ESG assessments & reporting are gaining prominence to address the requirements of a varied set of stakeholders, such as investors, shareholders, institutions, regulators and customers. These require the identification & prioritization of the most relevant & impactful factors; and a systematic assessment of measures that protect the environment & people, address climate change and strengthen human rights.

With various frameworks already in place and others in development (please refer to an indicative list of existing and evolving frameworks in the ensuing section) the choice and usage of the pertinent standards for ESG assessments and reporting have gained complexity.

In this relative maze of ongoing evolution, deployment of the concept of materiality (with reference to the pertinent standards/frameworks) has become a critical & early component in developing a lasting and successful ESG strategy of an organization.

Existing frameworks

Such as those set out by the Sustainability Accounting Standards Board ('SASB’) the United Nations on business & human rights, the Climate Disclosure Standards Board, IFRS sustainability disclosures, The Global Reporting Initiative ('GRI’]) the Carbon Disclosure Project and the Financial stability board’s task force on climate-related financial disclosures.

Evolving frameworks

Such as those being developed by the US Securities and Exchange Commission, the European Financial Reporting Advisory Group and the International Sustainability Standards Board.

Defining materiality

The GRI has defined “material” as those ESG topics that may reasonably be considered important for (a) Reflecting the organization’s economic, environmental, or social impact, or (b) Substantively influencing the assessments and decisions of stakeholders.

These include climate change, diversity & inclusion, human rights, supply chain management, risk management, business continuity & corporate governance.

The 2-dimensional model

The first dimension of the materiality assessment should focus on financial aspects and an analysis of the broader issues. The financial assessment should entail an exclusive focus on ESG risks that could have an impact on an organization’s financial value.

The second element (double materiality assessment) should seek to address ESG issues from both a financial impact and the impact of an organization’s activities on the environment and society at large. 

The 6-factor framework

The ensuing key tasks (developed in-house by our firm with reference to best practices & globally accepted standards/frameworks) are used for undertaking a materiality assessment.

• Define the scope | Determine the scope of the assessment, with reference to specific stakeholders & after considering areas, sectors, or operations that need evaluation. Consider the nature of business, industry & expectations from stakeholders. Identify the framework/s being used by the organization’s competitors and narrow the assessment further to the direct competitors. Using the same framework will facilitate benchmarking for the organization’s investors, customers, employees & other stakeholders, who may have varying information requirements on ESG initiatives. Go beyond the specific regulatory requirements for other factors as different countries and jurisdictions may have varying legal constructs governing corporate disclosure, as well as different legal liability profiles.
• Assess internal data & policies | Review internal data and existing policies, procedures & reports related to ESG issues. The objective should be to identify areas where the organization has already taken action or has policies in place.
• External benchmarking | Use the information relating to the organization (gathered from internal & publicly available sources) & conduct additional research to benchmark against industry peers, best practices & relevant ESG frameworks, standards or guidelines (e.g., GRI or SASB) to identify commonly recognized ESG topics that are pertinent to the organization and locations being covered.
• Prioritize ESG topics | Analyze the information gathered from stakeholder engagement, internal data & external benchmarking to identify the most significant ESG topics for the organization. In doing so, consider the frequency and severity of potential impact, stakeholder concerns, regulatory requirements & industry trends.
• For the environment, these could include carbon emissions, climate change vulnerability, energy conservation, water stress, waste management (including electronic wastages), land usage & clean tech opportunities in green buildings, and renewable energy among others.
• For social, these could include labour management, privacy & data security, human capital development, health & safety, supply chain labour, consumer financial protection, responsible investment, community relations, access to finance, access to health care, human rights & working conditions in the supply chain and inclusion & diversity.
• For governance, these could include the tone at the top, ownership & control, management of the board, executive compensation, code of conduct & business ethics, risk management, transparency in accounting, and tax to name a few.
• Materiality matrix & diagnostics | Create a materiality matrix or heat map to visualize the identified ESG topics based on their significance to both the organization and its stakeholders. Plot the issues on the matrix based on their impact and level of stakeholder concern.
• Validate and refine | Validate the identified ESG topics by seeking feedback from the relevant stakeholders. The matrix so developed should be refined (if necessary) based on their input.

An effective materiality assessment sets the tone for an organization to identify risks with opportunities & assess the impact of its measures relating to sustainability. By disclosing the material ESG factors and providing clear explanations of their significance, organizations can demonstrate their commitment to responsible & sustainable practices; and consequently, build trust with their stakeholders.

Raising the thresholds on materiality would translate into insufficient information with the costs to undertake such an assessment outweighing benefits to the market. This can result in adverse perceptions taking shape on the ability of an organization to provide complete, transparent, comparable & reliable information.

On the other hand, low thresholds for materiality can result in extensive & potentially excessive reporting and consequently, enhance pressures on organizations in such assessments, while placing an overwhelming burden of information on stakeholders. There is a possible irony in the transparency agenda and in that the greater the volume of information, the more confusing or incomprehensible it risks becoming.

A systematic approach to making the materiality assessment, with a collaborative & multifunctional process involving the board of directors, management and other stakeholders will enable you to unlock new opportunities for growth & value creation while contributing to a more sustainable environment.

We will keep you posted on developments relating to the standards and best practices for ESG assessments & reporting. In the interim, have a great week ahead.

PS: To those celebrating the 4th of July, here is wishing you a joyful and prosperous holiday!

Best wishes

Markets team

MGC Global Risk Advisory

About Allinial Global

Allinial Global (formerly PKF North America) is currently the world's second-largest member-based association (with collective revenues of approximately USD 5 billion) that has dedicated itself to the success of independent accounting and consulting firms since its founding in 1969. It currently has member firms in over 100 countries, who have over 28,000 professional staff and over 6,000 partners operating from nearly 700 offices across the globe.

Allinial Global provides its member firms with a broad array of resources and support that benefit both its member firms and their clients in the key impact areas of learning and development, human resources, international outreach, technical support, knowledge-sharing platforms through its specialized communities of practice, marketing resources, information technology and best practices in practice management.