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Understanding materiality, double materiality, and dynamic materiality

The concept of materiality goes deeper than you may have realized. Here’s an explainer on the different forms of materiality, and why they matter.

Sustainability reporting is an organization’s practice of disclosing publicly its most significant economic, environmental, and social impacts.

To contribute to sustainable development and to be transparent about sustainability, an organization must identify, measure, and report on those positive and negative aspects pertinent to its operations, as required by stakeholders.

What is materiality and why is it important?

In general, materiality refers to those aspects of an organization that are relevant or significant, and which may have negative consequences if not managed correctly.

Legal, compliance, financial, operational, strategic, and reputational material topics or materiality are relevant across business functions. Materiality is also becoming more relevant in non-financial topics such as ESG metrics, although these still have financial implications.

The Global Reporting Initiative (GRI) provides global standards for sustainability reporting, and defines material topics as those topics that represent the organization’s most significant impacts on the economy, environment, and people, including impacts on their human rights.

Materiality varies across industries, countries, and can even differ between similar industries. It depends largely on the nature of the operation, and the environmental and social setting.

To help an organization be sustainable and create long-term value, materiality must be considered dynamically and per operation, considering the entire set of stakeholders and their concerns and interests.

What are double materiality and dynamic materiality?

The concept of ‘double-materiality’ is new and was first formally proposed by the European Commission in 2019.1

In essence, double materiality refers a two-pillar approach to reporting. It is not only knowing the ESG-related effects on an organization resulting in financial risks or influencing business value (also referred to as an outside-in view), but the environmental and social impacts that the organization’s operations have on the world (sustainability-related or inside-out perspective).

Using the example of climate change resulting from greenhouse gas emissions, the business risk is how climate change may affect or disrupt its operations and thus the organization’s performance, whereas the impact view concerns how the organization is contributing to climate change via its own carbon footprint.

Source: Guidelines on reporting climate-related information (2)

There are various benefits to using double materiality.

It leads to extensive and more engaging internal and external stakeholder interactions in order to better understand their diverse needs, concerns, and interests.

It helps increase focus on sustainable development and value creation. And it creates corporate transparency, helping to identify risks and opportunities.

Different global standards have different approaches to materiality. Certain standards, such as the TCFD and SASB, focus on financial disclosures that may affect enterprise value, whereas others, such as the GRI, guide disclosures from a broader impact perspective.

Dynamic materiality relates to timelines.

In a 2020 whitepaper, The World Economic Forum stated that “One area in which investors have begun initial explorations is anticipating how issues might become financially material either across an entire industry or for a specific company. What is financially immaterial to a company or industry today can become material tomorrow, a process known as ‘dynamic materiality.’”

What this means is that organizations need to be forward looking and proactive.

They need to review their materiality register (those risks and opportunities, and their associated assessments) constantly to ensure that there is no development that goes unnoticed or unattended, and that they are aware of the forces that will shape their business environment over the next 5, 10 and 15 years.

Overview of Impact, Financial, and Dynamic Materiality (Source: JSE Sustainability Disclosure Guidance June 2022)