What is material to a sustainability report? How to see the wood from the trees

There has been much written about how materiality definitions for financial reporting fail to meet the needs for sustainability reporting.

Current financial materiality definitions share two key themes:

  1. Information is material if its omission or misstatement could influence a reader;
  2. The reader is usually considered to be an investor.

However, the rise of sustainable reporting has introduced two further facets to materiality:

  1. For an item to be material, consideration should be given to the risks the item poses to the environment or people;
  2. The reader may be an investor, but could also represent a range of other stakeholders, in particular those interested in the non-financial actions of a business.

Introducing salience to sustainability reporting

These four themes, however, are not mutually exclusive. To demonstrate their overlap, the UN Guiding Principles Reporting Framework, an initiative of Shift and Mazars, brought to the fore the concept of ‘salience’. This does not replace the traditional concept of materiality but can be a helpful entry point to introducing materiality into sustainability.

Salience is defined by the above initiative as: “Something that is prominent or important. It stands out conspicuously.  A company’s salient human rights issues are those human rights that stand out because they are at risk of the most severe and negative impact through the company’s activities or business relationships. The concept of salience uses the lens of risk to people, not the business as the starting point, while recognizing that where risks to people’s human rights are greatest, there is strong convergence with risk to business.”

Importantly, when looking at the whole of sustainability, salience should not only apply to people:  'human rights’ in the above definition could be replaced with ‘risks to the environment’.

The solution: a new perspective

In essence, understanding what is material to a sustainability report requires a change in perspective: to first think about risks to the environment and risks to people. The most severe risks to these externalities are those that have the potential to be most material, because - if those risks were to arise - there is likely to be a financially material impact on the business.

For example, should oil companies report the risks of pollution arising from blow-outs at their oil platforms, or health and safety impacts from accidents at oil refineries? Should garment manufacturers be reporting on living wage issues in their supply chains and water pollution arising from the use of chemicals in the dying or tannery processes?

For most industries, the answers to such questions can be found in studies that help identify the five or six most material environmental and social risks on which we should expect companies in those industries to report. Take the garment industry, for example. The following issues are known to pose significant risks:

  • Environmental impacts of cotton production
  • Environmental impacts of waste pollution
  • Failure to pay a living wage in the supply chain
  • Poor working conditions in the supply chain
  • Use of child labor

Resistance to sustainability reporting can be expected: companies still have the option to explain why they haven’t reported on certain issues and can focus their reporting on other areas they feel are more relevant to stakeholders.

The benefits: consistency and confidence

The benefits of following the salience approach to materiality is that it will bring consistency to the issues reported and a clear indication to companies and stakeholders alike on the areas being prioritized.

Two issues I often hear about the current approach to sustainability reporting are:

  1. It isn’t concise. Potentially important information is lost in the clutter of extraneous information. A further benefit of the salience approach to materiality is that both the reader and the company will become used to seeing more focused sustainability reporting.
  2. It is rarely fair and balanced. Regulators have noted that sustainability reporting can become an extension of marketing collateral. However, by adopting a firmer approach to materiality, it will urge companies to take the disclosure of non-financial issues more seriously: for example, its policies, the effectiveness of those policies, the benefits, the challenges, stakeholder engagement and how impacts are remedied.

Time to reverse the lens

How a company approaches materiality today is crucial for their chances of achieving meaningful and representative sustainability reporting. The financial definitions of materiality do not need to change, but by using the concept of salience we can reverse the lens by looking first at risks to the environment and to people and not the business. In doing so, we can identify what is material to a sustainability report, as those that pose the greatest risks to the environment and people are also likely to become the most material financial risks to the business.