Beyond Financial Metrics: How Double Materiality is Redefining Business Sustainability

For many years, companies have primarily evaluated sustainability through the perspective of financial success. However, the rising effects of climate change and societal unrest have driven authorities to hold firms more accountable for their environmental, social, and governance (ESG) activities.

The double materiality concept emerged as a response to the concurrent dual challenges of climate mitigation and adaptation in corporate strategies. Double materiality pushes companies to simultaneously consider how both climate related risks impact their financial performance and how their operations affect the environment and society. While the focus has traditionally been on climate mitigation – reducing emissions and minimizing environmental harm, the reality is that we are already facing an elevated climate environment with extreme events like floods and droughts that effect everyday life (thus necessitating climate adaptation).

The European Union (EU) is increasingly promoting and incentivizing companies to also consider adaptation strategies. This approach encourages companies to build resilience and adapt to the changing climate conditions, acknowledging that both mitigation and adaptation are essential for long-term sustainability.

As a consequence, the idea of business sustainability is evolving significantly, including both financial and non-financial components. This move is paving the way for the growing relevance of "double materiality," a revolutionary technique changing the face of sustainability reporting.

What is Double Materiality?

Double materiality is an idea that extends the scope of sustainability reporting to encompass not only the financial consequences of an organization's actions but also the impacts on the natural environment and society. This dual lens approach means that companies need to report figures related to these issues from the financial and impact points of view to obtain insight on significant sustainability matters.

Its popularity can be attributed to the EU Corporate Sustainability Reporting Directive (CSRD), where the firms will be required to make a double materiality assessment from 2024 onwards for nearly 50,000 report preparers.

Origins and Regulatory Changes

Double materiality is an EU-native idea developed in the context of the Sustainable Finance Disclosures Regulation (SFDR) and the CSRD acts. True to its approach of requiring investment management companies to report on self-serving and planetary risks, the SFDR recognizes the notion of the double bottom line. The CSRD, in contrast, increases ESG regulatory drive and greenhouse effect obligations and insists on double materiality, referring to ESG materiality and effect materiality.

The EU has made several changes in its regulations to compel firms into opting for sustainable and transparent modes of operation. The CSRD, implemented on January 1, 2024, mandates that large public-interest entities provide ESG information alongside a report on the influence of environmental factors on the organization's value. The EU also has a Non-Financial Reporting Directive (NFRD), under which large public-interest entities are to report ESG data. This directive is part of the structural reforms of the EU Equity market as part of the Green Deal, both EU policy objectives of making Europe the first climate-neutral continent by 2050.

Different Aspects of Double Materiality

Double materiality requires companies to consider both the outside-in and inside-out perspectives.

1.      Outside-In Considerations

The outside-in-facts examination looks at the manner in which sustainability-related occurrences and trends impact the organization in terms of gains and threats. This includes:

• Stakeholder engagement: The business has to distinguish between people who are influenced by the organization and people who, in turn, can affect the industry.
• Materiality determination: Deciding if sustainability issues are material, engaging internal and external personnel with knowledge on different sustainability matters.
• Dynamic materiality: Concerning the dynamic materiality that, in essence, recognizes the fact that the materiality of an issue changes over time due to the changing societal norms or regulations.

2.      Inside-Out Considerations

The inside-out perspective examines the temporary, mid-term, and long-term effects whereby a company, its business operations, and its value chain contribute to or have an impact on people and the environment. This includes:

• Impact materiality: Assessing the benefits or drawbacks of employing policy options, decisions, actions, or products regarding the social effects on the environment.
• Financial materiality: Assessing sustainability issues and their potential as a short-term, medium-term, or long-term threat to or benefit from a business's financial position.

Importance of Double Materiality in Future-Proofing Business

Double materiality is essential for future-proofing business because it:

1. Enhances corporate transparency: Double materiality enables organizations to meet the stakeholder concerns regarding the impact that the organization's decisions have on the environment and society as well as within the company.
2. Improves risk management: They link the effects of sustainability and risks with enterprise risk management, providing a broader perspective on risks and opportunities at the double materiality level.
3. Aligns sustainability strategy: Thus, double materiality is significant for strategic sustainability work as it ensures companies' growth and business sustainability. Double materiality should be integrated into the company's accounting and reporting system.
4. Supports regulatory compliance: In the case of CSRD, the reporting entities are required to carry out two materiality assessments, thereby making the process legal.
5. Influences investor relations: The implications of double materiality cause reporting affect the capital that a company is able to attract, given that an increasing number of investors take their interest in sustainability impacts into account.

It is clear this is an innovative approach to reporting that expands the circle of corporate sustainability reports. Derived from the EU's legislation, sustainability assessment is mandated from a financial and impact angle. This manner of reporting is vital to prepare ventures for future conditions that can be associated with sustainable risks and opportunities management.

For newcomers, such as the companies and investors aimed at the sustainability industry, the double materiality is much more than just compliance with the rules and regulations; it is the way to survive and grow.

Implementing such an approach into corporate structures can help companies prepare for drastic changes and support progression towards a more sustainable future.