A powerful compass for businesses

Marie Chevalley and Emmanuel Rondeau explain why double materiality is much more than just an element of CSRD reporting, how it will have a lasting and positive impact on business analysis and show how it can help build a sustainable future

Most European institutions have only recently become acquainted with an important new concept: double materiality. The acquaintance might be new, but it will not be short because the EU’s Corporate Sustainability Reporting Directive (CSRD) requires companies to apply it in depth, starting this year for large companies.

It’s a concept that expands the traditional idea of materiality by requiring companies to assess and report their sustainability in the round. That is: both in terms of how environmental, social and governance (ESG) issues affect the company’s financial performance and how a company’s operations and activities affect the environment and society. Double materiality enhances corporate resilience and stakeholder trust by promoting responsible business practices that consider long-term impacts on society and the environment.

Although double materiality is new for many, a few organisations have been using it for some years, benefiting from better risk assessment as they use IRO (Impact, Risks, Opportunities) to understand which topics are material. DBS Bank in Singapore, for example, published its first double materiality assessment in 2021 as illustrated below.

Identify material factors

Given that double materiality analysis will become a new standard, lessons will need to be learned on the initial implementation steps. Below are a few challenges that organisations need to navigate.

Although double materiality is new for many, a few companies have been using it for years, benefiting from better risk assessment

First, choosing your topics. One of the pitfalls of double materiality analysis is the tendency to report on all topics instead of choosing those with the most impact. The real value of the double materiality analysis lies not only in its ability to indicate which topics to report on, but in using the process as a strategic tool.

Second, applying a robust methodology. The European Financial Reporting Advisory Group (EFRAG) has issued guidelines on building the double materiality matrix, but stresses that the ultimate process is “left to the judgment of the undertaking…and should reflect… [its] facts and circumstances”. That is why it is essential to follow a robust methodology and build a matrix that will not only be useful for identifying reporting topics but also a means of understanding the risks and opportunities within the company’s ecosystem.

A properly structured methodology encompasses several critical steps:

Understanding context: companies need to develop a thorough understanding of their operational context, including business relationships and the broader environmental and social landscape. This involves analysing business strategies, mapping out value chains and identifying key stakeholders and their concerns.
Identifying material topics: organisations should compile a comprehensive list of potential material topics related to sustainability, encompassing both impact materiality and financial materiality throughout the whole value chain. This is crucial to avoid disruption in the value chain and to discover overlooked risks.
Assessing materiality: after identifying potential material topics, companies must assess their significance based on established criteria. This includes evaluating the scale, scope and irreversibility of impacts, as well as the likelihood of occurrence. By applying these criteria, organisations can prioritise issues that are most relevant to their operations and stakeholders.

Third, to carry out a thorough double materiality analysis, it is essential to involve stakeholders. This engagement fosters trust with stakeholders and strengthens the value chain – both upstream and downstream – by establishing dialogue and considering various perspectives.

Building trust: involving stakeholders in the materiality assessment process enhances transparency and accountability, which are essential for building trust with customers, investors, employees and communities. Stakeholders are more likely to support organisations that actively seek their input and demonstrate a commitment to addressing sustainability challenges.
Identifying overlooked risks: by engaging with diverse stakeholders, companies can uncover risks that may have previously gone unnoticed. These insights can lead to a more comprehensive understanding of impacts across the entire value chain, enabling organisations to address potential challenges proactively.

Fundamentally, double materiality is a risk exercise. It has to identify the ESG factors that will have the most impact on the future financial performance of the organisation, as well those organisational activities that generate the greatest negative externalities.

Shareholders are more likely to support companies that actively seek their input and demonstrate a commitment to sustainability

A sheep-dip approach – screening the pros and cons of all existing activities – won’t work. The objective is to deliver a fair, overall assessment and to highlight, especially at the start of such a game-changing process, which areas are most impacted and where efforts should be concentrated first. As a rule of thumb, the initial target should be to single out the 20% of business activity responsible for 80% of the impact.

DBS Bank in Singapore published its first double materiality assessment in 2021

Source: DBS

Double materiality as a strategic tool

Because it is a radically new and thorough approach, building a double materiality matrix will reshape each company’s strategic analysis. It might look like a daunting step, but it’s not the first time that matrix building has changed how businesses examine value.

At the end of the 1960s, the Boston Consulting Group (BCG) published the now famous growth share matrix. According to BCG, at one time, around half of all Fortune 500 companies applied the matrix, and it’s still taught in business schools today.

In comparison with the double materiality matrix, the growth share matrix looks relatively crude. It is a table, split into four, with growth on one axis and market share on another, which is used to help companies decide which strategic business unit to prioritise and how to allocate resources. It is, nonetheless, very useful.

The double materiality matrix could have a similar role in the coming decades, as non-financial performance progressively steps up alongside financial returns as a determinant of corporate attainment.

The new matrix will provide management with a factual and objective assessment of how their products and business practices affect society. They can then identify potential risks associated with environmental degradation, social inequality and regulatory changes, while also uncovering opportunities for innovation and sustainable growth.

Making informed decisions

Double materiality analysis can provide companies with valuable new insight. But for that to be effective, you have to not only report on the data but also be able to leverage it into useful information and processes. The EFRAG has listed around 1,200 data points under the ESRS framework, 80% of which are qualitative and 20% quantitative. Such data points are found across the organisation, outside of the normal financial data reporting architecture.

With limited resources, the focus will be on collecting the data needed to comply with the new reporting obligations. But that might lead institutions to miss the point. The objective of double materiality is not only to enable in-depth comparison of companies’ ESG performance, but to put in place processes that support data-driven ESG decisions across the entire value chain.

Organisations that get their double materiality analysis right should be able to enhance sustainability efforts and also identify inefficiencies in their operations.

That could lead to significant reductions in resource consumption. By correctly utilising accurate data analytics, organisations can optimise resources, enhance operational efficiency, comply with regulations, drive innovation and foster collaboration. For instance, companies leveraging advanced analytics have reported making energy consumption reductions of 25-30%, which brings substantial cost savings and a lower carbon footprint.

An effective double materiality matrix can serve as a powerful compass, steering a company’s sustainability strategy to drive transformative changes across its business model. By placing sustainability at the core of decision-making, it accelerates the transition to a more sustainable future for all. Companies that embrace sustainability and resilience today will be the leaders and innovators shaping the world of tomorrow.

Marie Chevalley is a sustainability consultant with expertise in ESG compliance and financial analysis. She focuses on CSR strategies, extra-financial reporting, and ESG data collection

Emmanuel Rondeau is a NED for a leading European financial institution and provides consultancy and training services to boards and executive committees. He has been a banker for 30 years, leading teams in France, the UK, the US and India