On 28 November 2022, the European Council adopted The Corporate Sustainability Reporting Directive (CSRD), an EU ESG (environmental social governance) standard which is poised to revolutionize Corporate Sustainability Reporting in the European Union. The broad applicability - it will likely apply to more than 50,000 companies across the EU – as well as its range of 12 subtopic documents will undoubtedly make it a challenging instrument to implement. At the same time, it represents a significant opportunity for reporting companies. The reason for this? Double Materiality.
What is “Materiality” and “Double Materiality”?
Materiality in accounting refers to the concept of identifying “what matters”, when a company prepares annual statements for investors and stakeholders. Materiality is a qualitative, sometimes subjective concept, yet it applies to quantitative information – a company’s financial reports. This seemingly apparent contradiction has led to some changes in interpretation and application since it was first defined in the 1940s.
Initially, a transaction or event was considered “material” if it was sufficiently large - in that it would concern the users of the company’s financial statements. “Materiality” was considered from the perspective of the company as recipient - the company experiencing events that could impact their finances. These events would range from changes in laws to business mergers, from natural disasters to changes in technology.
More recently, events ranging from potential interruption of the supply chain, to adverse Environmental, Social, or Governance (ESG) behavior by others within a supply chain, have been included in the consideration of “‘materiality”’. These new impacts highlight the interconnectedness of our global economy, yet from a reporting perspective, show the company as subject to the impact of others. The financial definition of "materiality" has been refined by the International Accounting Standards Board (IASB) in 2018 as:
Information is material if omitting, misstating or obscuring it could reasonably be expected to influence the decisions that the primary users of general purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity.
Yet, there is a consequence to every action: human and corporate activity have a significant impact on the health of the planet. Company “things that matter” can not only be viewed from the perspective of the company as a recipient of risk. They can also be considered from the perspective of the company as a generator – the company being the generator of events that impact the planet.
Enter the EU Corporate Sustainability Reporting Directive (CSRD) and “double materiality”. Double materiality is the accounting for “what matters”, from two perspectives: the impact on a company as recipient of events, and the ESG impact on the planet by a company as a generator of events.
Where’s the Opportunity in Double Materiality?
First and foremost, it adds to existing analytical tools, allows for a deeper understanding of issues, and uncovers new considerations or concerns, as interconnected relationships surface between the impacts a company is experiencing and those it’s exercising.
As such, it enhances the level of engagement with stakeholders (as opposed to only shareholders), helps focus on the most critical issues and helps structure a sustainability policy, allowing for a complete picture of a company and the environment . Ultimately, this approach will compel companies to not only conduct ESG and CSR measures as a matter of goodwill but as a substantial part of company strategy, directly impacting their bottom line.
Let’s look at three notable opportunities to companies:
It makes it easier to identify focus areas: companies already often know the areas where their operations have an outsized impact - a double materiality analysis helps them to focus actions to alleviate or even eliminate and reverse those impacts. To give an (overly simplistic) example: A tourism company offers jeep tours through a mountain range and provides food and drink in single-use plastic containers. It has known for a long time that littering of participants was a problem, and that the old jeeps it uses are not only burning outsized amounts of fuel, but are also very loud. However, it has not done much besides asking tourists not to litter, because both new jeeps and reusable containers were considered too expensive.
After years of good business, business is becoming difficult as fewer and fewer tourists are coming to the area. A materiality approach would report to shareholders that a certain decline in tourism means a reduction in revenue and a continuing dynamic might lead to worse outcomes in the future.
A double-materiality analysis would go a step further and also evaluate a company’s impact. It might find that wildlife has left the area because of noisy jeeps and trash filling the roadsides. As a direct consequence of reduced wildlife and unpleasant, littered scenery, fewerless tourists visit the area. Suddenly the company has an incentive to reduce its impact on the environment, which is directly related to its own survival.
This directly leads to the second advantage, which is putting a dollar value on the impact. In the example above, the cost of new jeeps and multi-use containers/cutlery and the revenue lost through fewer visitors would not necessarily be seen as related. Caring for the environment is thus pure cost and additional advertisement or multilingual tour guides might be seen as a way to grow visitor numbers.
Once the manager realizes that the company is losing money every year because fewer people want to visit a diminished forest and the company is garnering a reputation for ecologically devastating tourism, investing in more fuel-efficient and quiet vehicles, along with alternative food containers, might not seem all that expensive anymore.
The third advantage is again connected to the second: reporting financially positive effects. Continuing with the tourist company example, imagine the company has now purchased the latest electric vehicle, installed solar panels to charge them, switched to reusable containers, and cleaned up litter by the roadside. As wildlife gradually starts coming back to the area, so are tourists. What would have been a story for a Sustainability Report (purchasing electric vehicles, thus reducing GHG footprint) becomes a financially material business decision.
The double materiality approach helped the company focus on the most important areas, identifying where their impact diminished their own commercial viability, and was able to remedy it. In the end, it is able to report increased revenue as tourists start flocking back and cost reduction as vehicles are fuelled by solar panels instead of diesel.
Now, of course, the expenditures have to be financed and amortized - but the overall concept is blatantly clear: conducting business responsibly and in an environmentally friendly manner must not be seen as a pure cost, isolated from financially relevant impacts a company is experiencing, but as a value add benefitting not only society but also a company’s bottom line. This has been clear for a while now in topics like energy efficiency, where less energy consumption means fewer emissions but more importantly fewer costs. Double materiality will allow companies to expand this approach and identify unexpected areas of action, where a change, of course, would not only benefit the environment but ultimately the bottom line.
What should companies do now?
The answer to this question is simple: Get started, now!
Only rarely will the analysis and remediating actions be as straightforward as in the example above. Given the wide range of metrics to report on, assessments following the double-materiality principle under the CSRD will be complex and time-intensive. At the same time, it will be rewarding and reveal a myriad of ways to improve responsibility, efficiency, and ultimately the bottom line.
This means, any steps will have to be taken incrementally, and trial and error will inform the learning process. This is no shame, as authorities and experts agree that the implementation of an instrument like this won’t happen overnight. As one expert pointed out on a recent forum: “We have spent decades building up global standards for financial reporting and accounting and it has enabled global economic growth - there is no reason why we shouldn’t be able to do the same for sustainability. But it won’t happen overnight.”
What are we doing?
Minespider recognizes and appreciates the impact the CSRD will have on corporate reporting and stands ready to support it. Our experts can take a look at your current data collection and help you identify any gaps in reporting you might have.
Furthermore, our platform is the ideal tool to help you collect necessary information along value chains. For example, the CSRD asks companies to collect information on circularity: How much material went in and out of the production process, how much waste was generated, how much material is going in or coming out of a recycling process, and so on. Minespider’s Product Passports help you capture that sort of data and pass on information, for example, to enhance the recycling process.
Undoubtedly, the CSRD is a big and challenging framework, with the concept of double materiality adding a novel layer of complexity. Yet that is exactly what makes it so promising. It elevates the reduction of corporate environmental impact from being a cost on a company’s books, with revenue only indirectly linked to an enhanced reputation and the avoidance of fines, to an analysis capable of transforming a business. It will take time, but the potential results are more sustainable, resilient, and profitable companies. Minespider stands ready to help and would be happy to support you on this journey.