Double materiality: question of semantics or substance?

By Marjella Lecourt-Alma, CEO of Datamaran

The definition of a critical business risk or opportunity is evolving, as business leaders grapple with a stream of disruptions – geopolitical, economic, supply chain, social and public health . What remains constant is the responsibility of business leaders to have a clear, objective, defensible and adaptive approach to determining their strategic priorities and disclosing relevant information.

We see this with recent regulatory developments, including the recent landmark climate disclosure proposal by the U.S. Securities and Exchange Commission (SEC) and last year’s Corporate Sustainability Reporting Directive (CSRD) launched by the European Commission (EC).

These two developments clearly show that what was once voluntary is now mandatory and that the convergence of environmental, social and corporate governance (ESG) and financial risks is accelerating. This convergence is commonly called “dual materiality” an approach that considers both financial, or outside-in, and impact, or inside-out, perspectives when assessing important issues.

Technical considerations aside, this principle reinforces the great awakening of capital markets and regulators to the importance of ESG and, perhaps more importantly, the need for business leaders to define very clearly who they and their businesses want to be in today’s disruptive reality.

While our current geopolitical, economic and public health crises may not be the organizational argument for ESG or dual materiality, they definitely reinforce the need for more authentic corporate leadership on a broader range of issues that go beyond the traditional balance sheet. And while progress has been made in some areas, there is a lack of action and urgency – which is why we are now seeing an acceleration of legal and political pressure.

So what exactly is dual materiality? And why does it become institutionalized as law?

At its core, materiality is an accounting principle that defines what information is useful. Businesses commonly use materiality assessment processes to identify financial risks and issues and determine which risks are material to their bottom line.

Traditionally, materiality was only focused on the inside. The disruptions caused by recent world events reinforce that the introverted approach is insufficient and risky. This is why regulators are now institutionalizing a dual materiality approach – to improve the reliability and comparability of information used by investors and other stakeholders, on the one hand, and to advance and scale sustainable solutions, on the other hand. ‘somewhere else.

With the rise of ESG, there is now a more concerted effort to evolve our understanding of materiality and consider outward impact. In other words, how could this company have an impact on climate change, human rights issues or public health? Until recently, he never explained the reverse.

Dual materiality assesses risks and issues from a financial and impact perspective. It identifies issues that reflect an organization’s social and environmental impacts, as well as information that supports strategic and stakeholder decision-making. This means companies need to take both an external and an internal perspective when looking at important issues. the landmark SEC proposal reinforces the importance for companies to look at material impacts from both a broader risk and opportunity perspective.

Similarly, in February this year, the Council of the European Union (EU) OK their position (“general approach”) on the proposal for the implementation of CSRD by the EC. The first set of sustainability reporting standards (draft standards) will be available mid-2022 and the first set of standards (final) will be available in 2023. Following this proposal, from 2024 more than 50,000 companies will be required report in accordance with mandatory EU sustainability reporting standards and conduct a dual materiality assessment.

Various other regulatory authorities incorporate the principle and ethos of dual materiality into their requirements, including EFRAG, GRIand IFRS.

Let’s take a few steps back to see how we got here

When we look at the evolution of ESG standards over the past few years, we see a progression and maturation in how “sustainability leadership” is defined. Leadership in sustainability first meant more reporting and more transparency, which led to these big “biblical” reports where anything and everything was reported. This was before the standards were created.

We are now at a point where reporting is no longer enough, but it is a “better strategy” and how to be a good corporate citizen. This requires a greater investment in ESG expertise and intelligence across the business, as well as an ability to have some level of foresight about what’s next, what’s changing and how to deal with it. – without silos.

The inflection point

Until today, ESG reporting has been defined primarily by voluntary practices, as key policy makers (market authorities as well as national and international regulators) have taken a sit and stare approach and let markets decide. how to deal with ESG.

The tide has turned, with jurisdictions now rushing to introduce strict mandatory requirements and financial market participants competing for the best quality ESG information that supports a dual materiality approach.

As we see with the SEC’s proposal, these requirements will respond to market developments that have been brewing for some time. The SEC’s nod to the Task Force on Climate-Related Financial Disclosures, or TCFD, crystalizes the importance of policymaking and voluntary frameworks as a hard-law precedent. The boundary between voluntary and mandatory is blurring faster than ever.

To put it simply, we are now undoubtedly at a stage where: strategy comes first and metrics come second. Now it’s climate change. And after? Regulators won’t stop there. That’s why it’s important for business leaders to consider a dual materiality approach that is comprehensive, data-driven and forward-looking, and goes beyond the traditional tick-box exercise of conformity. Ultimately, it’s as much about creating value as it is about mitigating risk.

This is what the convergence of financial and ESG materiality is all about. For example, in the short term, it may not make financial sense to pull out of an entire market, as many companies are doing in response to the war in Ukraine. But it’s good corporate leadership and, in the long run, the right thing to do. This is a critical time for companies to focus their efforts on reshaping what is truly a strategic priority for today and tomorrow.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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