Implementing Double Materiality
Double materiality is a foundational principle in successful ESG programs.
There are many important reasons for organizations to embrace and act on double materiality principles.
There are many important reasons for organizations to embrace and act on double materiality principles. Understanding and effectively communicating these reasons will help ESG managers to secure the buy-in and commitment needed from senior leadership to make meaningful changes within their organization.
Reasons why companies should implement double materiality and other ESG processes today can be viewed in 3 categories:
Enterprise Risk Management
Double materiality factors encompass a wide range of enterprise risks that may impact an organization’s ability to execute its business strategy, including environmental disasters, changing consumer preferences, social unrest, governance scandals, and more. By considering these ESG factors within an enterprise risk management program, companies can anticipate and mitigate risks that might not be evident through traditional financial analysis but would otherwise have a material impact on their strategic plans.
Many of the uncertain risk factors described above will also present new strategic opportunities for organizations who are able to embrace and exploit them faster than their competitors. Changing consumer preferences will create markets for new products and services. Upstart organizations will find openings to leapfrog larger competitors that are more invested in the status quo and will thus find it harder to change. Overall, a systematic analysis of double materiality factors can help organizations to identify new opportunities, as well as ways in which competitors may attempt to overtake them instead.
Reputation & Trust
Companies with strong ESG commitments often enjoy enhanced reputation and trust among consumers, investors, and other key stakeholders. By conducting double materiality assessments and using them to formulate comprehensive ESG programs, companies can demonstrate their commitment to not just profit but also people and the planet, thus strengthening their brand and customer loyalty. Conversely, as described above, failing to prepare for ESG can have significant negative consequences for a company’s reputation. Governance scandals, environmental accidents, and regulatory penalties can all destroy massive amounts of shareholder value in a very short amount of time.
Embracing double materiality factors and implementing ESG programs will uncover and present significant challenges for many organizations. These challenges will in turn spur research investments and new innovations. A great example of this can be seen in the electric vehicle market. After initial consumer acceptance and demand for electric vehicles, significant concerns arose regarding the costs of battery production and the environmental harms from the mining of rare earth materials. These challenges have led to massive research investments and advances in new technologies that lower both costs and environmental damage of battery production. Companies must decide whether they wish to lead innovation or be prepared to react quickly to new innovations that are driven by double materiality factors.
Ability to Attract and Retain Key Talent
The most elegant business strategies will fail in execution if an organization cannot attract and retain the key talent that they require. Employees and potential hires are increasingly valuing employers with a clear commitment to sustainability and other ESG priorities. For example, Deloitte’s 2023 Gen Z and Millennial Survey surveyed over 22,000 Gen Z and millennial respondents in 44 countries and found that over half of Gen Zs (55%) and millennials (54%) say they research a brand’s environmental impact and policies before accepting a job from them. Companies that demonstrate this commitment in their ESG programs and actions will find it easier to attract and retain the resources they need to achieve their strategic objectives.
Access To More Investors Capital
Many investors now prioritize ESG factors in their investment decisions. They recognize that companies with strong ESG profiles often exhibit better risk management and long-term financial performance. This was demonstrated by a 2023 McKinsey study that examined 2,269 public corporations and found that companies with revenue and profit growth plus strong ESG scores enjoyed outsized market returns when compared to companies with revenue and profit growth alone. More often, investors are looking for strong performance and real ESG commitment. Organizations that accomplish this will enjoy easier access to capital and better share price growth.
Client Pressures and Consumer Preferences
Nearly all companies’ financial performance will be affected by changing customer preferences toward ESG priorities. Today’s consumers care about ESG issues and are showing it with their wallets. McKinsey collaborated with NielsenIQ to analyze five years of US sales data, from 2017 to June 2022. The data covered 600,000 individual product SKUs representing $400 billion in annual retail revenues. These products came from 44,000 brands across 32 food, beverage, personal-care, and household categories. Overall, they found that products making ESG claims grew an average of 8% faster than products that made no such claims. Growth was even higher when consumers perceived the claims to be more authentic.
Similarly, corporate customers are increasingly requiring their suppliers to demonstrate real commitment to ESG. Expect this trend to grow rapidly in 2024, as the European Sustainability Reporting Standards begin to take effect. As described in Chapter 1, these regulations will require organizations to consider the ESG impacts related to its business partners, including its suppliers. Any organization that provides services to European clients (or to companies with operations in Europe) will quickly find themselves incentivized to have effective ESG programs and reporting.
Operational Efficiency & Rebates
Focusing on the ESG priorities that emerge from double materiality assessments can generate cost savings in many areas. Effective ESG programs tap into ideas and suggestions from front line workers who observe waste firsthand and are often best suited to find opportunities for improvements. These can include reduced resource and material costs, lower capital costs, lower insurance premiums, lower turnover costs, and increased access to tax incentives and government rebates.
In one example, an installer of mechanical equipment asked its installers to suggest ways to achieve the company’s recycling targets. The installers pointed out that after they finished installing new equipment, they left the old equipment on the customer’s site for the customer to deal with on their own. The installers suggested bringing the old equipment back with them, so they could ensure that it was recycled properly. Upon further investigation, the company discovered that recycling the old equipment would allow them to qualify for government incentives. They implemented the program, providing a value-added service for their clients, and generating millions of dollars for the company, which far exceeded the cost of their recycling program.
For many organizations, double materiality is no longer a voluntary exercise, with ESG emerging as an integral part of regulatory and legal compliance in many jurisdictions. The European Union is at the forefront of this effort. For example, the Sustainable Finance Disclosure Regulation (SFDR) mandates financial market participants to disclose how they integrate ESG risks into their investment decisions. The EU Taxonomy Regulation provides a classification system for environmentally sustainable economic activities, guiding investment towards more sustainable projects. The Non-Financial Reporting Directive (NFRD) requires large companies to disclose information on the way they operate and manage social and environmental challenges. Additionally, as described in Chapter 1, the European Sustainability Reporting Standards (ESRS), takes effect January 2024 for the first wave of affected companies. Central among the 12 ESRS standards is the need for organizations to perform double materiality assessments.
While the U.S., U.K. and other countries have been slower in adopting ESG regulations compared to Europe, there has been significant movement in this area. For example, the Securities and Exchange Commission (SEC) has been increasingly focused on ESG-related disclosures. In 2021, the SEC announced the creation of a Climate and ESG Task Force to identify ESG-related misconduct. Many other countries, such as Canada, Japan, and Australia have various levels of ESG reporting requirements, particularly focused on climate risk and sustainability.
Double materiality is a foundational principle in successful ESG programs.