Defining Materiality

A quiet and gentle war is simmering away in relation to defining materiality in a sustainability context. For some of you, that won’t really matter. For others, the cold materiality war of 2014 will have profound consequences.

This blog contains :

  • Some of the main definitions of Materiality in a sustainability context and why they matter
  • Discussion of how materiality interacts with transparency and comparability, and
  • Identification of some of the main actors and influencers in relation to sustainability and materiality.

questions or decision making conceptDefining Materiality

Three organisations have probably the most influential definitions of materiality: GRI, SASB and the IIRC. The differences between the definitions can have profound consequences for an organisation’s approach to sustainability reporting.

Global Reporting Initiative

GRI’s definition is indirect and implied from the framework:

Reports should cover Aspects (GRI-identified issues) that:

•    Reflect the organization’s significant economic, environmental and social impacts; or

•    Substantively influence the assessments and decisions of stakeholders

Sustainability Accounting Standards Board

SASB’s relies on the one used by the US Supreme Court, being:

[Material issues are those that] either individually or in aggregate, are important to the fair representation of an entity’s financial condition and operational performance … necessary for a reasonable investor to make informed investment decisions.

Presenting a substantial likelihood that the disclosure of the omitted fat would have been viewed by a reasonable investor as having substantially altered the total mix of information made available.

International Integrated Reporting Committee

IIRC’s definition is explicit:

An integrated report should provide concise information that is material to assessing the organization’s ability to create value in the short, medium and long term.

What’s not explicit from that definition is that the audience for the information is providers of financial capital, which means that investors and providers of debt are front and centre.

Discussion of Framework implications

Aligning with GRI’s G3 will usually involve disclosure on a wide variety of CSR issues, and includes having to disclose issues that may not be especially material, but for which disclosure is demanded by combative or demanding stakeholders. However, compliance with G4 (as opposed to G#) is likely to result in disclosure on a smaller number of metrics for many companies due to the new reliance in that framework on materiality.

Aligning with SASB is likely to mean that some stakeholders are ignored because of a deference to the interests of shareholders, which are likely to be different to those of stakeholder, especially if the shareholders in view are of more Friedman-esque views. For some companies it will mean increased disclosure on compulsory forms (such as the US’s Form 10-K) but very little disclosure overall, especially compared to the approach of IIRC and GRI.

Utilising the highly relational six-capitals approach of IIRC will mean a longer process of calculating the impact on business of various sustainability issues, and greater disclosure of reasoning on material issues, but also in a highly material reporting approach.

But what does all of that mean for sustainability professionals?

Largely it means that there are decisions to be made about which definition of materiality to use, or to use a hybrid or blend of more than one. The Table below (Comparative Table of Materiality definition and process for major frameworks) lists some of the main differences between the three frameworks.

Comparison Image A.1 Comparison Image B.1Click on the table to download a copy in pdf format.

In the most extreme case, aligning with SASB could mean that organisations only disclose on the short-listed issues contained in SASB’s sector-specific frameworks. That will, in my view, lead to suboptimal performance because it is likely that several issues beyond those included by SASB can create (or destroy) value for organisations. Reliance on SASB is likely to be a minimalist approach to sustainability. It’s important to meet investor expectations, but they aren’t the only ones that matter.

At another extreme, reliance on IIRC and its capitals analysis may lead to disclosure of a very, very long list of ‘material’ sustainable issues, although the framework itself is somewhat ambiguous about how much disclosure will be enough. The GRI G4 also gives plenty of wiggle room for companies to make their own decisions about which issues are the most relevant.

But why are the frameworks in tension in the first place? Answering that question requires an understanding of materiality along with comparability and transparency.

Transparency, Materiality and Comparability

Materiality isn’t necessarily compatible with two other important drivers for sustainability reporting: Transparency and Comparability. In order to understand the importance of materiality, one needs to understand what those other things mean, who cares about them and how they don’t align with each other.

Transparency

Transparency is disclosure of sustainability information about the impact of operations within organisations and also on wider civil society. And at some level, the greater the transparency, the greater the trust created for the readers of sustainability reports.

But one of the trade-offs is that wide-ranging transparency has the consequence of increasing costs for organisations, with no direct connection to return on such costs.

One of the great successes of the GRI is the increased trust in business through clearer reporting of issues that concern many stakeholders. But equally, one of the criticisms of GRI (at least until the G4 version) is that in order to be compliant at the highest level, organisations need to use a lot of resources to report on issues that may not be especially relevant for their operations, but which were important for one or more issue-focussed stakeholders.

Another increase in transparency encouraged by GRI is the increased extent and nature of supply chain disclosures on relevant issues, including human rights and health and safety.

Comparability

Comparability refers to the ability of someone to make relatively reliable judgments on information published by different organisations on particular sustainability issues. GRI has provided a relatively ubiquitous set of common metrics that allows direct comparisons of sustainability performance.

There can be a lot of value (especially for investors and managers) in understanding relative performance against other similar organisations and also other organisations generally, but comparison of metrics that aren’t particularly relevant seems to destroy value.

Materiality

A focus on materiality will decrease comparability because it will reduce the number of metrics common across all companies. It also may reduce overall transparency, because non-material issues might not be included in a report.

The SRI community is trying to connect sustainability to corporate performance and presumably welcome the help they will get in identifying the most important issues for companies, especially if they can be connected to creating value.

images

How they interact

As a general rule, transparency will not be useful per se for materiality, but will often increase comparability. Speaking of which…

An increase in Comparability probably generally increases transparency, but may reduce the effectiveness of identifying the most material issues. Add to that the problem of false comparisons (such as comparing vastly different sectors with the same metric and assuming conclusions are valid) and comparability isn’t the patron saint of advancing the cause of sustainability.

Putting it plainly, comparability either requires an exhaustive list of metrics or clear consensus for all concerned about what the comparable issues should be. Precious little such consensus exists.

It is possible to reconcile the various approaches taken by IIRC, SASB and GRI, although it isn’t straightforward. Blended approaches are possible, provided that care is taken to track the information needed for relevant disclosures in order to secure compliance. That doesn’t mean that you will need two processes to comply, but it does mean increased complexity within the process.

SASB’s approach is minimalist and doesn’t require a materiality process, although from a stakeholder engagement perspective would very likely benefit from using one anyway. IIRC’s approach requires analysis of materiality from an organisation’s perspective but with a view to the trade of value with the six capitals. GRI’s approach requires two or three axes of analysis, with an eye to transparency.

Mandatory Reporting

There seems to be a growing drive to have mandatory reporting of various ESG measures. Included in that drive is the European Commission’s growing European Policy on CSR and a strange agglomeration of Governments who are publicly talking about the importance of ESG metrics in reporting (from the usual Scandinavian countries to some less expected South American and Asian countries). No doubt the experience of countries like South Africa who are now into their third year of compulsory reporting of ESG metrics will be informative. There isn’t a great deal of focus on materiality by such actors who seem to be more driven by comparability.

The Sustainability Stock Exchanges Initiative is supported by the UN to standardise stock-exchange mandated sustainability reporting. It includes several UN bodies or affiliates.  The initiative is promoting universal frameworks, but is also investigating capacity of companies and stock exchanges and the effects of standardised reporting. More details can be found on their website: http://www.sseinitiative.org/.

Companies that report compulsory metrics may still get significant value out of a thoroughgoing materiality process because they can still decide how to allocate resources with more nuance than can be achieved through compulsory stock exchange reporting requirements.

In contrast, SASB is also trying to achieving a kind of mandatory reporting, acting in cooperation with the US Securities and Exchange Commission (SEC) and required filings (such as Form 10-K and 20-F). There is good evidence that sustainability reports are already trending toward alignment with Form 10-K filings. SASB’s definition and investigation of materiality is relatively unique in that it is an evidence based review of two factors. Firstly, evidence of interest in a particular issue (mostly from investors). Secondly, evidence of economic impact of that issue. SASB’s sector-specific guides are also limited to a relatively small number of sustainability issues, which means many potentially relevant issues are ignored:

SASB's Range of Material Sustainability Issues

Practitioners who have to manage stakeholder engagement and reporting will do well to understand the differences present in definitions and focus of the frameworks.

 

 

Print Friendly, PDF & Email

3 comments

  1. […] Last week at the official UK launch of the GRI G4 reporting framework, one of the big questions that came up was how to reconcile the G4 framework with the recently published Integrated Reporting Framework launched by the IIRC in December 2013. Although materiality is a central concept in both – the definition of materiality differs under each framework. Dwayne Baraka’s recent blog entry provides a great synopsis of the principal definitions of ‘materiality’ currently in circulation. Check it out here. […]

  2. Join us for an online materiality think tank | Framework says:

    […] For more information, read Dwayne Baraka’s Defining Materiality. […]

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.