Conventional and alternative materiality determinations
May 2015 User View by Chris Tuppen, Senior Partner, Advancing Sustainability Ltd and Honorary Professor, Keele University, United Kingdom
HOW does the contemporary business strategist decide which issues to focus on? For all companies, getting the process of materiality assessment right is critical because correctly identifying the material issues creates a substantive and essential link between strategy and sustainability. And integrating sustainability into the business is a necessary precursor to integrated reporting.
When it comes to intangible asset valuation, sustainability issues that might initially be non-material, at least from a financial point of view, can quickly become material to a business if the wider stakeholder community deems them to be significant. Thus, in determining materiality from the sustainability perspective, most organizations consider a broad mix of views. The results are often presented graphically, with a ‘stakeholder’ axis (usually the vertical axis) and a ‘company’ axis. They may also be presented as a two-dimensional matrix in tabular form. Either way, the most material issues appear at the top right-hand corner.
Such an approach was first described in detail in the Materiality Report published by AccountAbility in 2006. This consolidated the work of a few pioneering sustainability reporters and highlighted how sustainability in business needed to move from compliance to value generation.
Since 2006 the AccountAbility methodology has been widely adopted and forms the basis of the related Global Reporting Initiative (GRI) technical protocol on report content. Issues deemed highly significant by stakeholders, but insignificant by the organization, will be found in the top left-hand corner of the materiality matrix. These are likely to be indicative of emergent issues that could become financially significant over time.
Issues deemed highly significant by the organization, but insignificant by stakeholders, will be located in the bottom right-hand corner. These are often mature issues, with stakeholders expecting them to be fully embedded in the organization as ‘business as usual’. If a business fails in its diligence to do this, seemingly mature issues soon climb up the stakeholders’ ‘significance’ ladder.
In 2011 my Fronesys partners and I did an analysis of materiality determination for sustainability reporting by leading corporates. We found many companies saying that the results of their materiality determination process had guided their sustainability strategy. Two companies indicated that the materiality analysis went beyond sustainability and actually had a direct influence on their main business strategy. Interestingly, these were both from the finance sector:
“A key element of sustainable development is to identify the relevant environmental and societal topics that are financially material to our long-term business strategy.”
“The issues most material to our business and stakeholders are assessed throughout the year; they feed directly into strategy development and are discussed in this report.”
However, many questions around strategic alignment were left unanswered, in particular:
- Should an issue deemed to be material in a sustainability matrix automatically be considered material under a more conventional accounting approach?
- If not immediately, over what frame might this be expected to happen, if at all?
- Should sustainability and traditional accounting and accountability remain separate or be combined into an integrated process?
Perhaps answers to these questions may have been found by those companies that have already experimented with integrated reporting. Although our analysis found the AccountAbility approach to be both workable and useful, it also highlighted a number of anomalies and shortfalls.
For example, for any given issue, there was often a large scatter in reported materiality levels, even from companies in the same sector.
In addition, while the underlying process framework was similar for all the companies surveyed, the detail of the process was often a black box with very little published detail on quantification algorithms and applied weightings.
It is clear that, to date, the AccountAbility approach has been mostly used to determine the materiality of sustainability issues. This is highlighted by the fact that most companies still disclose no more than tentative linkages between materiality in the sustainability context and their commercial business strategy.
With the advent of Integrated Reporting, it will be important to strengthen and combine sustainability and conventional business materiality determination. This should reinforce the need for greater transparency on how the output of the materiality process has influenced the overall, long-term strategic thinking of the company. It will also involve a consideration of the full value chain impacts of the business and, in order to make a more direct link to financial accounting, possibly, the incorporation of environmental and social externalities.
(Extract from: Making Investment Grade: The Future of Corporate Reporting, Centre for Corporate Governance – USB, Deloitte and UNEP, 2012)