The Intersection of Materiality and ESG:
A Foundation for Business Excellence
28 June 2019 - By Evan Harvey and Susanne Katus
Key stakeholders – investors in particular – are getting more and more involved in the topic of materiality, especially as it intersects with environmental, social and governance (ESG) issues. Because these issues are now more prominent in corporate responsibility, risk identification, and enterprise strategy, it’s important to understand how companies assess and respond to their material impacts. What is the materiality assessment process? How is it changing? Are there best practices for companies to follow?
On Monday 24th June, Datamaran hosted a workshop with Nasdaq, the International Federation of Accountants (IFAC), Morgan Stanley, BNP Paribas Asset Management and other thought leaders to explore current trends in materiality, provide practical guidance on ESG, and propose practical ways forward for companies and their stakeholders.
Although it sounds pretty obvious, the consensus was that we tend to overcomplicate materiality. As Stathis Gould, Deputy Director of IFAC put it, “a concept so inherently straightforward has become far more complicated than it should.” An easy way of viewing materiality is as a business process that reflects how particular issues impact a company's relations with external and internal stakeholders, its operations and its ability to create value over time, beyond the balance sheet.
Materiality needs to go beyond reporting. It's a process inherently linked to conversations about business strategy and integration of ESG issues – but the words seem to have gotten lost, according to Celine Suarez, Executive Director Global Sustainable Finance at Morgan Stanley.
Adam Kanzer, Head of Stewardship Americas at BNP Paribas Asset Management, believes that talking about the process gets us out of the fight over metrics, for which we don't yet have a baseline standard. Talking’s good for engagement, for ensuring all our stakeholders are on the same page.
Materiality underlines a company's engagement on ESG issues, but it needs to be seen through the lens of value creation – not exclusively from an ESG point of view. Investors want more transparency on the process, as this helps them understand a company in context – its management strategy and its governance process.
Materiality is a fundamental business process that crystalizes relevant information in the context of principal business risks and opportunities. So it needs to reflect more than management's perception alone. As Adam Kanzer said, "You cannot rely exclusively on a management's judgment of risk." All those who are important in the running and upkeep of the business, and have an in-depth understanding of the way the business works, need to have an input in order to provide the most accurate possible picture. It should be a reflection of significant audiences. A multi-stakeholder approach is important to investors as they want to know what other stakeholders are demanding of the company.
There is no single, one-size-fits-all approach to materiality, as explained in Nasdaq's latest ESG Reporting Guide. No single framework or method of disclosure that works for everybody. Your approach needs to suit your individual business and the nature of its operations. There needs to be a balance between rules and principles-based disclosure practices.
A perennial concern about materiality assessment is over which standard or framework to follow. If you’re using materiality to inform your strategy, you need to cast a wider net than relying exclusively on one particular standard or framework. It is a ranking and prioritization exercise that requires strategic business thinking and engagement. The standards and frameworks are not a holy grail; they are tools that help businesses narrow down the materiality process from a disclosure context. Take guidance from the parts that are relevant to you.
Materiality is inherently an investor-oriented concept but, in the words of Adam Kanzer, “we've put it in the hands of corporate counsel.”
The future of materiality
Markets change over time. Businesses change over time. The concept of materiality needs to evolve in order to adapt to changing market expectations. Accordingly, we discussed the key considerations for companies when planning their future approach to materiality:
Relevant and significant information for boards and management – Disclosure and value-creation should not be thought of in isolation. The two are inseparable in the running of a successful business.
Alignment and connectivity – Internal to external, financial to non-financial, short term to long term.
Expanding filters – Now that more data analytics tools and technologies are available to help companies showcase evidence of interest, financial and reputational impact, companies need to expand their filters to ensure they explore all issues in the right level of detail and identity those outside their normal field of vision.
Timing and time horizons – Critical matters play out over longer periods, so dealing with uncertainty is key.
Frequency – Materiality assessments need to be dynamic and evolving, not just once a year.
Form – The completion of securities filings and voluntary reports where appropriate.
Key value driver metrics – Understanding how to assess each issue, and communicating value creation and protection to all key stakeholders.
Confidence – Expanding technology lends greater credibility to your data and the quality of your information, but it needs to get better all the time. It’s a moving target.
A company’s approach to materiality needs to be confident yet adaptable, shifting yet comparable, consistent yet flexible. That's where data and technology can help. For instance, Lisa Epifani (Manager, ESG Engagement in Corporate Governance) said: "We are using Datamaran's AI-powered platform to be proactive in relation to materiality as it helps us identify and track issues that are emerging."
There are certainly wrong approaches, but there is no one right approach. Like a business, a materiality assessment is an organic thing, changing with the world around it. They key is to understand your business and your stakeholders, and to mold your analysis around your ever-evolving needs.
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