Materiality assessments: The missing link for sustainability strategy
Materiality is a hot topic among CSR professionals grappling with questions of what to report, and how. As the name implies, the so-called “materiality assessment” promises to answer these questions, showing an organization the activities, impacts and achievements it should communicate to stakeholders. But what exactly is a materiality assessment?
Mark A. Serwinowski is the president and founder of MetaVu, a strategy consultancy that helps clients measure, manage and communicate their return on investment in sustainable development (SDROI). Michael Muyot is the president and founder of CRD Analytics. He designed the SmartView 360 Platform, which powers sustainability indexes, rankings and Bloomberg research reports; including the NASDAQ OMX CRD Global Sustainability Index (QCRD), the Sustainability Leadership Report and Regional Sustainability Rankings.
Together, they have analyzed hundreds of sustainability reports through their firms' strategic partnership, which manages operations for the NASDAQ Global Sustainability Index. Serwinowski and Muyot also are co-hosts of SDROI TV, a program addressing the rapid evolution of sustainability reporting, ESG impact investing and sustainable development ROI.
King: What is a materiality assessment in context of sustainability, and what is the purpose?
Serwinowski: In short, a materiality assessment is an exercise in stakeholder engagement designed to gather insight on the relative importance of specific environmental, social and governance (ESG) issues. The insight is most commonly used to inform sustainability reporting and communication strategies, but it also is valuable to strategic planning, operational management and capital investment decisions.
From a reporting perspective, we see a majority of companies publishing sustainability data, yet not effectively communicating their sustainability story in ways that are relevant to diverse stakeholder audiences.
Muyot: Indeed, many lean too heavily on quantitative ESG performance data (such as emissions, resource consumption, diversity and equal opportunity), or approach sustainability communications as a PR exercise -- telling fluffy, feel-good stories about relatively narrow sustainability initiatives.
King: How exactly does a materiality assessment inform reporting strategy?
Serwinowski: Materiality assessments inform reporting in three key areas -- disclosure strategy, content design and stakeholder communications. The process inventories, assesses and quantitatively analyzes stakeholder perspectives on a company’s ESG performance. Internally, it’s an important tool for making the business case to senior management on why and how to report ESG and other non-financial data.
Muyot: The materiality assessment data also inform content design for the actual CSR reports, guiding communications strategies for individual stakeholder groups such as investors, analysts, customers, partners and employees. Targeted communication strategies are even more valuable when companies move to web-based sustainability reporting. In contrast to a traditional printed report, web-based sustainability reports can be cost-effectively tailored to readers’ preferences in real-time.
Serwinowski: This approach allows companies to communicate a global message that speaks to all stakeholder groups and targeted messages for individual stakeholder groups -- for example, investors. For instance, NextEra Energy says, “We’re the largest generator of renewable energy from wind and sun in North America.” That global statement speaks to all stakeholders, but their consumer-specific message highlights community investments, while their investor-specific message highlights cyber-security investments.
King: So what does a well-designed materiality assessment look like? What’s best practice?
Muyot: The process needs to be a rigorous engagement across all stakeholder groups. The best way to ensure engagement at all levels is to start with the C-suite and Board of Directors. If they don’t agree to participate, that’s a big red flag and almost a sure sign the project either will fail or be lackluster in its findings and recommendations. When a company is able to enlist its top officers and directors, that not only sends a strong signal to employees, investors, customers and suppliers, but also it ensures a strong sample of actionable data.
Serwinowski: What we’ve seen is the majority of companies referring to materiality assessments are simply doing informal internal reviews. In order to gain the full value of the process, a materiality assessment needs to formally engage the entire community of stakeholders, both internal and external. This typically begins with a workshop to develop an inventory of material issues with executives from across the organization’s functional units. The inventory is then used to formulate a set of questions for a survey instrument that is completed by stakeholders outside the company -- including customers, suppliers, investors -- and within.
Once the survey is administered, the resulting data set should be quantified for a correlation analysis, usually via a matrix that contrasts the various stakeholder perspectives. This quantified analysis provides the missing data on stakeholder perspectives that informs strategic planning and allows a company to link reporting (ESG and financials) to operations.
Muyot: Many companies also say it’s valuable to have an experienced third party lead the process. A third party can facilitate more candid internal communication and help prevent political blow-back. Additionally, a true subject-matter expert can provide a more objective point of view on ESG issues and survey design, and bring tested experience to the resulting reporting strategy.
King: You say materiality assessments can link reporting with operations and financials. Can you give an example of what you’re referring to?
Serwinowski: The issues identified in a materiality assessment touch every aspect of a company’s business model. Analyzing stakeholder agendas quantitatively enables a company to determine if an ESG issue is a risk to be mitigated or an opportunity to be pursued, and consequently it guides strategic planning.
Carbon is probably the most mature example. Despite the lack of regulation here in the U.S., many companies already are reporting on carbon management because they believe climate change may be an important issue to their stakeholders. Capturing quantitative stakeholder feedback on carbon can validate or change that reporting strategy, but the value-add is realized when the carbon data is viewed through operational and financial perspectives.
For example, analyzing carbon in context of production efficiency and EBITDA helps a company understand how its business model would be affected by a price on carbon. If the carbon footprint of a production facility or product is a significant market driver, then the company can assess its risk-to-hold value of its current assets, and inform business and financial planning, such as where to best allocate its OPEX budget towards operational improvements, or its CAPEX towards R&D and innovation.
In this example, a rich data set on stakeholder perspectives further informs investment decisions that are based on carbon impact of competing products. It’s easy to see how this data can affect the approach to risk management, operational management systems, product development, R&D, marketing and stakeholder communications.
King: So why don’t more companies do materiality assessments?
Muyot: The sustainability reporting community borrowed the term “materiality” from the financial realm, and it’s proven both a benefit and a bane. It has heightened awareness of ESG issues, but also has created a stumbling block for some companies -- particularly American multinationals -- that are sensitive to the legal and regulatory implications of financial disclosure.
Serwinowski: And that’s the rub. Materiality in financial reporting is premised on regulatory requirements, yet sustainability reporting is still voluntary. We see many publicly traded companies approach materiality assessments for sustainability reporting from the point of view of the annual report, 10-K.
Michael Muyot: The corporate reporting teams involve investor relations and legal counsel, who weigh in and say, “Wait, our 10-K articulates select issues about what we footnote on financial materiality, and you guys are suggesting we disclose everything under the sun. Why would we be burden ourselves? Sustainability reporting is still voluntary.”
Serwinowski: The perception is that culling through the identified stakeholder issues for reporting is too burdensome or may expose a weakness. But the reality is companies that do the work gain valuable roadmaps for enterprise risk management and strategic planning.
The historical trend on sustainability reporting was “less is more.” That is, if you’re not prepared with a positive impact story, say nothing. In today’s fast-moving, social media-driven markets, real, substantive content is fundamental. From the stakeholder perspective, telling your sustainability story and the progress of your journey is a strength. To investors, it’s a proxy statement of management quality; to customers, it informs choice and brand loyalty; and to public institutions and communities, it’s table stakes for establishing or maintaining a company’s social license to operate.
King: Interest in materiality assessments does seem to be picking up. Why is that?
Serwinowski: There are three recent developments driving adoption of materiality assessments -- investor demand for more disclosure, global reporting framework synergies, and financial market convergence. Investors want more transparency on ESG risks and opportunities, as illustrated by the recent spike in shareholder proxy demands. At the same time, there is new guidance from institutions such as the Global Reporting Initiative (GRI), International Integrated Reporting Council (IIRC) and Sustainability Accounting Standards Board (SASB). GRI’s G4 framework includes clarified guidance on assessing materiality; the IIRC’s recently released framework (PDF) includes materiality as a key component of an effective report, and SASB is working to create sector-specific materiality guidance.
Muyot: In the financial market, socially responsible investors (SRI) are converging with traditional market investors, who are accounting for sustainability issues as they would traditional risks and opportunities. This was demonstrated when the Investor Network on Climate Risk (INCR) joined with NASDAQ, NYSE and several other global exchanges in requesting that the World Federation of Exchanges make sustainability/ESG reporting a mandatory listing requirement for all stock exchanges. In fact, the INCR proposed segments of a listing requirement specifically include a materiality assessment in annual financial filings. It’s clear the role of these assessments is becoming more important to the future of CSR reporting.