Materiality

Get an overview of materiality as it relates to ESG, sustainability and financial reporting, and the various definitions in use today.

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What is Materiality?

Materiality is the term used to describe whether or not a topic is relevant and important to a company's Environmental, Social and Governance (ESG) plan. It refers to the impact of a specific measure as part of a company's overall ESG strategy.

Materiality is also a principle used in accounting and business audits. Although we will be discussing materiality with particular reference to ESG reporting in this guide, the concept of it in accounting is worth briefly outlining.

Materiality in accounting

Materiality is also an accounting standard. In accounting, it is the principle that all items or issues likely to impact investors’ decision-making must be recorded in a company’s financial statements. We can think of this as ‘single materiality’.

The rising importance of ESG matters has led to what is called ‘double materiality’.

Single materiality VS double materiality

If single materiality is concerned with matters that directly impact enterprise value, double materiality is the idea that there are also business issues that should reasonably be considered material (and therefore recorded in financial statements) because of the impact they have on the world around us.

Definitions of materiality

Because of the development of ESG and its impact on companies, there is now more than one definition of materiality. The main ones to be considered are:

ISSB
GRI
EFRAG

(Need help with all these acronyms? Check out the ESG glossary.)

ISSB: Financial Materiality

The International Sustainability Standards Board, or ISSB, takes a linear, single approach to the concept. According to this definition of materiality, companies need only report on matters that directly influence enterprise value. This is called ‘financial materiality’.

GRI: Impact Materiality

The Global Reporting Initiative (GRI) explains in its paper, The Materiality Madness: Why Definitions Matter, that there are other issues organisations should report on because they affect the economy, environment, and people. This is called ‘impact materiality’.

EFRAG: Double Materiality

EFRAG has adopted the double materiality approach, which is in essence a combination of financial materiality and impact materiality. EU organisations must report on both matters that have a direct impact on enterprise value and those that affect the economy, environment, and community.

What is dynamic materiality?

Dynamic materiality is another definition, which is essentially a precursor to double materiality. It prioritises the ISSB definition but introduces the concept of reporting on ‘pre-financial information’. This is because, in a nutshell, the non-financial impacts of an organisation will become financially material over time.

How is materiality assessed?

For organisations looking to improve their ESG credentials, a materiality assessment is the first step.

A materiality assessment is a strategic process aimed at gauging the significance of distinct ESG and sustainability aspects within your organisation's context. By analysing multiple dimensions, this evaluation focuses on two critical perspectives:

the potential influence on your organisation, and
the level of importance to stakeholders.

Through this methodical approach, you can pinpoint and comprehend the ESG topics that hold the greatest relevance for your company's sustainable growth and stakeholder engagement.

What is an example of materiality?

An example of materiality in the context of ESG and sustainability is when a company identifies a significant environmental issue that could have a substantial impact on its operations, reputation, or financial performance.

As an example, let's consider a hypothetical manufacturing company that produces electronic devices. During a materiality assessment, the company discovers that a key component of their manufacturing process involves the use of a rare mineral extracted through environmentally harmful practices. This mineral is essential for their products, and any disruption in its supply could impact their ability to meet customer demands. In this scenario:

60-second takeaways

Materiality is the term used to describe whether or not a topic is relevant and important to a company's ESG strategy.

Materiality in accounting (single materiality) is the concept that anything likely to impact investor decision-making must be recorded in financial statements.

Double materiality is the idea that, as well as issues impacting investor decision-making, issues impacting the world around us should also be recorded.

There are multiple definitions of materiality in ESG, most notably from ISSB, GRI and EFRAG.