Is materiality for ESG and sustainability reporting changing for the better?

Introduction:

For more than a decade, companies have used the concept of materiality as the basis for identifying and communicating their impact on the environment and society within corporate social responsibility (CSR), sustainability, or environmental, social, governance (ESG) reports. Materiality in these reports differs from financial materiality, which is defined under securities law. As sustainability- and climate-related disclosure regulations are enacted, there is a notable shift in how materiality is defined and applied. Additionally, emerging reporting standards, such as IFRS S1 and S2, provide unique guidance on how to define materiality and apply it when developing an over-arching strategy to disclose decision useful information. This post explores the changing landscape of materiality in sustainability reporting and how companies can evolve their disclosure strategy. 

Traditional approach to materiality in sustainability reporting:

Traditionally, materiality for sustainability reporting (now commonly referred to as “impact materiality”) is assessed through a qualitative process that involves researching industry trends, peers, and leading companies as well as direct engagement with both internal and external stakeholders. Through this qualitative process, a business can determine if the research results and stakeholder feedback correlate, indicating that the business has an impact on that topic. Over time, there has been an overall upward trend in the volume of material topics disclosed by companies who use this process for voluntary sustainability reporting, sometimes eclipsing 20 topics deemed to be “material”.

For voluntary reports aligned with the Global Reporting Initiative’s (GRI) Universal Standards, the reporting company must disclose information for all GRI standards that align with a material topic. If 20 topics are deemed to be material, the reporting company carries a significant burden regarding the information to be collected, validated, and disclosed to maintain alignment with GRI. While GRI allows organizations to omit disclosures of performance data for select justifications, there are a growing number of organizations that omit metrics and performance data for material topics without disclosing such justification. These omissions call into question whether the organization is effectively measuring and managing impacts related to a material topic, which triggers further thought into whether the topic was material in the first place.  

The evolving definition of materiality:

Recent regulations have attempted to address the issue of materiality head-on, primarily by trying to incorporate the concept of financial materiality within sustainability reporting. The CSRD and underlying European Sustainability Reporting Standards (ESRS) signal a key shift towards a disclosure framework where financial and impact materiality (referred to as “double materiality”) are both considered. These regulations and underlying standards emphasize the importance of disclosing information that have a material impact on users' decision-making processes. In other words, they urge companies to focus disclosures on sustainability data that has an impact on overall company performance, aligning with the principle of "less is more" in reporting. 

Not only do the ESRS have a different definition of materiality, but they require companies to disclose significantly more information on the management of each topic deemed to be material. Specifically, the ESRS require the reporting company to disclose policies, actions, targets, metrics, and financial effects of a material topic. If the reporting company cannot meet the disclosure requirement of the ESRS but deems a topic to be material, it must disclose when it expects to be able to meet the disclosure requirements.

Where materiality in sustainability reporting goes next:

The changing definition of sustainability materiality, the transition to a mandatory disclosure environment, and the heightened expectations from stakeholders for disclosures is creating a fundamental shift in the determination of material topics for sustainability reporting. Companies are already designating “priorities” out of the list of material topics to use as the basis of sustainability strategy development, yet the remaining material topics are still included in reporting. As regulations go into effect, it could be common to start seeing those additional topics be removed from sustainability reports to narrow the scope of sustainability disclosures embedded within financial filings.

Where can Sustas help your organization regarding materiality?

As a provider of sustainability accounting solutions, Sustas is prepared to help clients with the preparation of investor grade disclosures for identified material topics. While we cannot perform a materiality assessment for your organization, we can assist with the steps that follow an assessment, including, but not limited to:

·       Identifying metrics related to material topics to communicate performance externally

·       Developing the reporting process to collect data and measure metrics

·       Preparing accounting and reporting policies or standard operating procedures that include controls to improve data quality and accuracy related to sustainability disclosures 

For more information on how we can help, please email us at stuart@sustasllc.com or complete an intake form on our website (www.sustasllc.com).