The sudden ‚materiality shock’

26APR

This is the first of four installments of a blog series covering crucial sustainability reporting issues on materiality, sustainability context, comparability and stakeholder inclusiveness.

Spring 2014 seems to be the moment in time where ‚materiality’ suddenly appeared on the screen of corporate sustainability reporters. At least one could wonder why within a couple of weeks countless workshops popped up around the world, webcasts were announced and books were published just on this one single issue of the sustainability reporting agenda. One author even declared a calm ‚war on materiality’. But wait a minute, the issue of defining what is material in sustainability reports isn’t by far new, so what’s the reason for this sudden shake-up? Several reasons could be mentioned:

  1. Since the publication of GRI’s G4 Guidelines in May 2013 materiality went to the forefront of communication items around the new Guidelines. The reports based on G4 should show ‚what matters, where it matters’. For that reason GRI visualized the application of the four report content principles as one seamless workflow. But is this new? The answer is no, because the same process was already pulled together in a resource document in 2010, but now got finally included in the main document, the G4 Guidelines, without considerable changes. Also, GRI’s certified training program presented a five-step process since its inception years ago that followed this logic, and thousands of practitioners around the world were trained for doing exactly that – defining what is material.The reason for the extra attention lies elsewhere: the combination between impact definition, boundary setting, transparent stakeholder dialog and the level of disclosure that GRI is demanding in this thematic triangle adds rigour and demands a much more crisp process. Gone are the times when a mentioning of stakeholder dialog was enough, a materiality matrix could be presented without further process description on how this was pulled together, and the legal shortcut of 50%+1 share was enough to cut off responsibility in reporting due to the one boundary chosen by the legal counsellor. So, for some ‚what matters, where it matters’ now suddenly means ‚what hurts, where it hurts’, especially for those that define sustainability as an additional topic that needs to be addressed through a separate report, and where the corporate strategy isn’t that much connected with sustainability thinking.
  2. Another reason for the new level of attention can easily also be detected when looking through the outcomes of KPMG’s 2013 international report quality survey amongst the biggest 250 companies, many of them call themselves leaders in sustainability. Just a couple of numbers to clarify the problem: 13% of the reports do not identity megaforces that affect business at all, and from the other 87% at least some megaforces are identified, with climate change only affecting 55% of businesses, ecosystem degradation is a just a problem for 18% of the G250. One can only wonder how identifying ‚what matters, where it matters’ is at all possible if so little sustainability context analysis is done in the beginning of the materiality definition process. When looking at information how often companies do assess materiality, 58% do not give any indication and 19% indicate a limited assessment of materiality. That means that just 23% of the G250 have a thorough process in place to assess matariality. This is shocking evidence. Stakeholder inclusiveness is another painful area to look at. For only 45% the process link between stakeholders and the materiality process is clear, for the majority stake of 55% the process is not yet clear (34%) or not explained at all (21%). Finally looking at target setting one might expect that material issues would also lead to clear targets, but the opposite is true. 13% of the G250 haven’t declared any targets, 28% of the reports carry some targets with no clarity on how they relate to material issues. 23% of the reports carry information that links to less than 50% of material issues, and finally 36% carry targets that relate to more than 50% of the material issues. The shortcomings of these data explain very clearly why the pocess of cutting through from sustainability context information through stakeholder dialog to material issues now needs to get more rigour. Companies just did what needed to be done, just little of them did more than absolutely necessary. We leave it up the reader to contrast this information with the many CEO speeches that tell us how much sustainability is in the genes and DNA of their organization.
  3. A new level of recognition of materiality is surely also due to the growing number of frameworks and guidelines around corporate reporting. Whereas GRI addresses materiality from the perspective of all stakeholders, the IIRC clearly defines materiality from the point of view of the providers of financial capital. SASB just replicated the definition of the U.S. Supreme Court, focusing on shareholders only. And that whole array of different definitions seems to be confusing, especially as many users see these documents as standards. It is therefore time to step back and again recognize that none of these documents are ‚standards’ or ‚cooking books’. They are recommendations as they present guidance and framing. Not more, not less. Furthermore they are still all voluntary instruments to trigger thinking about the inclusion of sustainability into an organization’s core – the business model and the strategy. If this is managed well we think the discussion on materiality will by definition become a no-brainer.
  4. Lastly, there is new fuel to the fire of mandatory sustainability reporting through the positive vote of the European Parliament to amend the European Transparancy Directive and make sustainability reporting compulsary for roundabout 6.000 listed companies in Europe, with a size of more than 500 employees. The Directive passed the European Parliament on April 15, 2014. The Directive needs to be translated into member-states laws and regulation, so that the application is only expected to start in 2017 for reporting year 2016, maybe even one year later. In short, material issues of importance need to be reported in annual reports or sustainability reports on corporate level. Discussion arises mostly on the point of the EU’s definition of CSR, saying it entails all voluntary action of companies above and beyond what is legally already demanded for. In our view this definition is counterproductive to the real meaning of materiality, and therefore misleading to help describe the core of the issue. Nevertheless, the fact that many companies are now demanded to report on their sustainability risks and opportunities, covering a range of issues that is nearly 100% overlaping with the UN Global Compact 10 core principles, has put new emphasis on the materiality discussion in companies.

In our view there is only one useful way of dealing with the issue of materiality, and that is to step one step back from the idea of standards that would tell us what clearly has to be done. We see materiality in the closest of all possible meanings: all areas in which the company affects or is affected by those areas of sustainability it can influence by its existence and through its doing, through products, services, as enablers and advocates of positive change. The measurement of ‚Net Positive Impact’ will therefore become the future litmus test of the right to exist for companies. It would be good for companies to already follow in the footsteps of those frontrunners that aim doing exactly this ambitious step.

Authors: Ralph Thurm is the Founder & Managing Director of A|HEAD|ahead, Nick de Ruiter is partner at Sustainalize.

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