In an economic downturn, companies face increased pressure to cut costs, reduce financial risks and maintain profitability. However, it is becoming increasingly clear that ESG matters cannot take a back seat, even in tumultuous times. Consumers are making it clear that even through the economic turbulence created by Covid-19 and the current energy crisis, they value companies showing sustainable leadership. Moreover, such disruptions to “business as usual” are only dress rehearsals for the greater system shocks that climate change will bring. As a result, a robust ESG strategy is essential to ensure companies’ continued success, and a materiality assessment is seen as a crucial foundation on which to build this.
An ESG topic is generally accepted to be considered as “material” if it affects – or has the potential to affect – the cash flow and financial value creation for a company (the definition being derived from the use of the term in the accountancy world). How such topics are identified is through an assessment (involving internal and external stakeholders) that reviews sector and company-specific ESG issues. However, recent evolutions in thinking now emphasise the concept of “double materiality”, which considers not only the financial implications (risks and opportunities) of issues, but also how the company’s operations have an impact externally, as viewed via the lens of “environment” and “social”. This refreshed approach makes a double materiality assessment (addressing both the “outside-in” and the “inside-out”) the first step in developing a robust sustainability strategy, and is one of many reasons companies should look to undertake such a task.
Prioritising
A materiality exercise takes the insights and perspectives of a vast array of internal and external stakeholders. This can bring new light to previously unconsidered topics, or help companies refocus efforts from over-saturated issues. It also showcases to stakeholders that their insights into the business are valued, and allows voices that often go forgotten (such as employees) to be heard. By compiling a list of topics and rating them, companies can see what is most important currently, how that is reflected in current strategies, and identify what is most important to stakeholders.
Quality over quantity
In an economic downturn, sustainability is often seen as “discretionary spend” and may be the first budget that is cut. However, the evidence suggests that consumers do value businesses that show leadership in transitioning to a more sustainable mode of operation, but then struggle with chasing multiple targets (aiming to solve every problem being unrealistic). By performing a materiality assessment, businesses are able to pinpoint the select topics that are most financially material to them, and (if undertaking a double materiality assessment) those where they have a heavy environmental and/or social impact. This allows for strategies to be curated to more directly address these specific issues, and enables companies to maximise their investments by concentrating efforts into those areas where positive change can be more widely seen. Being able to prioritise the opportunity for driving real progress more selectively, also enables senior leadership to demonstrate they have a more robust and credible understanding of their company’s impact across the value chain, and that sustainability will be embedded within any future strategy, and not just seen as an afterthought.
ERM/financial risk
Hard times typically bring heightened financial risks. Companies gain a comprehensive understanding of their environmental and social risks by conducting a materiality assessment, and also, just as importantly, identifying how these can become financial risks. This broader perspective allows companies to identify potential threats that may have been overlooked via a traditional (single) materiality assessment. Materiality assessments are a useful tool for companies to integrate sustainability issues into overall enterprise risk management, especially through the financial materiality aspect. This is particularly relevant to the environmental impacts of climate change (such as supply chain disruption due to flooding), which can pose huge bottom-line risks if left unmanaged. Understanding these non-financial risks enables companies to address overall mitigation and resilience, helping future-proof business operations.
Investor security/assurance
Stakeholders, including investors, customers and regulators, increasingly expect companies to be accountable for their environmental and social impacts. Even in challenging economic times, demonstrating a commitment to sustainability can enhance a company’s reputation and maintain stakeholder trust. In these times of economic turbulence, evidence of a clear list of material topics and associated action plans can give investors the transparency and security they need to see to feel confident in longer-term business stability. Additionally, a materiality assessment provides the insights required to align sustainability efforts with stakeholder expectations, highlighting the value a company places on such opinions.
Reporting trends and regulations
Regulatory bodies revise reporting requirements to reflect the changing materiality landscape. The latest update to the Global Reporting Initiative added a specific materiality disclosure, requiring each topic deemed material by a company to be reported on, with a description of its materiality and how this was determined. Moreover, the new requirements of the EU Corporate Sustainability Reporting Directive (CSRD) are based on double materiality, with disclosures determined by those topics deemed material through an assessment. Likewise, the International Sustainability Standards Body’s (ISSB) latest disclosure requirements focus on the financial impacts of material topics, starting with climate disclosures. In order to align with these trends and regulations, companies must start looking at materiality assessments, ensuring readiness especially when (as is the case with CSRD and, potentially, ISSB) reporting becomes mandatory. To learn more about how we at SLR are supporting companies in preparing for growing reporting requirements, watch our webinars on how to use double materiality to aid in reporting here.
Capitalise on sustainable opportunities
Economic downturns may necessitate cost-cutting measures, but these measures do not have to compromise sustainability. A materiality assessment can help identify areas where cost-reduction efforts can be aligned with sustainability goals. For example, optimising resource use and reducing energy consumption saves money and reduces a company’s environmental footprint (via lower greenhouse gas emissions). Considering the financial impact of material topics, materiality assessments can identify areas that could be a cost-saving opportunity for businesses, such as increasing investment in more sustainable solutions (eg renewable energy), or designing out waste in product development or service delivery.
Companies that excel in sustainability, will also enjoy a competitive advantage. This can be crucial for market positioning and customer loyalty during a tough trading environment. A materiality assessment enables companies to identify sustainability-related opportunities that can set them apart from their peers. This can further benefit the internal operations of a business. If topics such as diversity, equity and inclusion, or talent attraction and retention, are revealed as a high priority, companies can position themselves as an employer of choice, and showcase the positive working culture they help to foster. Economic turbulence always highlights the importance that a motivated workforce has for a company’s continued success, and ensuring that staff are prioritised is always advantageous.
Long-term game
Lastly, it is important to remember that sustainability is not a short-term endeavour; it is about ensuring the long-term viability of a business. By considering financial (and non-financial) materiality, companies can make informed decisions prioritising sustainability. These decisions may involve investing in green technologies, diversifying supply chains to reduce environmental and social risks, or enhancing employee wellbeing. Such actions contribute to long-term business resilience, and support the sustainable development essential to creating a better world for everyone.
Performing a materiality assessment is now widely recognised as not only best practice, but a strategic imperative for companies, particularly during testing times. To learn about how we are helping companies integrate their double materiality processes and enterprise risk management processes, watch our webinar here. Your double materiality can help you holistically understand risks and opportunities, align sustainability efforts with stakeholder expectations, and set you up for long-term resilience and success in an increasingly volatile trading environment.