stakeholders.
The rationale behind this stringent reporting criterion is to foster a culture of accountability among corporations. By enforcing a higher standard of transparency, businesses are not only expected to take their ESG commitments more seriously but are also encouraged to actively pursue a transition towards achieving net zero emissions. This shift is crucial for mitigating the impacts of climate change and aligning with global efforts to limit temperature rise by 2030.
The introduction of double materiality standards represents a pivotal step towards ensuring that companies' sustainability claims are both verifiable and impactful, thereby reducing the risk of greenwashing and promoting genuine environmental stewardship.
Double Materiality Assessments Explained
A double materiality assessment is a comprehensive evaluation that enables organizations to identify the sustainability and ESG issues that are significant both to their operations and their stakeholders. This type of assessment is instrumental in shaping an organization's ESG strategy and in determining the prioritization of its initiatives. It involves a thorough examination of the organization's activities, as well as those occurring within its value chain—both upstream and downstream.
For example, an organization that sources its electricity from a coal-fired power plant is exposed to significant risks related to environmental and climate impacts, despite not being directly involved in the operations of the coal plant. These risks are identified through the double materiality assessment process, highlighting the interconnected nature of sustainability issues along the value chain.
Conversely, should an organization opt to transition to a renewable energy source, this decision is also scrutinized under the lens of double materiality. While the initial financial investment might be substantial, potentially posing a short-term financial risk, the long-term benefits could be considerable. Not only could the organization experience financial gains over time, but it could also contribute positively to the welfare of local communities and the global climate. This illustrates the dual focus of double materiality assessments: they consider both the immediate financial implications and the broader societal and environmental impacts of an organization's actions.
Examples in Different Industries of Double Materiality
The concept of double materiality prompts organizations to examine their internal and external practices and their effects on ESG matters, and how these factors, in turn, influence them. Here are several examples where adopting a double materiality perspective can lead to beneficial ESG outcomes:
Financial sector: A bank may choose to provide loans exclusively to companies that do not harm the environment. This decision not only enhances the bank's operational performance and public image but also reduces its risks and promotes environmental sustainability.
Professional services: An accounting firm might introduce a wellness program for its staff, boosting their health and well-being. This strategy aids in retaining and attracting employees while decreasing absenteeism.
Manufacturing: A manufacturer’s shift to using sustainable, renewable energy sources can help achieve carbon neutrality, improve local air quality, boost the company's brand and reputation, and decrease costs in the long run.
Retail: A retailer may evaluate its entire supply chain, opting for suppliers who adhere to ethical labor practices. This move benefits the workforce and minimizes the risk of negative public reactions to unethical business behaviors.
Agriculture: A farm adopting a new rainwater harvesting system reduces reliance on local water resources and cuts costs over time.
Energy: An energy company heavily dependent on fossil fuels might invest in research and development to explore renewable energy alternatives. Such an investment advances global carbon neutrality objectives and attracts environmentally conscious investors.
- Education: An educational institution that revisits its gender and diversity policies to promote inclusivity becomes more welcoming to underrepresented groups, enriching the experience for students and staff, and enhancing its reputation.
Why is Double Materiality Being Debated?
Double materiality, despite its potential, has sparked considerable debate and controversy primarily due to its vague and unspecified nature. Here is a concise overview of some of the main issues:
Absence of a unified approach: One cause for controversy around double materiality stems from the varied interpretations it invites. What is deemed material for one entity might not hold the same significance for another, leading to inconsistencies in reporting. This variation opens the door to subjective interpretations and the risk of greenwashing.
Ambiguity over the target audience: Another point of contention is identifying the intended audience for these disclosures. Traditionally, financial disclosure reports targeted investors, catering to their specific requirements and expertise in navigating complex financial documents. However, double materiality broadens this scope to include a diverse range of stakeholders such as non-profits, employees, labor unions, local communities, and the broader public. This diversity raises questions about the format and target audience of these reports, particularly when financial data can be challenging for many to access.
Definition of 'material' remains elusive: Lastly, there is ongoing difficulty in defining what constitutes a material impact on environmental, climate, or other ESG concerns. The debate hinges on whether materiality should concern investors exclusively or if it should encompass the general public's interests, considering impacts material if they matter to a 'reasonable person.' However, this introduces a level of subjectivity in determining who qualifies as a 'reasonable person.'
Despite these challenges, organizations like the International Financial Reporting Standards Foundation (IFRS) and initiatives such as the International Sustainability Standards Board (ISSB) are making strides in addressing these issues within the financial industry by advocating for the inclusion of climate-related and ESG issues in materiality considerations.
Furthermore, the EU's new CSRD is enhancing the financial disclosure framework, signaling progress in tackling double materiality. Let’s explore this further by looking at how the EU is approaching double materiality.
The EU’s Approach to Double Materiality: NFRD & CSRD
The European Union has significantly supported the concept of double materiality, effectively embedding it within its regulatory structures governing sustainability reporting. These regulations acknowledge the observation that society's overarching inability to account for environmental and social costs has, at times, led to scenarios where detrimental corporate practices in these areas have been met with financial gain, thereby sacrificing the well-being of the planet and social equality.
Below is an overview of how these regulatory frameworks incorporate the principles of double materiality:
NFRD
The EU Non-Financial Reporting Directive (NFRD), effective across all EU member states since 2017, mandates that large public interest entities, including those listed on an EU-regulated market, banks, and insurance companies, disclose their ESG practices, as well as climate-related information.
The directive adopted a dual materiality perspective, necessitating that regulated entities disclose climate-related information that influences the organization's value, and report on activities impacting ESG issues or climate change.
Despite its intentions, the NFRD has been critiqued for its overly broad reporting requirements, which critics argue do not provide enough detail for investors and stakeholders to accurately gauge an organization's ESG impact.
CSRD
The introduction of the CSRD modifies the existing NFRD, with implementation starting in 2024. This directive widens the NFRD's coverage to include small and medium-sized enterprises (SMEs, with the exception of microenterprises) that are considered public interest entities, mandating them to report on various sustainability issues pertinent to their operations.
Furthermore, the CSRD demands detailed reporting on how sustainability concerns impact the organization, as well as the organization's effects on societal and environmental aspects, adopting a double materiality framework. This approach necessitates organizations to disclose information on both the challenges they face due to sustainability matters and their operational impacts.
The CSRD emphasizes a double materiality perspective, defining it as the understanding of both the risks to the organization and its impacts as separate considerations of material importance. This directive also obliges reporting companies to keep in mind the various users of their reports, ensuring the information is tailored appropriately for entities like investors, nonprofits, and the general public.
Set to phase in starting 2024, the CSRD's timing is crucial, outlining a schedule for compliance across different organization types in the coming years:
By January 2024, entities currently regulated by the NFRD, namely large EU public-interest entities and their significant subsidiaries with a workforce exceeding 500, are to comply.
By January 2025, the directive extends to all other large entities within the EU not previously covered by the NFRD, including large non-EU entities or parent companies listed on an EU-regulated market, with more than 250 employees.
By January 2026, it includes all SMEs listed in the EU.
By January 2028, it encompasses non-EU entities not listed on an EU-regulated market but operating within the EU.
How To Incorporate Double Materiality into Your ESG and Sustainability Programs to Comply with the EU’s CSRD
As double materiality becomes increasingly important, now is the moment to consider its implications for your organization. Each organization will have a distinct approach to double materiality, reflecting its specific operational context, but here are some universal steps to help initiate the process:
Step 1: Identify Your Obligations
The necessity to disclose or report varies by geography, sector, and organization size. It's crucial, to begin with, a clear understanding of the regulations that dictate your reporting requirements for both financial and non-financial data. This understanding will also aid in distinguishing between what is material and immaterial to your organization.
Step 2: Perform a Double Materiality Evaluation
This process enables you to grasp the impacts, risks, and opportunities specific to your organization. Undertaking a double materiality evaluation is a strategic step towards setting your ESG/sustainability goals and prioritizing actions to mitigate risks effectively.
Step 3: Document Your Double Materiality Approach
Compliance with many double materiality frameworks requires detailed documentation of your plans, management strategies, budgeting, and execution from this perspective. Whether it involves conducting stakeholder interviews, surveys, scenario analysis, or other forms of research, maintaining comprehensive records is essential.
Step 4: Accurately Gather and Report Data
Effective double materiality practices entail the collection and reporting of a broad spectrum of financial and non-financial data, which can present complexities. Instead of relying on spreadsheets, collect all your data and information into one system using a solution like the AMCS Sustainability platform.
AMCS, a global leader in environmental software solutions, has unified Quentic & FigBytes, market leaders in safety & sustainability, to complement its global suite of technology solutions that power foundational industries.
The Quentic and FigBytes platforms combine data collection, management, and calculation with powerful reporting tools that simplify every EHSQ and sustainability challenges. By supporting stakeholders from the boardroom to the assembly line, AMCS, Quentic, and FigBytes power smarter, safer, and more sustainable operations
With the large time commitment and amount of data from across multiple geographies required for a CSRD report, a cloud-based software like the AMCS Sustainability Platform can:
Conduct a materiality assessment and build a materiality matrix
Streamline data collection and centralize sustainability information to simplify CSRD double materiality compliance
Update methodologies used to comply with internationally accredited frameworks like CSRD
Customize reports to meet the requirements of individual ESG standards including ESRS
Need help tackling double materiality for your organization’s sustainability program? Connect with an AMCS expert today and see how AMCS Sustainability Platform can help automate and manage your entire ESG and sustainability program, including double materiality and beyond.