The value of materiality assessment in an Annual Report

Aug 11, 2022
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What is materiality assessment?

According to KPMG, ‘Materiality assessment is the process of identifying, refining, and assessing numerous potential environmental, social and governance issues that could affect your business, and/or your stakeholders, and condensing them into a short-list of topics that inform company strategy, targets and reporting’. Simply put, materiality assessment helps an organization understand issues that matter most to its internal and external stakeholders. These issues have the potential to influence shareholders’ decisions.

Stakeholder engagement forms a crucial part of a materiality assessment. Your organization can gain valuable inputs from your stakeholders, which you can then incorporate while assessing your material topics.

Why is it important?

Corporate organizations can use the process of materiality assessment to view their business from a sustainability lens and try to embed sustainability with their existing business processes. It helps in:

  • Ensuring significant social and environmental topics are embedded in the business processes
  • Identifying trends such as water scarcity, climate change, and community concerns that could impact the business
  • Investing in resources that matter the most to your organization and its stakeholders
  • Identify issues that need your attention but are not yet addressed
  • Identify where your organization is creating or depleting value for society

Although sustainability reporting is not mandatory as opposed to financial reporting, conducting a detailed materiality assessment can act as a guide to planning a company’s sustainability journey. There is no set time to conduct a materiality assessment, however, it is advisable to conduct one after significant changes to a business such as acquisitions, mergers, expansion to new geographies, new product line development, major regulatory changes or major black swan events, etc.

Increasing demand for transparency, investor demand and increasing emphasis on materiality reporting in frameworks and accounting standards such as Global Reporting Initiative’s (GRI) G4 guidelines, the International Integrated Reporting Framework, and the Sustainability Accounting Standards Board (SASB) are enabling companies to move beyond profitability metrics and identify topics that may have material impacts in the future.

‘Materiality’ in financial and sustainability reporting

In financial reporting, the information is considered material if its omission or misstatement in financial statements impacts the decision of the users relying on those statements. However, in sustainability reporting, materiality refers to the ESG issues that matter most to the stakeholders and their impact on business operations.

For instance, managing water resources is a material issue for soft drink manufacturers. They are, therefore, likely to face pressure from stakeholder groups if the water used in soft drinks lowers the availability of water for consumption by the communities in the sourcing region. Failure to notice water scarcity as a material issue can:

  • Lower net sales and profits
  • Reduce the drinking water availability for certain stakeholder groups
  • Open window for conflict of interest between the management and the stakeholders
  • Degrade the brand image and reputation of the company in the long-run

Process of conducting a Materiality Assessment

There is no single way or universally-accepted approach to conducting the Materiality Assessment process and many companies onboard external consultants or leverage their sustainability teams to manage the process. Broadly, the materiality assessment can be divided into the following stages:

  • Identifying the ESG risks and opportunities
  • Classifying the identified materiality risks into categories
  • Identifying external stakeholder groups to engage and seek input using surveys, discussions, etc.
  • Prioritizing categories based on stakeholder feedback
  • Incorporating a framework such as a materiality matrix to represent the consolidated information, assign a score and prioritize key sustainability issues
  • Engaging with the senior management and internal stakeholders to evaluate the matrix and incorporate it into the overall business strategy
  • Tracking the progress by publishing a sustainability report, with a detailed account of the materiality matrix and other key sustainability metrics

Illustrate using a materiality matrix

After listing materiality issues and gathering information on the issues that matter the most to stakeholder groups, companies can use a materiality matrix to present their findings. The matrix represents key sustainability issues in two dimensions with ‘Impact on the business on the X-axis and ‘Importance to stakeholders’ on the Y-axis. The issues can further be classified into ‘Moderate’, ‘High’, and ‘Very high’ based on their priority. An example of Unilever’s materiality matrix is presented here:

Benefits of materiality assessment

  • By evaluating risks in addition to financial statements, companies can estimate the overall hazards, blind spots, and growth opportunities.
  • Curating a list of future material topics, observing insights from ESG trends, and understanding stakeholders’ perspectives and views on various ESG risks can enable the company to stay relevant in the business in the long run.
  • Continuous evaluation of opportunities from emerging environmental problems can fuel innovative products or service offerings, creating a competitive edge over others. Circular economic models have influenced product development for companies such as Nike, Adidas, Puma, Burger King, and H&M, among others. For instance, Nike tapped into the circular economy and launched a new product line, the Space Hippie footwear, a collection made entirely from factory and post-consumer waste. Similarly, Adidas rolled out sneakers made using plastic collected from beaches and oceans to combat ocean pollution.
  • Showcasing a company’s process to filter important ESG metrics can win the trust of the stakeholders. By concisely reporting their key sustainability issues through focused communication, companies can highlight important topics effectively to their stakeholders.
  • By gathering inputs from internal stakeholders, senior management, sustainability or CSR managers, the process of materiality assessment can break silos and build cross-functional teams, thus creating value.
  • Allocating resources to mitigate sustainability issues can enable the company to strategically plan and allocate its teams, technologies and resources, resulting in efficient business operations.
  • Conducting materiality assessment displays a company’s commitment to sustainability, proactive risk management, strategic planning, etc., all of which can help companies build a strong reputation and brand image in the long-run

Companies can start their materiality assessment journey by taking smaller steps today to gather data and resources. Conducting a materiality assessment is often the starting point for fostering and maintaining conversations related to sustainability. By sharing this progress in corporate reports, companies can gain the trust and confidence of the stakeholders. If you would like to discuss your corporate reporting requirement, reach out to Report Yak, and we would be happy to draft a perfect report for maximum impact!