Defining Double Materiality in the Sustainability Reporting Scenario
Originally, the concept of materiality in corporate reporting served to determine what information is relevant to disclose for the users or audience. However, the term “double materiality” started to gain traction and was officially introduced in the corporate reporting landscape with the release of the European Union (EU) Non-Financial Reporting Directive (NFRD) in 2014. The NFRD requires certain large companies to disclose non-financial information, including environmental and social matters, in their annual reports. It recognized the importance of reporting on both the impacts that companies have on society and the impacts that society has on companies – double materiality.
Financial reporting standards use the concept of financial materiality to determine what needs to be included in a company’s disclosure. While jurisdictions differ on their exact definitions, information is typically material to disclose if a ‘reasonable investor’ would consider it important in its financial decisions, and equivalently, if excluding the information would alter a financial decision. This definition of materiality focuses on the financial risks to a reporting organization for their value creation.
Demand and adoption
The rationale behind the emergence of double materiality was the growing recognition that organizations’ impacts extend beyond their own operations and financial performance. Stakeholders, including investors, customers, employees, and communities, started demanding more transparency and accountability regarding the social and environmental consequences of business activities.
Existing voluntary sustainability reporting standards have incorporated the concept of materiality in different ways. The Sustainability Accounting Standards Board (SASB), which is now consolidated into the International Sustainability Standards Board (ISSB), applied materiality at the ‘issue’ level, meaning that each company would determine which of the SASB standards were important to disclose to depending on their industry (i.e., which issues were material to the organization depending on their industry). The Global Reporting Initiative (GRI) similarly applies its definition of materiality at the ‘topic level’ that the company will need to include in their disclosures and considers the impact that an organization has on multiple stakeholders in addition to financial investors, such as the community, the environment, and so forth, instead of solely the financial risk.
The newly introduced EU CSRD (European Union Corporate Sustainability Reporting Directive) is set to replace the NFRD, affecting almost three quarters of all businesses in the European Economic Area (EEA) as well as certain non-EU companies who fall under certain criteria. As it was the NFRD who first incorporated double materiality into their framework, it follows that the EU CSRD has made the concept of double materiality a defining feature/factor of its disclosure requirements.
Expanding the scope of sustainability reporting
The incorporation of double materiality in the sustainability reporting landscape indicates a shift in what regulatory bodies are asking for from reporting companies and will have significant implications for the future of sustainability disclosures.
The inclusion of double materiality as a mandatory requirement expands the scope of sustainability reporting as a whole. It demonstrates that stakeholder expectations and trust are of increasing influence as focus moves towards the importance of transparency and sustainability strategies of reporting companies. This is also consistent with investor’s needs, allowing investors to gain a deeper understanding of how reporting companies will be able to respond and adapt to risks and opportunities such as sustainability challenges, regulatory changes and stakeholder expectations. With the disclosure of double materiality, investors will be more confident in where they are to allocate their capital. Finally, the integration of double materiality will aid in the standardization of reporting frameworks globally and will facilitate comparability and consistency in reporting no matter the jurisdiction or sector.
Ultimately, this evolution in sustainability reporting promotes sustainable business practices and the integration of ESG factors into decision-making processes.