Materiality assessments are a first step in sustainability strategy and are required by many standards. They help organizations define the ESG topics that are most important to them and their stakeholders. Assessments are conducted by identifying topics, evaluating those topics in terms of business importance, and validating those priorities with external stakeholders through surveys or interviews.
When you open an ESG (environmental, social, and governance [link to ESG article]) report, it often starts with the organization’s materiality assessment. But what is materiality in ESG, and how do you assess it?
What is materiality?
Originating in accounting, “materiality” generally means “information that should be included because it could influence decision making.” On the contrary, “immaterial” means that something isn’t relevant or significant enough to make a difference.
In the context of ESG, materiality means defining the environmental and social topics that are important to the organization and its stakeholders. There are two main perspectives on materiality:
- Inside-out: how the organization impacts its environment and stakeholders. This would be mostly applicable for reporting to external stakeholders.
- Outside-in: how the environment or stakeholders impact or pose a risk to the organization. This perspective is often applied in finance, such as by TCFD or SASB.
Today, many apply “double materiality,” meaning organizations should consider both 1) their impact on the environment and 2) the environment’s impact on them. This definition of materiality is applied by the EU Corporate Sustainability Reporting Directive and the Global Reporting Initiative (GRI), among others.
Ultimately, the chosen definition of materiality depends on the objective and audience.
What is an ESG materiality assessment?
ESG is very broad, and not all issues are relevant to all organizations. An ESG materiality assessment is an opportunity to identify the most important issues for a particular organization and its stakeholders. For example, human rights are very important to a global apparel manufacturer but not a local maple syrup farm. Materiality assessments provide a systematic approach to prioritize ESG topics.
The resulting topics are often presented in a materiality matrix that contrasts the impact on the company and the importance to stakeholders. Two examples are:
Source: Microsoft’s 2020 Environmental Sustainability Report
Source: Nestle 2020 Materiality Assessment
Why are materiality assessments important?
Materiality assessments are an important starting point for setting sustainability strategy. The key benefits are:
- Informing strategy: Organizations can specify where they are creating or reducing value for society. From there, they can identify opportunities for the business.
- Engaging with stakeholders: Assessments are an opportunity to interact with internal and external stakeholders. This strengthens their buy-in, adds legitimacy, and increases the likelihood of having a positive impact.
- Managing risk: Assessments are trend-spotting exercises that help organizations anticipate risks and plan accordingly.
Beyond strategic benefits, materiality assessments can also help mitigate legal or reputational risks. Materiality has long been applied in accounting and finance and is becoming applicable to ESG issues through regulations, such as the SEC Disclosure Rule which requires companies to disclose material environmental risks.
Of course, materiality assessments are only as useful as the actions that follow. Assessments are merely the first step before an organization can define KPIs, launch projects, and measure social and environmental impact.
How to conduct a materiality assessment
Now that you’re sold on materiality assessments, let’s look at how they are conducted. Generally, materiality assessments involve defining the scope, identifying ESG topics, prioritizing them in terms of materiality, and getting feedback from stakeholders.
As a starting point, consider KPMG’s 7-step framework for materiality assessments:
- Define purpose and scope: remember what we said about materiality? How it’s defined depends on the organization’s objectives and audience.
- Identify potential topics: a great starting point is reporting standards, such as GRI and SASB
- Categorize: the long list of potential topics can be clustered into 3 categories – environment, society, governance – and then subcategories as needed
- Gather information about the impacts of these topics: consider these topics within the context of the organization and its stakeholders
- Prioritize: use this information to form a preliminary priority of topics by the importance to the organization and stakeholders
- Engagement management: validate the prioritization with internal stakeholders, such as the board, management, and employees
- Seek stakeholder feedback: engage with external stakeholders, such as customers, suppliers, NGOs, local communities, and regulators, for their feedback. This can be done through surveys or interviews.
As for how often materiality assessments should be conducted, experts advise as often as possible, considering budget and resource availability. Issues and their materiality can change rapidly, such as the prioritization of employee health during the covid-19 pandemic. Therefore, companies should assess material issues in a more agile, ongoing way that is not strictly tied to the annual reporting process.
Materiality assessments can be conducted in-house, with third-party consultants, or with software solutions. To learn more about how software solutions can enable your sustainability strategy, contact us at firstname.lastname@example.org
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