The EU’s proposed Corporate Social Responsibility Directive (CSRD) introduces new sustainability reporting rules for listed or large companies. Reporting, though, is only the end of the story. Stories start with identifying the main characters. For CSRD, this means asking what sustainability topics play the biggest role in a company and take centre stage in its sustainability strategy.
CSRD is redefining the way most companies currently answer this question. As a result, they will need to revise their sustainability strategy to comply with CSRD. The most significant change is the introduction of “double materiality”.
Double materiality turns sustainability into a two-way street
Materiality is a difficult word to indicate whether something is worth reporting on. Companies cannot focus on all possible sustainability topics. They can focus their efforts and resources by determining which are the most material issues.
Most companies determine their CSR strategy by focusing on a few material topics where the organization has a larger environmental or social impact. For example, a production company might have identified climate mitigation as a material topic because of its CO2 emissions. This approach is called environmental & social materiality.
CSRD considers this insufficient to determine your sustainability strategy. Only looking at a company’s impact on sustainability topics is like crossing the street while only considering the cars from one side. This would only work in a one-way street. However, sustainability issues can also present risks and opportunities to a company. It’s a two-way street where we need to consider both sides. This is double materiality.
With double materiality, it all depends on who is making the impact on who:
- Environmental & social materiality: a company impacts sustainability (e.g. waste generation)
- Financial materiality: sustainability issues impact a company (e.g. extreme weather events such as floodings affecting production capacity)
Source: European Commission
The way each type of materiality is determined is currently being fleshed out. However, one thing is sure, the good old GRI materiality matrix won’t cut it anymore.
Environmental & social materiality
There are a few things to keep in mind when determining a company’s environmental & social impact.
Scale – How bad is it?
A topic will be high on the scale if laws are violated. E.g. if safety laws are not respected. Important international agreements could also fall into this category. E.g. if the business strategy is not compatible with the Paris climate agreement.
Scale also depends on the context in which the impact takes place. E.g. the nitrogen emissions of an animal farm will be more harmful if it is close to a fragile ecosystem.
Scope – How much are we talking about?
The scope looks at how widespread a company’s impact is. E.g. how many square meters of rainforest are lost when opening a mine? How many people are displaced because of this?
Remediability – Too late to apologize?
This examines whether and to what extent the negative impacts can be remediated. E.g. if a river is polluted, can the water quality be restored?
Likelihood – Are you willing to bet on it?
For some sustainability issues, a company doesn’t have an impact yet. But there can be a risk. Whether an issue is material can therefore also be influenced by how high the risk is. E.g. How likely is it that my subcontractors use child labour?
The Belgian chocolate producer Galler lost €9 million due to the 2021 floodings in Belgium. They are not the only ones who suffered. The European Environmental Agency estimates that in the last 40 years, there was around €500 billion in damages in the EU due to extreme weather events. They predict that this will only increase due to global warming.
This example highlights what they call the “physical risks“. It is about assessing how a warming climate, loss of biodiversity, etc., will affect a company’s financial health.
Another way to determine financial materiality is by determining the “transition risks“. Our societies are changing in response to the sustainability challenges we face. This means new regulations, changing consumer behaviour and the creation of new technologies. Such change can bring financial risks. For example, significant carbon price changes can affect the profitability of polluting industries.
Sustainability also brings financial opportunities. For example, energy efficiency investments reduce energy costs. Alternatively, EU funding for electric transport creates business opportunities in that sector.
From material topics to measurable results
Identifying a topic as material is not enough. It’s essential to set KPIs & targets to monitor progress. Companies also need action plans to ensure targets are met. While this is not always easy, it is important to do this for every material topic you identified.
Willem Roekens, consultant at TheRockGroup
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