This is the third in a four-part series dedicated to enhancing the value of materiality assessments. Previously, we discussed why companies should assess double materiality and explored how companies can monitor dynamic materiality. Here, we discuss why companies should focus their materiality assessments on impacts rather than perception.
The concept of double materiality provides clarity that companies should report on matters that influence enterprise value ("financial materiality") and matters that affect the economy, environment and people ("impact materiality").
This shift also brings a change in how companies should understand the materiality of matters that affect the economy, environment and people. In short, the field is moving away from methods that are often assessed based on perception and toward methods based on impacts.
While impact materiality covers both positive and negative impacts across economic, environmental and people dimensions, the UN Guiding Principles on Business and Human Rights (UNGPs) provide an essential methodological foundation for how impacts across all these dimensions should be assessed.
The key to this shift is a change in how stakeholders are defined and how matters of importance are identified and prioritized.
In the past, materiality assessments often defined stakeholders as those whose judgments, decisions and actions may be influenced by the company’s sustainability disclosures; material matters were those that were "of interest" and "decision-useful" for report readers.
Impact materiality, by contrast, defines stakeholder as an individual or group that has an interest that is (or could be) affected by the company’s activities and decisions. This includes rightsholders — stakeholders whose rights are (or could be) affected by the company’s activities, even if they are not users of a company’s sustainability reporting.
As the EFRAG European Lab Project Taskforce (the entity tasked with creating the new EU sustainability reporting standard) described in their report to the European Commission:
The interests of the stakeholders that are users of sustainability reporting are not necessarily proxies for the potential and actual impacts of the company on people and the environment. In practice, if reporting entities determine impact materiality based on what all users of sustainability reporting find decision-useful, then it is quite likely that everything comes out as "material." (…) [This] approach has dominated most companies’ practices with regard to impact materiality, inviting certain experts, NGOs, and others to express their interests in what the company should report through "materiality" meetings or online questionnaires. This has not led to sufficiently relevant information being disclosed from a double materiality perspective.
Impact materiality determines material issues based not on whether they are "of interest to stakeholders," but whether they have "an impact on the economy, environment, and people."
For example, when incorporating the UNGPs into the Global Reporting Initiative’s (GRI) new Universal Standards, the GRI revised its definition of materiality to reference "topics that reflect its most significant impacts on the economy, environment and people, including impacts on human rights."
In the past, materiality assessments often relied on assessing internal and external stakeholder perceptions to help determine material issues for disclosure. Internal stakeholders were asked which sustainability topics are most significant to the business, while external stakeholders were asked about their expectations of the company and which issues might influence their judgments and decisions. While prioritization methods varied, quantitative methods via interviews and surveys were often used to rank issues according to their importance.
By contrast, the impact materiality approach stresses that not all stakeholder interests are of equal importance because human rights are an entitlement of all people under international law, and everyone has a right to a healthy environment. For this reason, companies are expected to assess the significance of an impact based on the severity and likelihood of impact, using an approach to assessing issues that is standard in the human rights field. This approach reflects the expectations set out by the UNGPs and in the GRI’s Universal Standards, and EFRAG is proposing a similar approach for the upcoming EU sustainability reporting standards.
To be clear, impact-based materiality does not ignore company-based internal stakeholders and other experts, especially when their insight is essential to uncover impacts that might otherwise be missed — for example, experts inside and outside the company can provide unique insights into the impacts of new technologies.
To meet these expectations, BSR is drawing upon two decades of experience in both materiality and human rights assessments to create a double materiality methodology that combines the best of both. In this methodology, we identify and prioritize a company’s positive and negative impacts on the economy, the environment and people based on:
- The scale of the positive or negative impact: How grave is the negative impact on the victim, the economy or the environment? How beneficial is the positive impact?
- The scope of the positive or negative impact: How widespread would the impacts be on the population and economies of ecosystems impacted?
- In the case of a negative impact, its remediable character: Is it possible to counteract or make good of the resulting harm?
- The likelihood of the positive or negative impact: What is the chance of the impact happening?
Our approach uses all internationally recognized human rights as a reference point, as companies may potentially affect any of these rights. It also recognizes that human rights are indivisible, interdependent and interrelated, rather than a collection of separate topics.
The impact materiality approach is being created as we write, and we seek opportunities to partner with member companies to refine it based on real-life experience. Several questions require further exploration, such as the relationship between a materiality assessment and a human rights "salience" assessment, as well as the precise prioritization criteria to use, what to include on an initial list of potentially material issues, and how to combine qualitative and quantitative inputs. If you want to learn more about our approach, please contact us.