Understanding materiality in your compliance

Across the many legislations, regulations, and reporting directives concerning sustainability and ESG, there’s a lot of talk about materiality — and often in differing terms, depending on the level and type of materiality that’s to be applied. To bring clarity to this oft-used yet nuanced term, we’ve gathered information and insights from our experts on the different types of materiality and materiality assessments that businesses need to consider for compliance and reporting requirements.

What is materiality?

The concept of materiality can be defined as the principle that determines the social and environmental topics most important to your business and its stakeholders. It’s a fundamental concept that originated in financial auditing and has been adopted and adapted to fulfil needs within the realms of sustainability and compliance. Materiality can be used to set the level of deviation that an auditor deems likely to influence the decisions of the intended users.

Materiality can be assessed in various ways and different sustainability frameworks uniquely define their particular requirements.

Generally, materiality can be broken down into financial or impact materiality. Here’s a summary of the defining points for each:

Financial materiality

Financial materiality looks inward. It focuses on the impact that the planet and society has on business operations and its success.

Financial materiality has been adopted by the International Financial Reporting Standards (IFRS) Foundation and the ISSB standards, in accordance with IFRS Accounting Standards. These standards state that “information is material if omitting, obscuring, or misstating it could be reasonably expected to influence investor decisions.”

An example of financial materiality could be the introduction of a new legislation regarding climate change. Businesses impacted by the legislation would need to consider how it will affect operations and determine if changes to processes will need to be made to accommodate the new legislation.

Impact materiality

Impact materiality looks outward. It’s primarily concerned with the impact that the business has on the planet and society — the inverse of financial materiality.

Impact materiality has been adopted by the Global Reporting Initiative (GRI), which states that it represents the “most significant impacts on the economy, environment, and people, including impacts on their human rights.”

To assess impact materiality, companies need to review current and proposed processes to determine if they’re the least impactful on the planet and communities. For example, an organization could examine its current waste management process to determine if there are operational changes that would reduce the amount or change the type of waste produced. It could also assess the ways that it’s handled and disposed of to see if these could be changed to make less of an environmental impact.

Single materiality versus double materiality

These two types of materiality — impact and financial — essentially look at two sides of the same coin. The former is concerned with the impact a company has on the environment and people, while the latter looks at how society and the environment affect business operations.

Historically, financial materiality has understandably been the main focus for businesses, financial institutions, auditors, and stakeholders. But this is beginning to change, with public demand for greater scrutiny and regulation regarding the areas of business operations covered by impact materiality. And regulators are paying attention.

Depending on various factors — including jurisdictions, company size, revenue, and type of operations — companies are likely to find themselves subject to the requirements of one or more of the various regulatory directives being introduced around the world. It’s therefore important to understand what may be required from a materiality assessment perspective, including whether single or double materiality needs to be applied.

The EU’s Corporate Sustainability Reporting Directive (CSRD) requires companies to adopt a double materiality approach to materiality assessment — which means assessing and reporting on both financial and impact materiality equally. According to Annex 2 of the Directive, “a sustainability matter meets the criterion of double materiality if it is material from the impact perspective or the financial perspective or both” — meaning a holistic approach needs to be taken to address these two types of materiality. This is a stark contrast with the ISSB, for example, which only focuses on financial materiality.

At the time of writing, only the CSRD has adopted a double materiality assessment model. But considering the expansive global impact of this directive — and the fact that many other sustainability-related reporting regulations are being developed worldwide — a double materiality approach is very likely to be one that businesses need to take.

The pros and cons of different types of materiality

There are, naturally, benefits and drawbacks to these types of materiality assessment. Let’s take them one at a time:

Financial materiality

Financial materiality is a great way to showcase business success and projected growth, but it can also run the risk of exposing potential challenges the company faces — or will face in the future. This can influence brand reputation, stakeholder engagement, and investor interest — either positively or negatively, depending on the outcome of the assessment.

Impact materiality

A good impact materiality assessment can do wonders for a company’s reputation and investor potential. According to PwC’s 2023 global investor survey, “three-quarters of investors say sustainability is important to their investment decisions, while more than half (57%) back greater clarity and consistency in sustainability reporting.” Which, of course, also means that a less-than-positive result may dissuade investment and ongoing stakeholder support.

Not only might a poor impact materiality outcome lose investment, but it can also be costly to make the operational changes required for compliance.

Single materiality

As previously analogized, financial and impact materiality are two sides of the same coin. Therefore, taking a single materiality approach means not having a complete report of a company’s sustainability. This can potentially lead to greenwashing accusations due to incomplete data being used to support claims that haven’t taken the wider picture into account.

Double materiality

Double materiality essentially culminates the pros and cons of everything explored above.

It takes more work and data gathering, and likely costs more for businesses to set up initially, but it will promote visibility — internally and externally — for greater stakeholder alignment and risk management. This instills trust and assures the business can be clear about its impact on the planet, reducing the risk of greenwashing while increasing visibility and understanding of any sustainability issues that can then be remedied.

Is single or double materiality better?

This is a difficult question to empirically answer. Both single materiality and double materiality have their pros and cons, but which one outweighs the other can only be decided on a case-by-case basis. The important thing to consider is which one will be right for a particular organization.

There are many factors and nuances to take into account when doing this. Here are some of the most important ones:

Company size and complexity

As companies get larger, they invariably become more complex. With that complexity comes less clarity of holistic oversight. For larger organizations, double materiality is usually a more effective assessment approach because it encourages and supports better visibility, so sustainability risks can be understood and managed on a company-wide scale.

Industry

Some industries are more exposed to sustainability risks than others. Energy and mining corporations, for example, are hugely impactful on the environment and have to comply with the most scrutinizing regulations because of it. Manufacturers can be anywhere along a vast spectrum, depending on the type and nature of manufacturing they do. Office-based operations, however, have significantly different regulatory requirements to fulfil — along with their own unique sustainability risks to consider.

Stakeholder influence

For some businesses, investors and customers are likely to be very interested in sustainability performance and this may dictate whether double materiality is needed to fulfil the expectations and demands of those influences.

Regulatory requirements

For many companies based or operating in the EU, double materiality isn’t a question of choice. If the CSRD applies to an organization, sustainability reporting with double materiality assessment is a requirement. The first CSRD reporting date is January 2025, reporting on 2024 business activity.

Whether it’s with single materiality or double materiality assessments, there’s an increasing need for corporations to have a clear view of sustainability risks and report on them. The regulatory landscape is continuing to incorporate more and more sustainability related legislation, which means businesses need to continually improve and increase efforts to reduce negative environmental impacts. Materiality assessments are an excellent way to accurately measure performance and plan for improvements where they’re needed.

Make materiality assessments work for you

To find out more about how materiality assessments fit within the bigger picture of sustainability and ESG reporting — and how your EHS metrics can play a vital role in it — take a look at these additional useful resources…