By ESG Analyst Sydney Foran
Double materiality helps bring both financial risks and ESG impacts into focus presenting a new standard of what it means to be sustainable. As businesses grapple with climate change, social challenges, and shifting stakeholder expectations, double materiality offers a roadmap to ensure that corporate actions align with sustainable outcomes, balancing profitability with purpose in a rapidly changing world.
What is Materiality?
Before delving into double materiality, let’s explore the meaning of “materiality” in the context of reporting on ESG and financial issues? Materiality refers to the importance of information in a given context, where its inclusion or omission could influence the decisions of those relying on it. If information has the potential to affect decision-making, it’s considered material; if it doesn’t, it’s immaterial. This concept ensures that only relevant and impactful details are highlighted, providing clarity for users of the information.
On the other hand, though it’s common to focus only on the absence of information causing the issues in decision making, it’s often the massive volumes of information that can cause a problem as well. Burying information in a pile of other irrelevant information obscures the facts just as much. This was seen in 2001 during the Enron Scandal. Enron, was an energy company, engaged in accounting fraud which led to its bankruptcy. The board of directors were unable to identify critical red flags because the management overwhelmed them with irrelevant and complex data thus indirectly withholding key information about the company’s financial risks.
This happens with ESG information as well—providing data for everything possible so nothing gets focused on. With that said, materiality requires a crucial balance of providing what’s relevant and necessary without overwhelming the user with information they don’t need.
In financial reporting, materiality often revolves around dollar amounts and their significance to the quality of an audit, for example. During this assessment, tests are conducted on financial data to determine whether the amounts are material based on specific criteria tailored to the situation. Determining whether sustainability information is material can be more challenging, largely because the process is relatively new. The same principle applies—if information is omitted or misstated in a sustainability report, and that information would have impacted the decision of the user had they known the correct details, it’s material.
What is Double Materiality?
The concept of double materiality highlights these financial and non-financial impacts on businesses as well as businesses impact on society and the environment around them. It also considers those unintended consequences resulting from the business’ activities.
Perspective 1: A Company’s Impact on Society and the Environment
The first consideration of double materiality focuses on how a company’s operations affect society and the environment. This includes assessing sustainable efforts, such as greenhouse gas emissions, water usage, or labor practices within supply chains. For instance, if a business is heavily reliant on carbon-intensive production, its environmental footprint would be a key component of materiality. Stakeholders, including investors, regulators, and the public, demand transparency about these impacts to understand how companies are addressing their role in both social and environmental challenges.
Perspective 2: Sustainability Issues Impacting the Company
The second perspective seeks to examine how external sustainability issues, such as climate change, resource scarcity, or evolving social expectations, affect the company’s financial performance and stability. This aspect of materiality considers risks like regulatory changes, physical climate risks, or shifting consumer preferences. For example, a company reliant on fossil fuels might face financial challenges due to new governmental climate-related policies, reputational hit due to environmental impact, and changing consumer preferences.
Regulatory Evolution and Implications
Double materiality is pushing for a global shift in regulatory expectations, with the European Union (EU) leading the charge. The EU Sustainable Finance Disclosure Regulation (SFDR) requires disclosure on how sustainability issues affect them as well as how their activities impact the environment and society. This marks a fundamental departure from traditional reporting, where the focus was solely on financial risk.
The EU Green Taxonomy and Guidelines on Reporting Climate-Related Information further the concept of double materiality encouraging non-financial reporting. These frameworks provide clear guidelines for disclosing both financial risks and environmental impacts, ensuring that companies address their responsibilities comprehensively. The Corporate Sustainability Reporting Directive (CSRD), implemented in 2023, takes this a step further by mandating that businesses report detailed sustainability-related information in line with double materiality principles.
For businesses, this regulatory evolution highlights the need to embed double materiality into their strategies. While compliance may seem challenging, it presents an opportunity to align with global best practices, enhance transparency, and meet the growing expectations of stakeholders.
Driving Business Value Beyond Compliance
Double materiality is not just about meeting regulatory obligations—it’s becoming an essential tool for driving business value and encouraging innovation. In considering a company’s impact on society and the environment as well as how these external factors influence the businesses financial performance, they’ll be able to identify new areas for opportunity. It also allows them to better understand their risks and how to mitigate them.
For example, integrating double materiality into decision-making helps businesses proactively address environmental or social issues that could harm their operations and reputation, such as supply chain emissions or unethical labor practices. Beyond mitigating risks, focusing on double materiality—an inside-out and outside-in perspective, allows companies to build trust and loyalty with investors and other stakeholders by demonstrating a commitment to sustainable practices.
Moreover, as revealed by the 2023 ISS Global Benchmark Policy Survey, 75% of investors now prioritize materiality assessments that account for external impacts. This shift shows growing demand from stakeholders for companies to practice transparency and accountability, aligning with their interests and expectations. By practicing double materiality, businesses can work to remain competitive in an evolving environment, enhance their market position, and attract sustainability-focused investors.
References
- Belyeu, K., & Ellis, M. (2023). 2023 ISS Global Benchmark Policy Survey . https://www.issgovernance.com/file/policy/2023/2023-ISS-Benchmark-Survey-Summary.pdf
- Deloitte. (2024). The Challenge of Double Materiality. Deloitte . https://www2.deloitte.com/cn/en/pages/hot-topics/topics/climate-and-sustainability/dcca/thought-leadership/the-challenge-of-double-materiality.html
- European Commission. (2019). Banking and Finance Guidelines on reporting climate-related information. https://ec.europa.eu/finance/docs/policy/190618-climate-related-information-reporting-guidelines_en.pdf
- European Commission. (2023a). EU taxonomy for sustainable activities. European Commission. https://finance.ec.europa.eu/sustainable-finance/tools-and-standards/eu-taxonomy-sustainable-activities_en
- European Commission. (2023b). Sustainable Finance Disclosures Regulation. Finance.ec.europa.eu. https://finance.ec.europa.eu/regulation-and-supervision/financial-services-legislation/implementing-and-delegated-acts/sustainable-finance-disclosures-regulation_en
- European Commission. (2023c, December). Corporate Sustainability Reporting Directive. Finance.ec.europa.eu. https://finance.ec.europa.eu/regulation-and-supervision/financial-services-legislation/implementing-and-delegated-acts/corporate-sustainability-reporting-directive_en
- GRI. (2024). Double materiality. The guiding principle for sustainability reporting. In GRI. https://www.globalreporting.org/media/rz1jf4bz/gri-double-materiality-final.pdf
- Kristina Russo. (2023, July 26). What Is Materiality in Accounting? Oracle NetSuite. https://www.netsuite.com/portal/resource/articles/accounting/materiality.shtml
- Permanent Subcommittee on Investigations. (2002). The Role of the Board of Directors in Enron’s Collapse. https://www.govinfo.gov/content/pkg/CPRT-107SPRT80393/pdf/CPRT-107SPRT80393.pdf
- Täger, M. (2021, April 21). “Double materiality”: what is it and why does it matter? Grantham Research Institute on Climate Change and the Environment. https://www.lse.ac.uk/granthaminstitute/news/double-materiality-what-is-it-and-why-does-it-matter/