Embracing Real World ESG Impact with Rise of Double Materiality

A changing regulatory climate and the need for better data has leaders examining their businesses through a two-sided lens.

Samuel Greengard, Contributing Reporter

July 2, 2024

5 Min Read
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Wavebreakmedia Ltd IFE-240405_10 via Alamy Stock

Spreadsheets, ERP applications, accounting systems, and other tools deliver a steady drip of insights about the current state of business performance. Yet, as the sustainability space evolves and new and more onerous regulations appear, enterprise leaders are recognizing a need to examine business activities more holistically. 

As a result, double materiality is gaining traction. The reporting method, spurred by the EU’s Corporate Sustainability Reporting Directive (CSRD), gauges a company’s overall impact on environmental, social, and governance issues. The framework relies on a double materiality assessment (DMA) to deliver more detailed and accurate data. 

“A lot of the oxygen right now is being taken up by double materiality,” observes Evan Harvey, audit and assurance managing director for sustainability and ESG Services at Deloitte. “Although things have been moving in the direction of a broader reporting framework, double materiality is being heavily driven by emerging regulations.” 

“Transparency around risks and opportunities -- and how they are managed -- is becoming critical for accessing capital, building more resilient supply chains and conforming to incoming regulations that focus on environmental performance,” says Thomas Maddox, global director of forests and lands at CDP, a not-for-profit organization that manages the global carbon disclosure system. 

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Material Changes 

The idea of connecting materiality to sustainability isn’t new. Businesses have traditionally relied on two techniques, financial materiality and impact materiality, to understand their activities and impacts. Both methods provide important information about sustainability and business performance. The former asks how various ESG components impact financial performance while the latter examines how a company impacts the environment and society. 

Kevin O’Connell, trust solutions sustainability leader at PwC, describes financial materiality as an “outside in” view that examines how sustainability factors may pose either a prospective material risk or opportunity that could affect a company’s financial performance and position over the short, medium, and long term. 

On the other hand, impact materiality delivers an “inside out” view. The focus can be on positive or negative impacts, along with actual or possible outcomes on people or the environment. “These can occur over the short, medium and long-term. They are directly linked to a company’s operations and its value chain,” he says. 

Neither approach alone delivers a complete picture, however. That’s where double materiality shines. By examining the business through a two-sided lens, it’s possible to see how sustainability initiatives affect the company but also how the organization impacts the larger world.  

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For example, a firm might explore the cost of switching packaging from plastic to recycled cardboard. This change would have an impact on the environment (impact materiality) but also lead to cost savings and potential sales gains (financial materiality). 

A New View 

A changing regulatory climate and the need for better data has put double materiality in the spotlight. In addition to strict reporting requirements imposed by the EU’s CSRD, double materiality intersects with the proposed SEC Climate Disclosure Rule as well as California’s Climate Corporate Data Accountability Act and Climate-Related Financial Risk Act. The common theme among all these measures is the need to gain a clearer and more accurate view of business activities and ratchet up reporting. 

The reporting process may require a double materiality assessment. A DMA is a structured process that drives fundamental change. Organizations must collect additional data, new types of data and better-quality data, including in areas such as Scope 3 emissions. This, in turn, may require new and improved tools and technologies to capture and analyze data (including IoT devices, AI and machine learning), revamped KPIs and metrics, and a third-party validation process. 

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“In many cases, double materiality requires companies to begin tracking things they haven’t tracked and tag data they haven’t previously collected,” Harvey says. This includes more detailed analysis of greenhouse gas emissions, biodiversity, labor, water usage, and even human rights. “This approach represents another level of sophistication and maturity in the sustainability space.” 

CSRD requirements have already taken effect for larger companies that meet key requirements, while full reporting for small and medium businesses will be required by 2028. This has implications and ramifications beyond an individual business. “One of the hallmarks of the CSRD law is that it comes with a rigorous focus on the extended value chain. This includes upstream and downstream from a company. It encompasses everything from sourcing and vendors to customers and output,” Harvey explains. 

Getting to Net Gains 

Developing a strategy to manage double materiality is critical. A framework must revolve around all key stakeholders and reach into all corners of the organization -- and beyond. “It’s important to get started early and address the gaps. There are numerous technical and practical considerations -- and it’s important to acclimate the culture to a more rigorous reporting structure,” Harvey says. 

While financial materiality and impact materiality are both voluntary, double materiality may fall into the required category, PwC’s O’Connell says. “Many companies will be subject to some type of regulation … and many companies will be subject to more than one. Managing multiple regulatory reporting requirements with limited resources and existing processes and data can present a real challenge, including the risk of introducing inconsistencies across the organization.” 

PwC has developed a seven-step process for executing on a DMA. It advises organizations to start with in-depth assessment of impacts, risks and opportunities and how they will drive strategy and policy. This is followed by identifying various sustainability factors; defining impacts, risks and opportunities; assessing the impacts; understanding financial opportunities and risks; drawing up the materiality overview; and, finally, identify all the strategic implications. 

According to Harvey, business and IT leaders should expect some speed bumps as their organizations transition to double materiality reporting. This includes a need to make sense of disparate data and sort through different interpretations of data, including what data to collect and what to report to stakeholders and regulators. It’s vital to avoid anecdotal assessments. “Double materiality must be data-driven, and it must clearly define costs and opportunities,” he explains. 

Yet, when an organization gets the double materiality equation right, the benefits extend far beyond regulatory compliance and an improved ESG report. A more disciplined process can improve forecasting, trim costs, improve sourcing, revamp processes, reduce risk, improve decision-making and even unlock innovation and value creation. “Double materiality can create connections between finance, risk, operations, and strategy,” O’Connell says. 

Concludes Harvey: “The double materiality process is intended to bring together all stakeholders and all impacts so that an organization can assess the business in a comprehensive way.” 

About the Author(s)

Samuel Greengard

Contributing Reporter

Samuel Greengard writes about business, technology, and cybersecurity for numerous magazines and websites. He is author of the books "The Internet of Things" and "Virtual Reality" (MIT Press).

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