“Materiality” is becoming increasingly important both in Japan and abroad. Numerous legislative bodies have passed laws mandating materiality assessment for sustainability-related financial reporting, and it is more important than ever for organizations to deepen their understanding of the key concepts behind the materiality assessment process.

So what exactly is, a materiality assessment? A materiality assessment is a process conducted by organizations to determine the significance of sustainability related issues or impacts on their operations, performance, stakeholders, and the environment. This assessment helps organizations identify and prioritize sustainability issues that could affect their ability to create value, achieve their goals, and have a positive impact on the world.

There isn’t a one-size-fits-all approach to materiality assessment. In fact, there are multiple perspectives on what makes a sustainability issue material to an organization.

In this blog, we will share why materiality matters, key concepts behind materiality, one approach to the identification of material topics, and how you can fast-track the materiality assessment process by combining sustainability knowledge with workshop facilitation expertise.

Why Materiality Matters

Materiality is a cornerstone of sustainable business practices, guiding organizations in identifying and prioritizing environmental, social, and governance issues that are most relevant and impactful. By conducting materiality assessments, organizations can pinpoint key sustainability challenges and opportunities that require attention and action. This not only helps in focusing resources and efforts where they can make the most significant positive impact but also enhances transparency and accountability, building trust with a broad range of stakeholders.

Materiality-driven sustainability strategies enable organizations to align their activities with stakeholder expectations, reduce risks, and capitalize on opportunities for innovation and growth. Ultimately, materiality can empower organizations to integrate sustainability into their core business operations, driving long-term value creation and contributing to a more sustainable and resilient future.

The meaning of “materiality”

The term materiality has it’s roots in corporate financial reporting. In finance, information deemed material is information that could effect the decision making of someone reading a financial report. Essentially, it refers to information on issues that could effect the corporate value of an organization.

However, the term materiality is now also commonly used in the world of sustainability strategy and reporting. A “material topic” refers to an aspect of a company’s operations or activities that has or could have a significant impact on sustainable development, or a sustainability related topic that could have an effect on corporate value.

In the realm of sustainability, there are numerous approaches to materiality, with the most discussed being impact materiality, financial materiality, and double materiality.

Let’s take a look at each of them, so you can understand which are most relevant to you and your organization.

Approaches to Materiality

Impact Materiality

Impact materiality addresses impacts on people and the environment in the upstream and downstream value chain of an organization. In impact materiality, an issue is deemed material if it has or could have a significant effect on the environment, economy, or people.

For example, in the context of environmental impact, a manufacturing company might identify carbon emissions as material if its operations contribute significantly to greenhouse gas emissions. Addressing this issue could have a substantial impact on reducing the company’s overall carbon footprint and mitigating climate change effects.

Similarly, in the context of social impact, a retail company might identify fair labor practices as a material topic if its supply chain involves factories with that may have poor working conditions. Improving labor practices within the supply chain could lead to better working conditions for employees and contribute to broader social sustainability goals.

Sustainability-related Financial Materiality

Sustainability-related financial materiality addresses sustainability-related risks and opportunities that may effect an organization’s financial value. According to sustainability-related financial materiality, an issue is deemed material if it is related to environmental, social or governance factors and has or could have a significant effect on a organization’s financial performance.

Sustainability-related financial materiality recognizes that ESG factors can have direct and indirect financial implications for businesses. These effects are numerous, and growing in our changing world. Unfortunately, the risks and opportunities are often overlooked by those who deprioritize sustainability initiatives.

To make the impact of sustainability issues on corporate financial health abundantly clear, here are a few common sustainability-related financial impacts:

1. Risk Management: Certain environmental or social risks, such as regulatory changes, resource scarcity, supply chain disruptions, or reputational damage, can pose financial risks to a company. Identifying and managing these risks is essential for protecting shareholder value.
2. Cost Savings and Efficiency: Sustainable practices, such as energy efficiency measures, waste reduction, or sustainable sourcing, can lead to cost savings and operational efficiencies. These cost savings can positively impact a company’s financial performance.
3. Revenue Generation: Companies that innovate and develop sustainable products or services can access new markets, attract environmentally conscious consumers, and generate additional revenue streams. For example, investing in renewable energy technologies can open up opportunities in the growing clean energy market.
4. Access to Capital: Investors are increasingly considering ESG factors when making investment decisions. Companies with strong ESG performance may have better access to capital, lower borrowing costs, and higher market valuation compared to those with poor ESG performance.
5. Regulatory Compliance and Legal Risks: Non-compliance with environmental or social regulations can result in fines, legal liabilities, and damage to the company’s reputation, ultimately affecting its financial performance.

Double Materiality

Double Materiality addresses both impact and financial materiality. This holistic perspective takes into account the interrelationships between impacts on the environment and society, as well as financial impacts to the organization. While giving consideration to the ways an organization can impact the world, double materiality also entails considering the risks and opportunities that may arise from sustainability issues and have an effect on corporate finances.

Double materiality assessment, an assessment for both financial and impact material topics, is required under the EU Corporate Sustainability Reporting Directive (CSRD) which took effect in 2023 and will have a rippling effect all over the world.

You can expect double materiality to become the global norm in the future. However, it’s important to note that the starting point for materiality prioritization should always be impact materiality, as impacts uncovered from an impact material perspective are material regardless of whether they are financially material or not. Impact materiality assessment can help uncover financially material risks and opportunities, and provide a thorough basis for double materiality assessment.

How to Conduct a Materiality Assessment

The first steps for materiality assessment will be the identification and assessment of impacts. The Global Reporting Initiative (GRI) provides thorough guidance on how to determine material topics. Below, we’ll walk you through the basic process for identifying material topics, as recommended by the GRI.

Step 1: Understanding Your Context

The first step to materiality assessment is developing an understanding of your organization’s unique context. This means creating an overview of business activities and relationships and their sustainability-related context. This information is crucial for being able to identify the impacts your organization has on the world.

You should develop an understanding of all of these dimensions of your operations:

• Activities: This includes the organizations purpose, mission, vision, and values, strategies, business model, product type, organization size, and sector.
• Business relationships: Types of business relationships (supplier, joint venture, franchise, etc.), types of activities undertaken by business relationships (manufacturing, logistics, etc.), geographic location of relationships, and the temporal nature of business relationships (long-term or short-term, project-based, etc.)
• Sustainability context: Economic, environmental, and other societal challenges associated with the business and sector, as well as expected compliance from intergovernmental organizations like the UN and OECD.
• Stakeholders: Individuals and groups who are affected or could be affected by the organization’s activities. This could include: employees, contract workers, governments, local communities, business partners, suppliers, consumers, trade unions, and more. ****

Step 2: Identifying Impacts

Once organizational context has been established, you can move on to identifying the impacts your organization has on the environment, economy, and people.

There is no single best method for identifying impacts. At Neuromagic, we have a GRI certified expert work with clients to gather diverse stakeholders from across departments to rapidly identify impacts across the entire value chain in an intensive multi-day workshop. This is the fastest way to kick-start the impact identification process, and can lead to the discovery of unexpected impacts.

Organizations can also use information from legal reviews, financial audits, compliance mechanisms, and risk management systems to inform this process.

Step 3: Assessing Impacts

After identifying impacts, organizations must assess them to determine which should be considered material. Impact assessment can be carried out by considering the “severity” and “likelihood” of an impact. The combination of the severity and the likelihood of a negative impact can be referred to as ‘risk’.

Below are the GRI definitions for “severity” and “likelihood”

Severity

Severity of negative impact is measured by:

• Scale: how grave the impact is.
• Scope: how widespread the impact is, for example, the number of individuals affected or the extent of environmental damage.
• Irremediable character: how hard it is to counteract or make good the resulting harm.

Severity should be assessed in relation to other impacts in the organization.

Likelihood

The likelihood of a potential negative impact refers to the chance of the impact happening. The likelihood of an impact can be measured or determined qualitatively or quantitatively. It can be described using general terms (e.g., very likely, likely) or mathematically using probability (e.g., 10 in 100, 10%) or frequency over a given time period (e.g., once every three years).

Step 4: Prioritizing Impacts

Once potential material topics have been identified and assessed, it is necessary to rank them based on priority. This priority ranking will help guide sustainability strategy within your organization, and determine a topic needs to be acted upon. It also will help determine which of these topics are of highest priority to track and report.

It is important to note that the significance of the impact an organization has on the world is the deciding factor for whether an impact should be material for reporting. Just because a topic is difficult to address or track, for example, does not mean it should be deprioritized.

In addition to prioritizing impacts based on their significance to your organization, it is important to review material topics with the organization’s highest governance body to ensure that action is taken to address them. It is also important to review international standards, like the GRI Sector Standards, to ensure that no common topics for your organization’s sector are overlooked.

Important Note — Stakeholder Engagement

Throughout the entire process, it’s important to engage with stakeholders and gather their opinions and feedback, whether through interviews, surveys, or utilizing your existing communication channels.

Stakeholder engagement can help you to:

1. Gather Diverse Perspectives: Engaging with stakeholders brings in a variety of viewpoints. Different stakeholders, such as customers, employees, investors, suppliers, and community members, may have unique insights into what sustainability issues matter most to them and the organization.
2. Identify Relevant Issues: Stakeholder engagement helps in identifying material sustainability issues that are relevant to the organization and its stakeholders. This ensures that the assessment focuses on issues that are significant in terms of their impact on the organization’s ability to create value over the long term.
3. Enhance Credibility: Involving stakeholders in the materiality assessment process enhances the credibility and transparency of the organization’s sustainability efforts. It shows a commitment to listening to and addressing the concerns of stakeholders, which can build trust and reputation.

Materiality at Neuromagic

At Neuromagic, we help organizations go through the materiality assessment process by facilitating a materiality workshop and following up with research and tailored recommendations. The materiality workshop condenses steps 1-3 of the materiality assessment process into a workshop of a few days.

During the workshop we help organizations to:

• Clarify their organizational context and value chain
• Identify material topics across the value chain
• Assess sustainability topics using a unique matrix designed by Neuromagic and informed by the GRI Standards

Throughout the workshop process, participants learn more about sustainability concepts, and are able to engage in cross-department conversations about the impacts, risks, and opportunities across the value chain.

We are then able to conduct research into best practices, global standards, and industry-specific trends to help guide clients in setting their own sustainability strategy.

If you’re interested in identifying and assessing your organization’s impacts and kicking off or re-evaluating your organization’s sustainability journey, feel free to contact us.

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