⚖️Double Materiality

What is double materiality?

Double materiality is defined as the union (in mathematical terms, i.e., union of two sets, not intersection) of impact materiality and financial materiality. A sustainability or ESG matter has double materiality if it is material from either an impact or environmental perspective, a financial perspective, or both.

First, we must define what materiality means from a sustainability perspective. Materiality is a financial accounting concept that, more recently, is seeing increased usage and relevance through a sustainability or ESG (environmental social governance) strategy, risk management, and reporting lens.

According to the the International Financial Reporting Standards (IFRS) Foundation, a topic is 'material' if it influences investors' perception of a company's enterprise value. For example, in sustainability, if an insurance company underwrites insurance policies in a region that's expected to increasingly be hit by storms and severe weather due to climate change, that is a material risk for the insurer. It ultimately informs the value and risk profile of the business.

So what is double materiality?

Sustainability Double Materiality

Recently, the IFRS' International Sustainability Standards Board (ISSB) has extended the concept of financial materiality to sustainability by provided two definitions of double materiality:

1. Financial materiality of sustainability topics outlines how sustainability impacts the financial performance and prospects of a company

2. Impact materiality of sustainability defines how a company's activities, operations, and value chain impact external stakeholders and the broader world

According to the European Sustainability Reporting Standards (ESRS), double materiality is

"The performance of an objective materiality assessment is pivotal to sustainability reporting which shall include relevant and faithful information about all impacts, risks and opportunities (IROs) across environmental, social and governance matters determined to be material from the impact materiality perspective or the financial materiality perspective or both."

Additionally, the ESRS recommends double materiality be assessed using "appropriate quantitative and/or qualitative thresholds" based on

(a) the severity, scale, scope, or significance of impacts, as well as

(b) their likelihood.

Financial materiality should be based on anticipated financial effects related to an entity or company's performance, financial situation, cash flows, access to capital, and cost of capital.

Impact or Environmental Materiality within Double Materiality

According to standards like ISSB and ESRS, an event or matter has impact or environmental materiality if it's connected to actual or high-probability significant impacts on the environment and/or society over a short-, medium-, or long-term timeframe. For example, if everyone who drives a car stops using fossil fuel transportation and switches to using electric vehicles (EVs), this has material environmental and social impact, both at a societal level, as well as for specific companies in the automotive and fuel value chain.

For companies, a matter or topic with double materiality can have impacts directly caused by the company's own operations, products, or services, or impacts linked to that company's upstream and downstream value chain.

In this type of example, if a company's product is created using child labor somewhere in its supply chain, that's a material risk for the company, even though the company itself may not have knowingly caused or contributed to the negative impact directly.

Similarly, a company deciding to invest in renewable energy will likely have double materiality considerations. The company could see an increase in short-term costs associated with clean energy CAPEX, but achieve long-term financial benefits, such as lower, more predictable energy costs, better energy security, and improved reputation, as well as positive environmental impacts, such as reducing greenhouse gas emissions. Another illustration of double materiality.

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