Double Materiality: The End of Selective ESG Disclosure

Among investing circles, double materiality is a hot buzzword. That’s because the concept influences major legislation that will change how companies disclose ESG data – both in the European Union and the United States. What exactly does double materiality mean, and why should businesses care about it? Let’s take a look by addressing commonly asked questions.

What does double materiality mean?

Double materiality refers to the risks that a company’s activities pose to the environment and society.

The term evolved from an accounting principle known as materiality, which refers to something that may have an impact on (be material to) how a company performs.

A material risk can threaten targets or goals, which of course investors care deeply about.  In the context of ESG, this is known as single materiality and means mainly ESG factors (such as extreme weather) that may pose a threat or opportunity to a business and its bottom line.

Single materiality tells you how vulnerable a company’s earnings may be to ESG risks. Single materiality does not tell you anything about how a company’s operations might affect the environment.

This is where double materiality comes into play.

Why does double materiality matter?

Double materiality figures into some important, stringent legislation being enacted by the European Union, which affects all organizations doing business in Europe, whether they are based there or not.

Almost a decade ago, the EU began requiring companies to report non-financial information in an attempt to make them more accountable for ESG issues. That was the first time disclosure requirements included the concept of double materiality.

But wide gaps soon emerged in the quality and quantity of information. The rules weren’t well understood or applied. So, a redrafted EU rulebook provides companies with more explicit requirements and forces many more businesses to comply.

That so-called Corporate Sustainability Reporting Directive (CSRD) will be phased in for the 27 EU countries starting in 2024.

The CSRD will create new, detailed sustainability reporting requirements and will significantly expand the number of EU and non-EU companies subject to the EU sustainability reporting framework. The required disclosures will go beyond environmental and climate change reporting to include social and governance matters (for example, respect for employee and human rights, anti-corruption and bribery, corporate governance and diversity and inclusion).

In addition, it will require disclosure regarding the due diligence processes implemented by a company in relation to sustainability matters and the actual and potential adverse sustainability impacts of an in-scope company’s operations and value chain.

The CSRD also makes it mandatory for companies to have an audit of the sustainability information that they report. In addition, it provides for the digitalization of sustainability information.

What kind of data will companies need to report as the EU embraces double materiality?

The details are murky and convoluted. But in essence, companies will need to report data such as:

• A brief description of the company’s business model, strategy and sustainability risks and opportunities. Under the CSRD, in-scope companies must set clear ESG targets and annually publish their progress on these targets, as well as their transition plans (if any). As a result, the focus on sustainability is no longer optional or voluntary, but mandatory, and must be embedded in the company’s long-term vision and strategy, and must also be applied to its policies.

• implementation plans in relation to the transition to a sustainable economy, measures taken to limit global warming in line with the Paris Agreement and to achieve climate neutrality by 2050 and exposure to coal, oil and gas-related activities.

• Sustainability matters that affect the company and the impact of the company on sustainability matters.

• Greenhouse gas emission targets.

• Policies in relation to sustainability (including incentive programs linked to sustainability matters).

• Cue diligence processes implemented by the undertaking in relation to sustainability matters and the actual and potential adverse impacts of the company’s operations and value chain.

Is double materiality coming to the United States?

Yes. double materiality is coming to the United States. In 2022, the SEC proposed a rule that would require a domestic or foreign registrant to include certain climate-related information in its registration statements and periodic reports, such as on Form 10-K. Although many businesses already disclose sustainability data, the SEC would make sustainability reporting mandatory.

The proposal, known as “The Enhancement and Standardization of Climate-Related Disclosures for Investors,” would require a registrant to disclose information about its direct greenhouse gas (GHG) emissions (Scope 1) and indirect emissions from purchased electricity or other forms of energy (Scope 2). In addition, a registrant would be required to disclose GHG emissions from upstream and downstream activities in its value chain (Scope 3), f material or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions.

That proposal is expected to be passed in 2023.

How do I know if I’m meeting the requirements of the EU and the SEC?

Many guidelines are proliferating to help businesses get the lay of the land, so to speak. For example, JP Morgan recently launched for its clients a tool to measure their double materiality impact. The International Sustainability Standards Board, launched in 2021 at the United Nations COP26 climate summit, is trying to write a global rulebook for climate and sustainability reports. Already, the US-based Sustainability Accounting Standards Board has guidance for single materiality (referred to as “outside-in”) that many companies use. The Global Reporting Initiative provides voluntary “inside-out” standards for reporting a company’s impact on people and the planet. Another international partnership, the GHG Protocol, has related guidelines for tallying the “scope” of a company’s efforts to curb greenhouse gases, including those emitted by suppliers and customers, which the ISSB wants to include. Some companies use SASB, some GRI, some both . . . and others, something different.

What should I do to prepare?

It is fair to say that the new legislation will have far-reaching impacts.

Companies will need to be more rigorous. They will have to put more effort into the harder elements of ESG such as the greenhouse gases they emit. A lot of companies have just ignored topics that cast them in a less flattering light and chosen the stories they want to tell. Those days are ending quickly. The days of selective disclosure are over.

There are already consulting firms available to help businesses assess what kind of data they need to report – here is an example. There is no shortage of commentary available (such as this one) regarding the details required, too.

Information to Help You

At IDX, we help IROs craft compelling narratives through our own corporate comms/IR expertise. We also publish some of our ideas with thought leadership. Preparing for changing ESG requirements is one of the major challenges that iDX discusses in a recently published white paper, How to Crush Every Investor Relations Challenge in Your Path. The white paper draws on 20+ years of experience helping IROs create compelling narratives that build trust with investors, as well as the data and insight we have collected over this time. Our strategic counsel, bespoke IR websites, data analytics, secure webcasting capabilities, and a 15-minute response time are all part of our IR offerings.

Learn more about them on our website, and read our white paper, How to Crush Every Investor Relations Challenge in Your Path, for more insight.