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Double Materiality Made Easy
July 16, 2024 • 9 min read
How to engage your stakeholders dynamically to identify risks and opportunities across your value chain comprehensively.
We love distilling complicated concepts into practical and relevant examples.
Example: Electronics Manufacturer
You are on the Board of a company manufacturing electronics. This company has a global supply chain operating mostly in the Balkans and Southeast Asia. The organization has never collected information from its supply chain partners on their Environmental Management Systems, working conditions, or human rights considerations.
You are on the Board of a company manufacturing electronics. This company has a global supply chain operating mostly in the Balkans and Southeast Asia. The organization has never collected information from its supply chain partners on their Environmental Management Systems, working conditions, or human rights considerations.
Source: Reimag.in Example, Double Materiality
Different approaches towards materiality have existed
The shift from a sole focus on financial materiality to double materiality has been gradual and influenced by growing awareness of the interconnectedness of financial performance with sustainability factors.
There are two types of materiality that companies need to consider:
Financial Materiality
How does this event or factor affect the financial health of the company?
E.g., The new regulation in Southeast Asia will increase my cost base by 4%.
E.g., The new regulation in Southeast Asia will increase my cost base by 4%.
Financial Materiality refers to how sustainability issues affect the financial performance of the company. This includes any risks or opportunities related to ESG factors that could have a significant impact on the company’s financial outcomes.
Impact Materiality
How do our products, services, or operations impact the well-being of the communities, customers, employees, and environment that we work in?
E.g., Our (lack of) waste management protocols has resulted in a spike of health issues for the community.
E.g., Our (lack of) waste management protocols has resulted in a spike of health issues for the community.
Impact Materiality is concerned with the outward effects of the company’s operations. This involves assessing how the company’s activities, products, and services affect external stakeholders and ecological systems.
Revisit and Review your Stakeholder List
Engaging a variety of stakeholders, both internal and external, is essential for developing a rigorous and comprehensive materiality matrix and log. Historically, the focus was often on shareholders and immediate business partners, overlooking broader societal and environmental impacts.
Neglecting stakeholder engagement has led to significant negative outcomes, such as environmental degradation, human rights abuses, and missed business opportunities. These issues arise because stakeholders lacked the platform to voice concerns or were not considered in decision-making processes.
Why Is This Often Overlooked?
- Complexity and Resources: Engaging a diverse group of stakeholders requires significant time, effort, and resources. Organizations might lack the capacity or expertise to manage this complex process effectively.
- Lack of Awareness: Some organizations may not fully understand the importance of engaging a broad range of stakeholders or may not recognize the breadth of their stakeholder network.
- Short-term Focus: Companies often prioritize short-term financial gains over long-term sustainability and stakeholder engagement, leading to the neglect of thorough stakeholder analysis.
- Perceived Irrelevance: There might be a perception that certain stakeholders are not relevant to the organization’s core activities, leading to their exclusion from the engagement process.
- Cultural and Institutional Barriers: Internal culture and existing institutional frameworks might not support or prioritize stakeholder engagement, leading to resistance or superficial implementation.
Revisiting the Definition of Stakeholder
Stakeholders are defined as individuals or groups affected, directly or indirectly, by an organization’s actions and decisions. This includes:
- Human Rights Holders: Workers, local community members, human rights defenders, migrant workers, persons with disabilities, indigenous peoples, consumers, and organizations such as trade unions that represent them.
- Customers: Individuals who use the entity’s products or services.
- Employees: Individuals working for the organization.
- Local Communities: Groups directly or indirectly impacted by the organization’s activities (e.g., unhealthy factory emissions affecting surrounding communities or affordable housing units for underserved populations).
- Suppliers and Distributors: Entities affected by the organization’s procurement practices, regulations, and quality control standards (e.g., a zero-tolerance policy on child labor affecting suppliers).
- Planet: The environment, impacted by the organization’s resource extraction, usage, and pollution.
By revisiting and expanding your stakeholder list, you empower yourself to ask the right questions and uncover risks and opportunities that might otherwise go unnoticed. This holistic approach not only addresses potential negative impacts but also uncovers new areas for growth and improvement.
Recognize that performance is interconnected
By assessing both financial and impact materiality, companies can gain a comprehensive understanding of their risks and opportunities. This approach not only enhances transparency and accountability but also drives long-term value creation by aligning financial performance with environmental and social responsibility.
What does good look like? Let us return to our manufacturing example.
Action: Launch Environmental Management System (EMS) audit across Tier 1 and Tier 2 suppliers
Finding: The electronics manufacturer conducts an EMS audit and finds that one of its key suppliers is non-compliant with environmental regulations.
Finding: The electronics manufacturer conducts an EMS audit and finds that one of its key suppliers is non-compliant with environmental regulations.
Financial Materiality
Observation: This non-compliance could lead to legal penalties and supply chain disruptions.
The non-compliance of the supplier is financially material because it could result in fines, increased costs to find alternative suppliers, and potential delays in production. Investors need to be aware of these risks as they directly impact the company's financial performance.
Impact Materiality
Observation: The EMS audit reveals that the supplier's non-compliance includes improper waste disposal practices, which are harming local ecosystems and communities.
The improper waste disposal is an impact material because it has significant negative effects on the environment and local communities. Stakeholders such as environmental groups, local residents, and regulatory bodies are concerned about these impacts, even if they don't immediately affect the company's financial performance.
Double Materiality
Following the EMS audit, the electronics manufacturer decides to work with the supplier to improve their environmental practices or find new suppliers who are compliant. This decision will increase short-term costs, but is expected to ensure long-term supply chain resilience and compliance with local regulation.
Financial Materiality
Improving supplier compliance or finding new suppliers increases costs in the short term, which could affect profitability. However, it mitigates risks associated with legal penalties and supply chain disruptions, potentially leading to long-term financial benefits.
Impact Materiality
Addressing the environmental compliance issues reduces negative impacts on the environment and local communities, responding to concerns from environmental groups, local residents, and regulators.
Source: Reimag.in Example on Materiality Types
CSRD calls for Double Materiality
CSRD explicitly adopts the double materiality framework. It expands the scope of sustainability reporting, requiring companies to report on how sustainability issues affect their business and how their business activities affect people and the environment. This regulation makes it clear that companies need to consider both the financial impact of sustainability issues on their operations and the impact of their operations on society and the environment.
Source: Reimag.in's adaptation from New Guidelines on Reporting Climate-Related Information, European Commission
