Understanding ESG Materiality
Series Article 4
As ESG Investing gains attention — and critics — understanding materiality has become even more important for companies and investors.
The StartingUpGood team is committed to sharing evidence-based information about ESG Investing to help all stakeholders better understand its importance and potential.
Here we provide some baseline definitions before attempting to address some of the complexities surrounding ESG materiality, which include:
We conclude with an overview of recent steps that the global community has taken to consolidate and simplify ESG reporting frameworks. We also provide some next steps for startups — and really businesses of any size — to incorporate ESG materiality into their operations.
Materiality and Double Materiality Defined
Material ESG issues are those that are likely to affect the financial condition or operating performance of businesses within a specific sector.
Double materiality refers to the two dimensions of materiality that are relevant for companies: the impact of ESG factors on the company (the ‘inside’ dimension) and the impact of the company on ESG factors (the ‘outside’ dimension).
As this Bloomberg article explains:
At the basic level it’s an accounting principle, referring to something that may have an impact on — be material to — how a company performs. A material risk can threaten targets or goals — something of keen interest to investors. In the context of ESG, this is known as single materiality and means mainly ESG factors that may pose a threat or opportunity to a business and its bottom line, such as extreme weather. It doesn’t tell you anything about how “green” a company’s business practices are, but rather how vulnerable its earnings may be to ESG risks….
“Double materiality” adds the risks a company’s activities pose to the environment and society to those that it potentially faces internally. How such things should be accounted for in corporate reports remains the subject of intense debate. For now, reports vary wildly, making it hard for investors to compare one company or fund with another and make informed decisions.
Materiality Depends on Industry
Different industries may face different types of material ESG issues, depending on their activities, stakeholders and risks.
For example, some material ESG issues for different industries are:
- Energy: greenhouse gas emissions, water stress, health and safety
- Technology: data privacy and security, human capital development, innovation
- Healthcare: access and affordability, product quality and safety, ethical marketing
- Consumer goods: supply chain labor standards, product environmental impact, customer welfare
You can explore more examples of material ESG issues by industry using the ESG Industry Materiality Map provided by MSCI.
Materiality Depends on Jurisdiction
Regulatory groups in the US and in Europe have different interpretations of materiality, mainly related to the definitions of materiality versus double materiality reference above.
Expectations about how companies should approach materiality also vary across jurisdictions, and U.S. regulators have taken a different approach than those in the European Union (EU). In the United States, the Securities and Exchange Commission (SEC) takes an investor-centered approach in its recently proposed rule regarding climate-related disclosures, focusing on climate-related risks and opportunities that might affect enterprise value and ensuring information reported does not mislead investors.
On the other hand, in the EU, the European Financial Reporting Advisory Group (EFRAG) views materiality in a much broader light. While value creation is important within EFRAG’s proposed sustainability reporting standards, EFRAG takes the position that double materiality is the “pivotal principle” for an organization’s assessment and that organizations must consider and disclose external impacts just as they do internal impacts.
Materiality Changes Over Time
ESG materiality is not static, but dynamic and evolving over time. Different ESG factors may become more or less relevant for different industries and companies depending on various trends and drivers.
A report published by the World Economic Forum in collaboration with BCG in March 2020 found some of the trends that drive ESG materiality to be:
- Hypertransparency: The increasing availability and accessibility of data and information on ESG issues, enabled by technology, media and regulation.
- Stakeholder activism: The growing pressure and influence of various stakeholders, such as customers, employees, regulators and NGOs, on ESG issues.
- Societal expectations: The changing norms and values of society regarding ESG issues, such as diversity, human rights and climate change.
- Investor emphasis on ESG: The rising demand and preference of investors for ESG integration and disclosure in their investment decisions.
Recent Milestones Towards Simplification
Global efforts are being made to create a single benchmark for ESG reporting.
- July 2020: GRI and SASB announce a collaborative work plan to show how companies can use their respective standards together.
- September 2020: CDP, CDSB, GRI, IIRC and SASB announce a shared vision for a comprehensive corporate reporting system that includes both financial accounting and sustainability disclosure, connected via integrated reporting.
- November 2020 — June 2021: IIRC and SASB merge to form the Value Reporting Foundation, a global nonprofit organization that offers a comprehensive suite of resources for enterprise value creation.
- November 2021: The IFRS Foundation announces the establishment of the International Sustainability Standards Board (ISSB) to develop a comprehensive global baseline of sustainability disclosure to meet investors’ information needs, and consolidates with the Value Reporting Foundation and the Carbon Disclosure Standards Board (CDSB) to help establish the ISSB.
- August 2022: The Value Reporting Foundation consolidates into the IFRS Foundation.
- Ongoing: The ISSB builds on the work of TCFD, CDSB, SASB and the Framework, incorporating TCFD and SASB into its exposure draft standards in response to market demand for simplification of the sustainability disclosure landscape.
Conclusion
It is important for businesses of all sizes and stages to understand how ESG materiality differs by industry and geography, and to monitor and anticipate the changes in ESG materiality over time.
Changes to ESG trends and how to report ESG performance can create both risks and opportunities for businesses and their reputations.
Next Steps for Startups
Here are some quick tips for startups to follow to determine and measure their ESG materiality:
- Start with purpose: Define the unmet need that your startup is addressing and the unique value proposition that you offer to your customers and society.
- Marry purpose with ESG: Identify how your startup’s activities and impacts align with ESG frameworks and standards, such as the UN Sustainable Development Goals, the Global Reporting Initiative, or the SASB Standards.
- Identify material risks and opportunities: Assess how ESG issues affect your startup’s financial performance, reputation, stakeholder relationships, and growth potential. Prioritize the issues that are most relevant for your industry, business model, and stage of development.
- Set ESG goals and metrics: Establish clear and measurable ESG objectives that support your startup’s purpose and strategy. Choose appropriate indicators and data sources to track your progress and performance over time.
- Engage with stakeholders: Communicate your ESG vision, actions, and results to your stakeholders, such as investors, customers, employees, regulators, and NGOs. Solicit feedback and input to improve your ESG practices and disclosures.
ESG Benefits
If you enjoyed this article, please FOLLOW the StartingUpGood Magazine here on Medium and our LinkedIn page for more stories about ESG.
And check out our ESG investing article series:
- Everyone Is Talking About ESG, But What’s the Bottom Line?
- Why the GOP Will Lose Its War on ‘Woke Wall Street’ — Spotlight on New York Magazine’s Article
- The Battle Over ESG Investing Heats Up as Proponents Fight Back
- Understanding ESG Materiality
- SVB’s Collapse: How the GOP’s Attack on ESG Ignores the Facts
- ESG Principles Prevail Amidst Political Discourse
- Two Recent Surveys Show Business Leaders Value ESG Practices
- Don’t Be Confused by Recent ESG Regulations and Legislation — Read our Primer!
- ESG Investing in 2024: Beyond the Acronym
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This article was written with the assistance of Bing.AI and ChatGPT-3.
