A definition and overview of double materiality in sustainability and ESG

The Hungarian Sustainability Act passed in December and the EU CSRD Directive require large companies to carry out a double materiality assessment covering their entire operations, but what does this mean?

Why is double materiality assessment key?

The double materiality assessment plays a crucial role in optimising the allocation of resources to achieve CSRD compliance, while providing invaluable insights to shape the overall strategy of the company:

1. It helps identify significant business opportunities, risks, trends and brand characteristics.
2. It helps you decide which ESG issues and initiatives your company should prioritise.
3. It provides a clear framework for management decision-making and resource allocation.
4. It helps to make the sustainability and ESG strategy more structured and rigorous by introducing a standard framework and methodology for assessing and prioritising materiality issues.
5. It can help improve collaboration between different departments and areas of the company, including corporate communications, investor relations, corporate social responsibility (CSR), sustainability and human resources (HR).
6. By clarifying what the organisation should disclose in its sustainability report, a good materiality assessment will save the organisation a lot of unnecessary work while highlighting important risks and opportunities.

Definition of double materiality

Double materiality is defined as the union of impact materiality and financial materiality. A sustainability or ESG matter has double materiality if it is material from either an impact from environmental/social/governance perspective, or from a financial perspective, or both.

Financial materiality

The set of ESG risks and opportunities that are financially material, i.e. that could have a positive or negative impact on the financial performance, cash flows and financing position of the reporting entity.

• Impact on financial performance – The primary criteria for assessing financial materiality is evaluating how an ESG factor affects a company’s financial health. Factors that can impact cash flow, revenue growth, profitability, and overall financial stability are considered to be financially material.
• Investor relevance – Factors that investors consider important in their decision-making process are often regarded as financially material. Investors place substantial emphasis on sustainability factors that can influence the risk-return profile of their investments.
• Industry relevance – The sector-specific nature of materiality assessments is vital. What may be financially material for one industry may not hold the same significance for another. Therefore, companies must consider industry-specific standards and benchmarks when assessing materiality.
• Regulatory environment – Companies must take into account relevant regulations and reporting requirements in their assessment. Compliance with these regulations ensures that financial materiality assessments align with legal expectations.

Impact materiality

According to the ISSB and ESRS standards, an event or matter has impact materiality if it has an actual or very likely significant impact on the environment and/or society in the short, medium or long term. For example, if everyone who drives a car stops using fossil fuels and switches to electric vehicles (EVs), this will have a significant environmental and social impact, both at the societal level and for individual companies in the automotive and fuel value chain.

For companies, an issue has a material impact if it is directly caused by the company’s own operations, products or services, or if it is an impact that is linked to the upstream and downstream value chain of the company.

For example, if a company’s product is manufactured with a deliberate breach of health and safety standards somewhere in the supply chain, this poses a material risk to the company, even if the company itself may not have knowingly caused or directly contributed to the negative impact.

Similarly, if a company decides to invest in renewable energy, it is likely to face a double materiality consideration. A company may see an increase in short-term costs associated with CAPEX associated with clean energy, but may also achieve long-term financial benefits such as lower, more predictable energy costs, improved energy security and a better reputation, something

Examples of double materiality in different business sectors

Double materiality can be observed in many different industries and sectors when companies make strategic decisions or risk assessments that take into account both financial and environmental impacts.

For example, in the consumer goods industry, a company may decide to adopt sustainable sourcing practices for the raw materials used in its products. This decision has an environmental impact by reducing the company’s use of natural resources, and is likely to have financial impacts in areas such as material costs, customer loyalty and brand reputation.

Another example of double materiality in the financial services sector is how banks are reviewing their lending practices and loan portfolios to ensure that they are not indirectly financing activities that are harmful to the environment. These decisions can have positive environmental impacts (such as divesting from fossil fuel investments), but can also affect the bank’s financial performance and credit risk.

Most companies apply and implement double materiality in their business in a variety of ways. From a financial perspective, investing in the health and wellbeing of employees helps reduce absenteeism and healthcare costs, which improves employee productivity and engagement. In addition, by promoting healthier lifestyles, an organisation can position itself as a better employer and attract and retain talent.

Double materiality in practice

Each organisation’s double materiality approach must be unique to its organisational context. However, there are some general best practices that organisations should consider when embarking on materiality assessment and strategic decision-making:

• Set up a stakeholder working group: stakeholders should be involved in the selection of relevant ESG factors. This team should consist of internal management, key staff and employees, as well as external stakeholders.
• Devote time to materiality assessment: the purpose of a materiality assessment is to determine which environmental and social issues are most important and have the greatest impact on the business and its stakeholders. This has a direct influence on the content of the CSRD report and the resources required to produce it.
• Gather feedback from stakeholders: the organisation should design and share an ESG materiality assessment that allows stakeholders to rate each factor based on perceived impact, relevance and importance.
• Carry out a materiality assessment: the assessment provides a numerical/visual picture, can help the business to better understand the double materiality aspects, determine which issues to focus on and decide how to allocate resources to address them.
• Use a double materiality framework: the most common of these are the ISSB, GRI and the ESRS standards of the EU Corporate Sustainability Reporting Directive (CSRD ).
• Use long-term scenarios and forecasts: when making strategic decisions that take into account double materiality, business leaders should assess the long-term consequences of strategic decisions and business practices and try to predict how they will affect the company’s financial and environmental performance.
• Plan and document the process for assessing materiality: many sustainability reporting standards, such as ESRS, require reporting organisations to disclose how they assess double materiality. Whether this materiality process includes surveys, stakeholder interviews, scenario planning or other inputs, double materiality should be defined, planned, socialized, timed and budgeted in the context of the organization’s sustainability reporting requirements.

Materiality assessment project

When we work with an organisation on a materiality assessment, we usually start with an industry and competitor survey to understand what competitors are focusing on in terms of ESG and sustainability. We then gather internal and external data and feedback to create a structured map of which ESG issues are most important to the organisation. Finally, we synthesise and organise these themes and stakeholder responses into a materiality matrix, strategic plan and recommendations that the brand, management and employees can own, adopt and support.

Whether your organisation already has an established ESG or sustainability strategy and materiality assessment, or is conducting a materiality assessment for the first time, the process can be challenging and uncertain. We offer a structured, multi-phase process that helps define a clear plan, uses data-driven analysis and industry benchmarks to assess materiality relevance, and engages stakeholders across the organization.