Sustainably and Materiality: Context and Details for Understanding What Counts
Few in the world of corporate sustainability believe there is no such thing as a “non-financial” issue. The fact is that in a world of declining resources and increasing population, sustainability is every day becoming more material to all companies and not just the select few who choose to act.
With over 5,000 companies employing the GRI sustainability reporting format and its new G4 focus on materiality and integrated (sustainability-financial reporting together), this is going to change. G4 sustainability materiality emphasis will push companies to identify for themselves the material risk of environmental, social, and governance issues.
What is Materiality and Why is it Important?
A generally accepted definition of financial materiality has long been established and generally accepted to be if the omission or misstatement on a given issue could influence the economic decisions of financial statement users.
The critical job of the auditor (whose work is to create and test financial statements) is to determine a monetary value that could materially influence the decisions of financial statement users. There are a number of generally accepted methods for estimating this value (for more information see my blog Puzzling Sustainability Materiality with Beer & Pizza http://bit.ly/1d6VlFF). Once defined, auditors apply a number of tests to financial statements to establish the existence of materiality concern or not on a given issue.
Materiality… is an expression of relative significance or importance of a particular
Matter in context to financial statements
Mortian 2011
That’s the basic theory of it. The really interesting part thought is that in practice materiality is defined by the collective sentiment and reaction of investors, creditors, managers, and regulators to audited financial statements. This means auditors can never precisely know what materiality is until all relevant actors have made decisions based the information found in reports
Sustainability and Materiality
The concept of sustainability materiality is not new either. In fact, many companies including my own, ES Global, have been defining, developed and refining the concept of corporate materiality as it relates to sustainability for many years.
One of the most accomplished actors in this field is Accountability, a UK consultancy, who argues a sustainability consideration is material if:
- an issue affects a company’s short-term financial performance;
- an issue affects a company’s ability to execute stated strategies and policies;
- performance on said issue does not meet best practices standards as established by peers and competitors;
- it substantially affects a company’s stakeholders’ behavior; and
- it substantially affects a company’s behavior relative to broad social norms or expectations.
In short, sustainability materiality issues are those that have, or pose the potential for a major impact on company operations, are important to a substantial number of legitimate company stakeholders, and can be meaningfully influenced by a company’s actions.
Like financial materiality, the real “amount” of sustainability materiality cannot be known in advance of publishing a sustainability because things change and stakeholders are reasonably unpredictable – thus the importance of considered transparency and reporting structure e.g., given by the GRI reporting format.
Defining Sustainably Materiality Correctly
Given the relative complexity of social and environmental issues, and because few best practice sustainability models and materiality comparatives exist, the chance of poorly defining sustainability materiality in advance of stakeholders making decisions is as likely as it is getting it right.
Sustainability materiality can be like quicksilver. Social issues come in and out of fashion, one day dormant the next a firestorm of interest. Witness the rapid explosion of the One Percent Movement or the now intense interest in textile factory work conditions. Had the recent factory fires and building collapse not happened in Bangladesh it would be unlikely that companies would be now scrambling to right the wrongs in their supply chains.
To make matters worse, sustainability materiality for any given issue will often have unique quantitative or qualitative measures, few of which are universally recognized by a standard authority. By contrast, financial materiality enjoys a plethora of structured and timely economic indicators/analytic enjoyed by financial auditor. This is not to say anticipating financial risk is easy, but given the disproportionate amount of standardized, reliable a relatively accessible economic data there is at least recognized means for making and defending financial materiality decisions.
Sustainability Materiality is Stakeholder Dependent
That sustainability materiality depends on what a broad range of stakeholders each with different interests (e.g., not just profits) only complicates matters further. Few companies have systems strong enough to anticipate much change at all. Most employ a few questionnaires or focus groups and call it engagement. Others employ experts such as my company ES Global, who try their best, but in the absence of a meaningful stakeholder engagement programs can typically identify 50% to 75% of the risk inherent in a company’s stakeholder network (not to mention identifying the many rich opportunities often found through meaningful engagement).
What is “material” also varies from sector to sector. What matters to a service sector firm is obviously very different from the concerns of a beverage company. Adecco, for example, will be very attentive to labor standards and laws, while cement companies like Cruz Azul will be highly attuned to supply chain and environmental issues, and national economic policy.
Even within sectors, different business models, supply chains configurations, marketing strategies, distribution networks and stakeholder groups affect materiality focus and estimations. A high end, global sports clothes company client of ours shares some but not all sustainability issues with a low-end children’s’ clothing maker, for example.
National and local context also play a role. There will some be materiality overlap between same sector American, Mexican and Argentinian companies, but less so for firms in South Africa or Bangladesh.
Gender and race issues are also likely to share similar objectives but the variables used to “price” materiality will vary in practice. For instance, in South Africa, the government has promoted black business ownership for years so many companies are look to expand local black-owned supply chain opportunities; in America, there is this focus too but to a much lesser extent compared to equal employment opportunity and hiring.
Broadly speaking there is overlapping core materiality issues for each sector, country and company. There are also contextual materiality variables which will also vary to degree. This makes materiality analysis especially tricky to define for global companies and for developing market national companies, where best practice corporate sustainability is still only emerging.
To sum, sustainability materiality shares analysis much with financial materiality. The volatile multivariate and multidimensional nature of social, environmental and economic trends and events, however, makes analytics more prone to influences that are extremely hard to anticipate.
This combined with the relatively immature nature of sustainability materiality analysis a complex undertaking.
In my next blog, I will outline our approach to materiality analysis.