Environmental, social and governance (ESG) is increasingly important for businesses that want to create long-term value, manage risks and opportunities, and meet the expectations of their stakeholders. However, the relevance of individual ESG issues (e.g. climate change; health and wellbeing; equity, diversity and inclusion; responsible procurement; etc.) is unique to each company – it’s operations, supply chain, industry and location. Therefore, it is essential to identify and prioritise the most significant ESG topics for your business and a materiality matrix is a standard, best practice, way of doing this.
What is a materiality assessment
A materiality assessment is the process of evaluating the relative importance of different ESG issues, and a materiality matrix is the output from this – a visual representation of the assessment in a graphical/diagrammatical format.
Materiality assessments are typically conducted through a range of techniques including interviews, surveys and desktop reviews.
Types of materiality assessment
There are two types of materiality assessment, the ‘traditional’ and the ‘double’ approach:
The traditional approach: This identifies high importance topics as those that are of both high importance to the business and of high importance to stakeholders.
The double approach: This identifies high importance topics as those which the business has a significant impact on, and those which have the actual/potential to have significant financial impact on the business.
Both approaches work in the sense of identifying a business’s top ESG priorities but the route chosen depends on the specific business needs. The double materiality approach is a requirement for companies in scope for EU CSRD legislation, but it is more costly to conduct, as the evaluation of actual/potential financial impacts on the business takes time. Further, we find it to be more prone to error as people are not generally skilled at quantifying the financial impact of an ESG issue.
For example, we conducted a traditional and double materiality assessment for a construction company, an industry known to have serious health and safety risks and for which sadly fatalities are not uncommon. What we found was that through the traditional materiality assessment, health and safety was a high priority issue (i.e. of high operational importance and of high importance to stakeholders), but through the double materiality assessment process it was only of medium importance as many stakeholders underestimated the potentially very high financial impact that health and safety incidents can have on a business (i.e. from fines; insurance premiums; operational costs from day’s lost; legal and remedial fees; etc.).
For this reason, unless it is legally required for a company (now or will be in the next 2-3 years), we recommend using the traditional approach.
Purpose of materiality assessments
Historically, materiality assessments were used to shape ESG reporting. Advocated by the likes of the Global Reporting Initiative (GRI), their purpose was to guide companies on the ESG subjects that they should cover, and to what extent, in their ESG reporting.
More recently, materiality matrixes are commonly used to shape ESG strategies, but here is where some companies go wrong, because a high importance ESG issue, does not necessarily need to be a high focus area in an ESG strategy. Why? Because a materiality assessment measures ESG issue importance, not performance.
Take climate change as an example. If, for a given company, the materiality assessment shows it to be a high importance ESG issue, yet the company is already Net Zero (or close enough) then it would be acceptable to not have any targets or a workstream in this area (beyond maintaining the current level of performance). However, in contrast, it would not be acceptable to have anything less than a significant amount of information on the company’s climate change policies, management activities, metrics and achievements in the annual Sustainability Report, given the high importance of the issue.
Using a materiality assessment effectively to create an ESG strategy
Thus, to develop the best ESG strategy, first a company should use a materiality assessment to identify important ESG issues, and then they should evaluate their current performance against these same issues – i.e. evaluating if there is high performance for high importance ESG issues; medium performance for medium importance ESG issues; and accepting that performance against low importance issues doesn’t necessarily even need to be measured. The optimal ESG strategy should then focus on closing the gap between performance and importance.
This approach will create a good ESG strategy but things are never quite that simple – to create a truly exceptional ESG strategy, for a company that is more mature in their sustainability approach (i.e. has already implemented the quick-wins across a range of ESG issues), we recommend focussing on one or two ESG issues to truly excel at. By doing this, the company gets greater internal traction and creates more business benefits than a materiality assessment alone can convey as it becomes a point of differentiation in their market. As for which topic to choose for this? That is an art, not a science, but one that we can help you with at Rawstone Consulting.
Contact us here to find out more about our ESG strategy consulting services.
Authored by Caroline Johnstone.