What Is Double Materiality? A More Holistic View of Impact
For organizations simply trying to ensure they are meeting the proper filing requirements, the recent introduction of the double materiality principle to financial reporting regulations may seem like an additional layer of complexity in an already comprehensive process.
We’ve put together a high-level primer on double materiality in an attempt to ease concerns and help corporations and stakeholders understand double materiality from a more holistic perspective.
To understand what double materiality is, we must first define the two primary schools of thought around materiality: financial and impact.
What is financial materiality?
In financial reporting, the term material is used to qualify reporting requirements. According to the Securities and Exchange Commission (SEC), material is defined as “those matters to which there is a substantial likelihood that a reasonable investor would attach importance in determining whether to purchase the security registered.”
In other words, for something to be material to financial reporting, a reasonable investor would consider it important and relevant to their decision-making process. In this case, the determination is made as to which ESG topics will have the greatest impact on economic value creation.
What is impact materiality?
According to the Global Reporting Initiative (GRI), impact materiality involves information used to qualify “the reporting company’s impact on the economy, environment and people for the benefit of multiple stakeholders, such as investors, employees, customers, suppliers, and local communities.” Impact Materiality is an analysis of how business operations affect (have impact on) people (workers and society) and the environment. Impacts can be directly or indirectly linked to a business’s operations, as a company’s value chain is considered during analysis, not just the entity itself.
The argument in favor of impact materiality is that non-financial impacts will, over time, become financially material. For example, if a corporation has a plant that is polluting a river used as a downstream source of drinking water, the cost of remediating that pollution and damage done to the brand image is financially material.
Double Materiality: A Holistic Approach to Sustainability Reporting
As the name suggests, double materiality recognizes the importance of corporate information concerning both a firm's financial value and its broader impact on the environment and society.
In particular, double materiality acknowledges that a company's non-financial impact on the world can be material, and therefore worth disclosing, for reasons beyond its financial implications. This includes, for instance, the impact of a firm's activities on human rights, climate change, and other environmental factors.
By considering both financial and non-financial impacts, the concept of double materiality aims to encourage greater transparency and accountability from corporations and to promote more holistic decision-making that takes into account the broader implications of business activities.
The GRI’s position on double materiality
The GRI is a leading organization in the field of sustainability reporting, and it plays an important role in shaping materiality reporting requirements for companies. They provide guidelines and standards for sustainability reporting, which include requirements for companies to report on their material environmental, social, and governance (ESG) issues.
The GRI's materiality principle emphasizes that companies should report on those ESG issues that are most significant to their stakeholders and that have the potential to impact the company's long-term sustainability.
“Financial materiality and impact materiality together under the umbrella of ‘double materiality’ are the only relevant forms of materiality, with both perspectives needed in a two-pillar structure - for financial and sustainability reporting - with a core set of common disclosures and each pillar on an equal footing.
- From the GRI publication Materiality Madness: Why Definitions Matter
The global perspective on double materiality
Various agencies, governments, lobbyists, and corporate organizations across the globe are weighing in on the debate around materiality and ESG reporting standards.
The GRI Standards, which are global standards that focus on impact reporting for a multi-stakeholder audience, are seen as essential in shaping a comprehensive global set of sustainability reporting standards that cover the information needs of investors and other stakeholders. By contrast, the International Financial Reporting Standards (IFRS) Foundation is focused on financial materiality for an investor centric audience.
The European Sustainability Reporting Standards (ESRS), developed by the EU, are grounded in a double materiality approach and aim to inform a multi-stakeholder audience, including investors.
Aligning your organization with the new GRI reporting standards
With the success of environmental, social, and governance (ESG) investing around the world, many organizations are well on their way to meeting the new GRI reporting standards.
Aligning with these standards will require firmly committing to adopting ESG behaviors as part of your corporate strategy. These changes include steps such as committing to a shift from fossil fuels to renewable energy, conducting ESG audits, and recognizing a broader pool of shareholders.