Importance of Materiality Assessment

Whenever the term ESG crops up, materiality assessment is the first thing that grabs our focus. But what exactly is materiality assessment? Firstly, understanding the term is of utmost importance. When you chalk out various factors under the umbrella of Environment, Social and Governance, there are thousands! Now, it is neither possible nor necessary to assess a company against every such factor. Materiality assessment is a tool which identifies the most prominent ESG issues for a particular company. Every organisation needs to understand which sustainability topic is relevant to the company and then proceed to work towards it. This is exactly what materiality assessment is. It is a formal evaluation of ESG factors. It is the foundation for a company’s ESG strategy.

The relevant ESG factors are chosen and further ranked in order of their relative importance. The factors or KPIs (Key Performance Indicators) are identified on the basis of their impact and potential impact on the company. These KPIs are the priority ESG topics that the company needs to focus on. Materiality assessment basically filters out the significant ESG factors that will impact a company’s operations.

For example, if an energy company is taken into consideration, environmental factors like GHG emissions and waste will be weighed much higher than the social factors. But if an IT company is looked at, the social factors will be placed above the environmental factors.

Role of stakeholders and the relevance of materiality assessment to them

The stakeholders of an organisation range from investors, employees, vendors and board members to trade groups, local communities and more. The decisions which are incorporated in a company ultimately affect the stakeholders and therefore their interests should be kept above at all times. The material ESG risks for a company should thus be listed after considering a company’s stakeholders. More and more stakeholder studies and interviews should be included in the process of identifying prominent ESG risks and issues. It not only broadens the scope of assessment but also provides novel insights that one would have missed during the course of the regular identification process.

For example, in order to augment employee well-being, maybe a company did not think of building a health and fitness centre in the office premises. But it runs a survey across all its employees and finds out that majority employees will feel more motivated and rejuvenated to work if the company premises have a fitness centre. This will automatically boost company performance. In this manner, taking opinions from stakeholders can help companies build the best ESG strategy.

Identifying areas that are of utmost relevance to stakeholder groups is best done through interactions with stakeholders. It will enhance stakeholder engagement and satisfaction as they witness the company’s willingness to prioritise interests aligning with theirs.

ESG frameworks

Materiality assessment also helps companies choose an appropriate ESG framework from a number of existing frameworks like SBTi, GRI, TCFD, BRSR, SASB etc. Because each framework is focussed on a select few factors, running a materiality assessment for a company makes the job of selection easier.

The process through which materiality assessment is carried out varies from country to country. For example, the US might have a different approach than the EU. The calls taken by the regulators, like the SEC (Securities Exchange Commission) in the US and the EFRAG (European Financial Reporting Advisory Group) in the EU affect the materiality assessment patterns. The process is influenced in accordance with the reporting requirements. As the SEC is more inclined towards climate-related disclosures, companies will try to address climate risks more. Whereas on the other hand, as EFRAG is more inclined towards value creation, companies in the EU will try to address the wholesomeness of sustainability.

Other benefits of materiality assessment

It also provides a lot of clarity to companies in framing policies and setting goals pertaining to ESG. It is a lens to achieve long-term sustainable growth in a company. Companies have begun to realise the market demand for sustainability and its impact on profitability and financial growth. Establishing a strategy to inculcate sustainability in a company’s DNA is gaining momentum; coming up with a sustainability strategy is best done through materiality assessment.

It also gives an insight into bright arenas for capital allocation. Companies get an idea of why and where they should invest their resources for better growth prospects. On the reputational front as well, conducting a materiality assessment reflects commitment and efforts towards sustainability which builds a positive image for the company.

Conclusion

It can simply be concluded that materiality assessment is one of the most important components for the long-term growth of a company and should effectively be made a part of corporate decision-making. The rising focus and need for ESG simply increases the relevance of materiality assessment. It will facilitate actions backed by impact. It not only identifies material ESG risks and opportunities but also helps in setting ambitious sustainability targets. It has proven to be a strategic business tool that could provide companies with an effective solution to business risks.

You can learn more about the importance of materiality assessment through an accredited ESG Expert Certification from Directors’ Institute.