4.1 Materiality from a financial perspective
The financial position and performance of an organisation could be profoundly affected by different ESG topics.
These financial effects could be derived from the organisation’s impacts, such as fines arising from withdrawing too much water from a drought-stricken area. They could also be derived from dependencies, such as that a housing construction company will have on the pricing, availability and quality of wood as a raw material. Financial effects can also arise from other circumstances not related to impacts or dependencies, such as an increase in revenue linked to an increase in demand for treatments for mosquito-borne illnesses that are on the rise due to climate change.
The negative and positive financial effects of ESG topics on an organisation are referred to as sustainability-related risks and opportunities. The purpose of a financially-focused ESG materiality assessment is to determine an organisation’s sustainability-related risks and opportunities, and assess the significance of each to determine whether it is material for reporting.
An organisation undertaking a sustainability-related financial materiality assessment might ask these questions – notice that they are inward looking, examining the effects that people, planet and the economy could have on the organisation with a clear financial focus:
- How could the price of carbon in five years affect our costs?
- Could a water scarcity in the local community in which we operate affect our ability to manufacture our products, and therefore our revenue?
- Is our lack of equality and inclusion in our workplace affecting employee turnover rates, which is decreasing operational efficiency and increasing recruitment costs?
4.2 The primary audience of information about ESG risks and opportunities
Recall again that in module 2 we learned that the key factors in determining whether information is material or not is the primary audience of that information, and how they would use that information to make judgements.
When determining whether an ESG risk or opportunity is material, an organisation should consider users of general purpose financial reporting as its primary audience. These could be, but is not limited to, existing and potential investors, shareholders, lenders and other creditors such as asset managers. Information about ESG-related risks and opportunities is generally considered useful to this audience to inform decision-making about providing resources to the organisation.
Unlike an impact materiality assessment, which requires engagement with its primary audience (affected stakeholders) to identify and assess impacts, there are less stringent requirements around the engagement of primary users of ESG-related financial information for the materiality process. For best practice, a materiality assessment focused on sustainability-related financial risks and opportunities should consider the views and interests of users of general purpose financial reporting. It’s expected that the organisation will already have mechanisms of dialogues with these audiences that it could leverage.
4.3 Guidance when conducting financial materiality assessments
The International Sustainability Standards Board (ISSB) is the leading body for guidance on sustainability-related related financial materiality and reporting. The ISSB governs the International Financial Reporting Standards (IFRS)- Sustainability Disclosure Standards, which incorporate the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD), and the Sustainability Accounting Standards Board (SASB) Standards. When used together, the IFRS and SASB standards provide a comprehensive framework for assessing ESG financial materiality and reporting.
4.4 A simplified process for undertaking a best practice sustainability-related financial materiality assessment.
The process to conduct a materiality assessment focused on the financial effects of ESG on the organisation is the same as that for an impact materiality assessment, except for stakeholder engagement.
To conduct an ESG focused financial materiality assessment, the organisation will:
- Understand its business context by mapping its value chain, considering its business activities, the sectors of those activities, and geographical locations.
- Map all stakeholders along the value chain, including geographical locations and business relationships, such as joint ventures, investors and consumers.
- Identify actual and potential ESG-related risks and opportunities across its value chain and business relationships. To identify risks and opportunities, the organisation may consider industry guidance provided by SASB, the financial effects of its ESG impacts and dependencies, regulations, peer and media reports, and so on. It could consider the views and interests of users of financial reports here.
- Assess the significance of the impacts by engaging with stakeholders and experts. It could consider the views and interests of users of financial reports here. The organisation is to set its own thresholds for significance, relying on objective criteria where it can. See Table 2 for a comparison of the different components to be considered when determining significance related to impacts, and risks and opportunities.
- Use judgment to define a cut-off point for material / not material.
- Categorise or group each material risk and opportunity according to its relevant topic, using the topics provided by the disclosure framework the organisation is reporting against. At this point, the organisation has determined its material topics. Refer back to this step in Module 3 for an explanation on categorizing and topics.
See slide 7 for a complete comparison of the financial dimension of ESG materiality with that of impacts.
4.4 A simplified process for undertaking a best practice sustainability-related financial materiality assessment.
The process to conduct a materiality assessment focused on the financial effects of ESG on the organisation is the same as that for an impact materiality assessment, except for stakeholder engagement.
To conduct an ESG focused financial materiality assessment, the organisation will:
- Understand its business context by mapping its value chain, considering its business activities, the sectors of those activities, and geographical locations.
- Map all stakeholders along the value chain, including geographical locations and business relationships, such as joint ventures, investors and consumers.
- Identify actual and potential ESG-related risks and opportunities across its value chain and business relationships. To identify risks and opportunities, the organisation may consider industry guidance provided by SASB, the financial effects of its ESG impacts and dependencies, regulations, peer and media reports, and so on. It could consider the views and interests of users of financial reports here.
- Assess the significance of the impacts by engaging with stakeholders and experts. It could consider the views and interests of users of financial reports here. The organisation is to set its own thresholds for significance, relying on objective criteria where it can. See Table 2 for a comparison of the different components to be considered when determining significance related to impacts, and risks and opportunities.
- Use judgment to define a cut-off point for material / not material.
- Categorise or group each material risk and opportunity according to its relevant topic, using the topics provided by the disclosure framework the organisation is reporting against. At this point, the organisation has determined its material topics. Refer back to this step in Module 3 for an explanation on categorizing and topics.
See slide 7 for a complete comparison of the financial dimension of ESG materiality with that of impacts.
