Both practices identify issues critical to the business – furthermore, both worlds adopt similar methodologies in identifying risks and opportunities.
Despite their similarities, the two worlds remain stubbornly separate, existing only within their realms and respective sections in the annual report.
How do we break down the barriers and allow for a unified understanding of “material risk”? We believe that this begins with first understanding the materiality and risk assessment processes and their differences, then examining where and how they overlap. This enhanced understanding thus allows businesses to effectively integrate sustainability risks within their risk management process.
The materiality assessment process seeks to identify the most critical sustainability issues for a business.
But first, how do we know what qualifies as ‘critical’ or ‘material’? We are seeing one of the fiercest debates in the sustainability landscape on this very topic – to whom is any given issue material?
Enter the concepts of single and double materiality. A single materiality approach considers whether any given issue has a potential to affect the company financially. A double materiality approach asks to consider not only financially material issues, but also others that have a potential impact on the economy, society, and environment.
Globally, the debate ensues as to which approach should be applied, with The European Financial Reporting Advisory Group (EFRAG) championing double materiality and the soon-to-be published The International Sustainability Standards Board (ISSB) standards relying on financial materiality.
Bursa’s definition[1] of material sustainability matters is “risks and opportunities arising from the sustainability impacts of the company’s activities… based on what is most important to the company and its stakeholders”. Bursa also encourages companies to consider whether the topics have an economic, environmental, or social impact on the value chain. In essence, a double materiality approach.
The first step in conducting a materiality assessment is to identify the key stakeholders who have influence over the outcomes of the business. This may be a plethora of actors including customers, management, employees, society, suppliers, shareholders, regulators – the list goes on!
Issues that are important to these stakeholders could potentially matter greatly to the business. Surveys, focus group discussions and interviews can help uncover the top-of-mind issues and provide an understanding of the context within which the issues are framed.
The saying goes “too many cooks spoil the broth”. Indeed, the key to a successful materiality assessment is striking a fine balance among the numerous yet equally important priorities of a diverse pool of key stakeholders. Just as sugar and spice and all things nice make our proverbial broth delicious, a successful materiality assessment is about paying due attention to the issues that are important to stakeholders as a collective.
This requires a ranking of the issues in terms of their relative importance and priority to the business within the context of the organisation, trends in the industry and the external environment.
A materiality matrix can help to visualise the priorities of these issues against two dimensions. One of the most common dimension-pairs are – ‘importance to business’ and ‘importance to stakeholders’. The matrix is often categorised into ‘moderate importance’ to ‘highly important’ (Figure 1).
Figure 1: Materiality Matrix
Risk management professionals may already see the resemblance between the materiality assessment process and the risk assessment process. In many ways, the materiality assessment process share similar features with the risk assessment framework set out by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
The risk assessment process seeks to identify the key threats to the organisation’s ability to achieving its strategic goals and the COSO framework is used and accepted globally to guide this process.
Just as the materiality assessment process seeks to understand the issues at hand by engaging with the organisation’s stakeholders, the first step in the risk assessment process is to gather feedback across the business based on a common set of assessment criteria. The assessment typically requires management to weigh risks against their likelihood of occurring and impacts on the company.
The material sustainability issues that were identified through the materiality assessments should be integrated into the above-mentioned assessment together with other potentially key risks.
With a universe of potential key risks, the next step involves an evaluation of these risks using both qualitative and quantitative techniques. An initial screening would be carried out by conducting interviews, benchmarking, workshops and surveys to have a deeper understanding of its likelihood and impact of each risk.
This is followed by a quantitative assessment requiring the assignment of numerical values to impact and likelihood through techniques such as scenario analysis.
This is where the materiality analysis differs because not all sustainability issues can be quantified in terms of their impact and likelihood - consider employees’ mental wellbeing, for instance. However, the impact of issues such as climate change can be measured through scenario analysis using internationally recognised standards such as the GhG Protocol[1].
In addition to assessing risks, organisations should develop an understanding of how risks are linked to each other and how they may amplify one another. For example, as the threat of climate change intensifies, operational risks may increase as extreme weather events disrupt business operations.
Like the materiality matrix, risk heat maps are used to prioritise risks against likelihood and impact with designated areas of ‘high risk’, ‘medium risk’ and ‘low risk’.
Sustainability issues that are mutually ‘highly material’ to stakeholders and the business may not necessarily appear on the ‘high risk’ category of the risk heat map, as there would be an additional consideration of likelihood and impact. However, it may be quite likely that a sustainability issue that is deemed highly material by the business and its stakeholders would be ranked as a high risk on the risk heatmap.
Figure 2: Integrating material sustainability issues in risk assessment
With the growing prevalence of economic, environmental, social and governance (EESG) risks and opportunities, it is ever more critical to effectively manage them through the risk management process. While materiality and risk assessments are separate processes, a point of convergence is needed where the organisation considers all risks and opportunities holistically.
Fundamentally, both processes work towards the same goal – understanding the organisation’s priorities in respect to stakeholders’ concerns, within the organisation’s context and external environment.
Black Sun is a global group of strategic advisors, consultants and stakeholder engagement specialists. We believe that brands and businesses can have a big impact on our society – they can shape more ethical practices, build more inclusive communities and deliver more sustainable performance. Ultimately, they can spark positive change in the world.
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