Time to apply the principle of materiality to materiality
November 2015 User View by Wim Bartels, Global Head of Sustainability Reporting & Assurance at KPMG, The Netherlands
AS an accountant it took me some time to understand the concept of “materiality” as used in the sustainability community. First of all it appeared to be meaning something different than what I was used to as a financial auditor, i.e. essentially referring to the importance of identified risks and opportunities rather than a threshold for errors or omissions.
Secondly, whereas the concept is quite straightforward as laid out on Materialitytracker, it appears to be quite complex in its application. Those companies who tried to integrate it into wider risk management found the individual sustainability issues being boiled down to ‘reputation risk’ in order to stay above the relevant financial thresholds used in risk management frameworks.
Those companies who took it as a separate exercise got lost in lengthy and mostly high-level meetings with stakeholders – as sustainability standards point to ‘stakeholder dialogues’ as an important element of the process to identify relevant topics. After these meetings they ended up with a list of topics that they attempted to plot based on ‘some kind of methodology’, which in many cases was not very robust and therefore destroyed the value of the process as a whole.
Ongoing discussions on materiality and the increased attention – rightly so – paid to the identification of the material issues in reporting standards point to the need for a ‘re-set’. Reading the GRI Guidelines leaves the impression that the process gets more and more complicated, including more intense and frequent conversations with stakeholders. At KPMG it made us wonder what this was all about fundamentally and what the essentials of a good materiality assessment are.
Clearly, materiality is not about reporting. Those who conduct the assessment once a year about three months before year-end miss the point. As explained above those who aim to integrate it in the conventional risk management framework might lose the right level of attention within the organisation. And those who set up roundtables with stakeholders asking them for ‘all they always wanted to ask the company’ overlook the wealth of insights and expertise available within the organisation on the basis of its existing networks with society.
Materiality is all about value – value to society and value of the company, which go hand in hand. Once this view is taken in a materiality assessment, the world changes significantly: the issues are no longer assessed in terms of their impact on profit and loss. Rather, they are reviewed on the basis of their impact on the value-creation of the company as a whole. This includes for example the (monetized) value of human capital, or in other words the level to which the company stays attractive to new hires who will decide to accept employment considering the societal issues the company addresses. I know some companies in the oil & gas sector who face challenges today in hiring the best engineers from university as they no longer want to join the ‘old energy’ sector.
Also, the long lists and full plots of material issues will be reduced to those that really make a difference to the company’s (long-term) value – which will make management and reporting more focused on a limited number of key issues.
We believe the materiality determination process should be brought back to its essence: keeping it as simple as possible, yet effective to function as a radar for the company and identifying the issues that will impact total value – again, with value being viewed in its broad sense. We recently published ‘The essentials of materiality assessment’ in which we share our views on the expected mechanisms in place as well as our opinion on some of the dilemmas companies face. We provide a 7-phase materiality process, aligned with KPMG’s Materiality Toolkit and Methodology.
To pick one dilemma companies face: Should you really conduct a materiality assessment every year? We don’t think so. It would be surprising if your issues change significantly from one year to the next. Therefore a complete re-assessment every year (including similar discussions with stakeholders as you had last year) does not make sense.
That been said, there are different levels of sophistication for the implementation. A thorough baseline assessment with extensive inputs followed by yearly updates based on internal and peer reviews would suffice mostly to ensure a good coverage of the material topics in your sustainability management and reporting.
In a sophisticated corporate environment, one would expect the material issues to be detected well before they become real as a matter of being future-proof. One would therefore expect a mature company to have a continuous ‘radar’ installed that spots the emerging issues (for example ‘responsible taxation’ back in 2011), taking a proactive and leading role.
To conclude, materiality should be brought back to its essence and get simple again. In addition, there is no doubt room for further improvement in almost every company to serve the business purpose.
The author can be reached at: Bartels.Wim@kpmg.nl