Exploring the Definition of Materiality

Exploring the Definition of Materiality

Materiality starts where guidelines stop

Wednesday, May 4, 2016 - 10:00am


“No man ever steps in the same river twice, for it’s not the same river and he’s not the same man”. Heraclitus, a pre-Socratic Greek philosopher born in in 535 BC, coined this statement, meaning that no entity may ever occupy a single state at a single time. However, his “colleague” Parmenides disagreed. Instead, he called reality “what-is”, meaning that change is simply the false appearance of a changeless, eternal reality. In short, Heraclitus believed that things exist as “processes”, while Parmenides believed that things exist as “states”.

But what does pre-Socratic philosophy have to do with Materiality?  More than you think, since there is a lot of confusion whether materiality is a process or not.

An ocean of definitions, principles, criteria, concepts and applications

March saw the release of the “Statement of Common Principles of Materiality” by the Corporate Reporting Dialogue Consortium. Released two years after the consortium’s establishment, the statement aims to pursue the much needed yet ambitious goal of greater coherence, consistency and comparability between corporate reporting frameworks, standards and related requirements.”

The publication is a joint initiative of global reporting bodies and discloses key findings on the application of materiality within a reporting framework:

  • Materiality is used in the financial and non-financial domains for reporting and other business purposes (e.g. “material adverse changes” clauses in business contracts);
  • Some countries (e.g. United States) have a legal concept of materiality, established by either case law, statute, or regulation;
  • Materiality definition is tailored to each organization’s mission, meaning that it is relative to manager’s contextual judgement, stakeholder validation and actual commensurability (if you can’t measure it, it can’t be material)

In addition to the voluntary reporting schemes, there is an increasing number of mandatory requirements regarding non-financial disclosure, which brings an additional layer of complexity to company assessment and disclosure practices. From the highly anticipated EU Directive on disclosure of non-financial information, to more specific regulations such as SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 in India, or the updated release of the South-African King IV Report, new dimensions of materiality are being added to an already busy field.

Failing to manage material issues has a real cost

The key takeaway from these different sources is that materiality is flexibletime-variant, and context-dependent. Consequently, the only defense against subjective and self-serving materiality is to ensure that the Materiality Assessment is accorded with a robust due process.   

An inadequate or uninformed assessment approach exposes entities to reputational and legal risks. The court of public opinion is often a good predictor of the real courtroom – especially considering the rise in mandatory disclosure requirements. The path from public outcry caused by greenwashing to legal accusations and sanctions for misrepresentation can be dramatically short.

More importantly, this risk is extended along the whole value chain. For example, Nestlé faces a class action lawsuit filed by California residents upon the allegation that it violated three California laws that prohibit false advertising and unfair competition because its supplier, Thai Union, knowingly uses forced labour to harvest fish used in its cat food.

A new approach

One of the key questions regarding the Materiality Assessment is how often companies should perform it, and the realistic time and resource demands associated with the maintenance of the process. Notwithstanding due process, emerging issues can rapidly change what is material;  just think of how the leak of the Panama Papers has put tax responsibility in the spotlight.

Frameworks and regulations are asking for a robust process without describing it and the standards to which companies are required to comply are increasing exponentially. More specifically, there are 10 times the amount of non-financial disclosure requirements today than there were 3 years ago. The infographic above zooms into this trend in the Americas.

Our approach to Materiality starts where guidelines stop

In our opinion, a robust Materiality Assessment should provide:

  • Competitiveness – achieved through benchmarking competitors
  • Compliance – achieved through monitoring hard and and soft law affecting the business and its value chain
  • Timeliness – achieved through engaging the communities around the business through direct stakeholder engagement and the monitoring of news and social media

Each component has a different time frame and calls for dedicated action. While competitor benchmarking can be done when a new report is published, monitoring regulations and engaging with communities should be constant exercises.

In the face of emerging ESG trends, how can companies ensure that they are on top of materiality? We think we have the answer. It’s called the Continuous Materiality Assessment  and Datamaran has the specific management tool capabilities to enable this process.

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