Materiality is a fundamental concept in accounting. A piece of information is material if it influences someone’s decision. According to the US SEC, if the information on a company is material, it should be disclosed if a reasonable person considers it important.
Information that is material in one setting may not be material in another. Typically, the company decides what is material and what is not.
Sustainability reporting has its origins in Global Reporting Initiative (GRI), where a stakeholder perspective is used. Here the concept of materiality is different. Materiality is based on whether a company’s actions have a positive or negative impact on the world. This is irrespective of whether investors think it is important or not.
Companies typically perform some stakeholder assessment to gather stakeholders’ views on what the stakeholders believe is important. Companies sometimes provide a “Materiality Matrix.” One axis is how important an issue is to the company from a value creation perspective. The other axis is how important this issue is to aggregate stakeholder values sentiment.
In 2011 SASB started looking at materiality. It classified materiality based on the industry. For example, the material issues for the iron and steel industry are GHG emissions, air quality, energy management, water and wastewater management, waste and hazardous materials management, employee health and safety, and supply chain management. The material issues for the commercial banking industry are data security, access and affordability, product design and lifecycle management, business ethics, and systemic risk management.
The EU Commission first introduced the concept of double materiality in 2019.
Double materiality is an extension of the financial concept of materiality. Double materiality means that topics can be material from both a financial and a non-financial perspective. Thus, topics that are material from an ESG perspective may have a financial impact over time. There is a continuity between financial and non-financial perspectives. It may appear as if there are two definitions of materiality. However, that is not the case. A topic can be material from either one or both perspectives.
A more recent approach to materiality is dynamic materiality. The concept of “dynamic materiality” was first introduced by the World Economic Forum (WEF) in early 2020 and gained traction. Dynamic materiality is based on the fact that the materiality of an issue can be dynamic, changing based on foreseen or unforeseen events. For example, take the case of a product that has negative externalities. Society may tolerate these externalities for some time. They may not be material at that point. However, with time, society realises the importance of these externalities, and they become material. Since dynamic materiality is forward-looking, it involves stress-testing ESG issues against a set of future events to figure out which issues are likely to be material. This also gives an indication of which issues are more sensitive to future shifts.
Companies need to keep abreast of the evolving concepts of materiality. This will enable them to report their sustainability actions more accurately and provide an impetus to their net-zero efforts.