Companies Need To Get Serious About Materiality

The days of the aspirational, marketing-driven corporate sustainability report are dead. In their place, consumers, investors, and regulators now expect companies to have some serious and verifiable substance behind their sustainability claims. The problem is: A large number of companies are failing.

According to a recent IBM study, although 95% of companies have environmental, social, and corporate governance (ESG) goals in place, only 10% have made significant progress toward meeting them. What’s more, only 2-in-10 consumers say they trust the statements companies make about environmental sustainability.

That mistrust exists for good reason. Corporate executives say that the practice of “greenwashing” is widespread in their respective industries. In fact, nearly three-quarters of executives said most organizations in their industry would be caught greenwashing if they were investigated thoroughly, according to a survey of nearly 1,500 executives across 17 countries and seven industries conducted in January by the Harris Poll on behalf of Google Cloud.

These broad-based concerns put the focus squarely on not just the final corporate reports themselves, but on the materiality assessments which underpin them.

This is the litmus test for companies to understand what is material to their respective businesses, and what ESG goals they are prioritizing with real, substantive efforts versus those that are just getting airtime because they sound good.

Materiality Assessments

As a term, materiality is lifted directly from the financial world. The definition most commonly used comes from the International Financial Reporting Standards (IFRS) Standards. It’s essentially defined as information that can influence and ultimately inform the financial decision making of an entity.

Simply speaking, materiality assessments define the sustainability and ESG issues that matter most to business and their stakeholders and guide the way they will report them and integrate them into overall business strategy and investment. They are meant to cut through the hype and put some quantitative measurement and accountability benchmarks behind corporate sustainability and ESG strategy, and ultimately, direct the reporting process.

Importantly, they also serve as a foundational aspect for independent assurance by third-party assessors, which is now in the process of being mandated under the Corporate Sustainability Reporting Directive (CSRD) and its associated European Sustainability Reporting Standards (ESRS) in Europe. Although some European Union (EU) lawmakers have recently pushed back on some of the disclosures required in the CSRD, it is clear that materiality will play a major role in the future of regulatory reporting, whatever form the final regulations end up taking.

Until recently, there had been a lack of guidance relating to standardized methodologies and agreed best practices relating to undertaking materiality assessments for sustainability and ESG reporting purposes. As a result, many firms didn’t know where to start, what to include, or how to report on their findings when it came to building a comprehensive strategy. Recent guidance from the European Financial Reporting Advisory Group (EFRAG), the body tasked by the EU to develop the ESRS, has helped to outline best practices, but companies still face challenges.

The Potential Limitations of Materiality Assessments

At its core, a materiality assessment is carried out to identify and prioritize a firm’s material impacts, risks and opportunities related to sustainability and ESG reporting. The findings from the assessment will also help to ensure that their values and goals are aligned with their strategic objectives – whether that’s an effort to reduce energy usage to help combat climate change, encourage diversity, ensure human rights, or address a host of other sustainability and ESG issues. While that may be the intention, in many cases, corporate ESG and sustainability materiality assessments have suffered from an ad hoc approach or even been non-existent in historic voluntary reporting scenarios.

The most common failing? Bad data. Sustainability reports that are based on insufficient or inaccurate data that does not specifically define corporate sustainability and ESG priorities are destined to lead companies down the wrong path. And most importantly, materiality assessment outputs have often lacked clear benchmarks and concrete data that allow firms to track their progress against their own stated goals. Without these, some companies’ materiality assessments have historically amounted to little more than a press release, as opposed to a clear course of action.

With the implementation of the CSRD and the ESRS, the EU will become a force for change in the way that companies approach materiality assessments. The legislation, which includes some of the most stringent sustainability reporting requirements ever to be imposed on businesses, requires companies to assume a double materiality approach, which includes disclosures on climate change-related risks in their businesses, as well as the potential impacts that their operations may have relating to risks on society and climate. Importantly, to meet that standard, companies falling under the scope of the CSRD and the ESRS will also need to ensure that effective materiality assessments are conducted, and that those assessments reflect a clear understanding and analysis of impacts, risks and opportunities across their value chains.

Compliance Proofing

Materiality assessments carried out using the new guidance set out in the ESRS will assist in helping businesses understand their focus from a reporting point of view. However, the danger is that decades old processes for understanding and adhering to Environmental Health and Safety (EHS) compliance obligations may be lost in this the glow of this shiny new thing. Businesses need to get to know the reporting and compliance requirements – not just those required by the CSRD, but in all EHS, Sustainability and ESG-related legislation in every jurisdiction in which they operate – that are applicable to their business.

It is counterintuitive to focus on climate change targets, without first ensuring that a business is meeting its fundamental air emissions legal compliance obligations. Once they understand what regulators want and, in some cases, more importantly, what their stakeholders demand, they must find a way to collect honest appraisals from their customers about what sustainability and ESG initiatives truly matter to them in addition to what issues matter to themselves and their strategic business objectives.

What’s more, materiality assessments are expected to be dynamic. Companies need to ask themselves how often they should be reviewed and updated, whether annually or when major changes occur in the company (i.e. mergers, acquisitions, divestments, new regions, products, processes etc.).

From there, firms need to start asking the tough questions about their sustainability and ESG goals. What is truly feasible? Can we pursue and ensure a certain sustainability goal through the entire lifecycle of our product/business? What goals do both we and our customers or clients prioritize above all others? And most importantly, how can we track progress against those goals with data that will meet the burden of proof, and ultimately, independent assurance, for compliance requirements?

The Road Ahead

Without defining clear, measurable goals, and the plans companies have in place to get to these goals, they run a massive exposure risk by simply making sustainability and ESG related claims for their own sake. That may have been the norm before, but the CSRD is likely the latest in a line of coming legislation that is set to hold firms to their big promises. At a time when investors, customers, and regulators are all becoming more attuned to and informed of greenwashing, a robust and independently assured materiality assessment should be the starting point for a company’s regulatory and reputational saving grace. If not, it could turn out to be its greatest liability.

Now is the time to sweat the details to stay on the right side of that equation.