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The sudden ‚materiality shock’

26 Apr

This is the first of four installments of a blog series covering crucial sustainability reporting issues on materiality, sustainability context, comparability and stakeholder inclusiveness.

Spring 2014 seems to be the moment in time where ‚materiality’ suddenly appeared on the screen of corporate sustainability reporters. At least one could wonder why within a couple of weeks countless workshops popped up around the world, webcasts were announced and books were published just on this one single issue of the sustainability reporting agenda. One author even declared a calm ‚war on materiality’. But wait a minute, the issue of defining what is material in sustainability reports isn’t by far new, so what’s the reason for this sudden shake-up? Several reasons could be mentioned:

  1. Since the publication of GRI’s G4 Guidelines in May 2013 materiality went to the forefront of communication items around the new Guidelines. The reports based on G4 should show ‚what matters, where it matters’. For that reason GRI visualized the application of the four report content principles as one seamless workflow. But is this new? The answer is no, because the same process was already pulled together in a resource document in 2010, but now got finally included in the main document, the G4 Guidelines, without considerable changes. Also, GRI’s certified training program presented a five-step process since its inception years ago that followed this logic, and thousands of practitioners around the world were trained for doing exactly that – defining what is material.The reason for the extra attention lies elsewhere: the combination between impact definition, boundary setting, transparent stakeholder dialog and the level of disclosure that GRI is demanding in this thematic triangle adds rigour and demands a much more crisp process. Gone are the times when a mentioning of stakeholder dialog was enough, a materiality matrix could be presented without further process description on how this was pulled together, and the legal shortcut of 50%+1 share was enough to cut off responsibility in reporting due to the one boundary chosen by the legal counsellor. So, for some ‚what matters, where it matters’ now suddenly means ‚what hurts, where it hurts’, especially for those that define sustainability as an additional topic that needs to be addressed through a separate report, and where the corporate strategy isn’t that much connected with sustainability thinking.
  2. Another reason for the new level of attention can easily also be detected when looking through the outcomes of KPMG’s 2013 international report quality survey amongst the biggest 250 companies, many of them call themselves leaders in sustainability. Just a couple of numbers to clarify the problem: 13% of the reports do not identity megaforces that affect business at all, and from the other 87% at least some megaforces are identified, with climate change only affecting 55% of businesses, ecosystem degradation is a just a problem for 18% of the G250. One can only wonder how identifying ‚what matters, where it matters’ is at all possible if so little sustainability context analysis is done in the beginning of the materiality definition process. When looking at information how often companies do assess materiality, 58% do not give any indication and 19% indicate a limited assessment of materiality. That means that just 23% of the G250 have a thorough process in place to assess matariality. This is shocking evidence. Stakeholder inclusiveness is another painful area to look at. For only 45% the process link between stakeholders and the materiality process is clear, for the majority stake of 55% the process is not yet clear (34%) or not explained at all (21%). Finally looking at target setting one might expect that material issues would also lead to clear targets, but the opposite is true. 13% of the G250 haven’t declared any targets, 28% of the reports carry some targets with no clarity on how they relate to material issues. 23% of the reports carry information that links to less than 50% of material issues, and finally 36% carry targets that relate to more than 50% of the material issues. The shortcomings of these data explain very clearly why the pocess of cutting through from sustainability context information through stakeholder dialog to material issues now needs to get more rigour. Companies just did what needed to be done, just little of them did more than absolutely necessary. We leave it up the reader to contrast this information with the many CEO speeches that tell us how much sustainability is in the genes and DNA of their organization.
  3. A new level of recognition of materiality is surely also due to the growing number of frameworks and guidelines around corporate reporting. Whereas GRI addresses materiality from the perspective of all stakeholders, the IIRC clearly defines materiality from the point of view of the providers of financial capital. SASB just replicated the definition of the U.S. Supreme Court, focusing on shareholders only. And that whole array of different definitions seems to be confusing, especially as many users see these documents as standards. It is therefore time to step back and again recognize that none of these documents are ‚standards’ or ‚cooking books’. They are recommendations as they present guidance and framing. Not more, not less. Furthermore they are still all voluntary instruments to trigger thinking about the inclusion of sustainability into an organization’s core – the business model and the strategy. If this is managed well we think the discussion on materiality will by definition become a no-brainer.
  4. Lastly, there is new fuel to the fire of mandatory sustainability reporting through the positive vote of the European Parliament to amend the European Transparancy Directive and make sustainability reporting compulsary for roundabout 6.000 listed companies in Europe, with a size of more than 500 employees. The Directive passed the European Parliament on April 15, 2014. The Directive needs to be translated into member-states laws and regulation, so that the application is only expected to start in 2017 for reporting year 2016, maybe even one year later. In short, material issues of importance need to be reported in annual reports or sustainability reports on corporate level. Discussion arises mostly on the point of the EU’s definition of CSR, saying it entails all voluntary action of companies above and beyond what is legally already demanded for. In our view this definition is counterproductive to the real meaning of materiality, and therefore misleading to help describe the core of the issue. Nevertheless, the fact that many companies are now demanded to report on their sustainability risks and opportunities, covering a range of issues that is nearly 100% overlaping with the UN Global Compact 10 core principles, has put new emphasis on the materiality discussion in companies.

In our view there is only one useful way of dealing with the issue of materiality, and that is to step one step back from the idea of standards that would tell us what clearly has to be done. We see materiality in the closest of all possible meanings: all areas in which the company affects or is affected by those areas of sustainability it can influence by its existence and through its doing, through products, services, as enablers and advocates of positive change. The measurement of ‚Net Positive Impact’ will therefore become the future litmus test of the right to exist for companies. It would be good for companies to already follow in the footsteps of those frontrunners that aim doing exactly this ambitious step.

Authors: Ralph Thurm is the Founder & Managing Director of A|HEAD|ahead, Nick de Ruiter is partner at Sustainalize.

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17 Comments

Posted by on April 26, 2014 in Sustainability Reporting

 

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17 responses to “The sudden ‚materiality shock’

  1. Robin Wood

    April 26, 2014 at 10:42

    Morning Ralph- excellent anaylsis, as usual. How might materiality help us close the context gap, and define the north stars required? When is a good time for you to talk this weekend? Warm regards, Robin

     
    • aheadahead

      April 27, 2014 at 12:14

      Hi Robin, there is no good materiality assessment without proper sustainability context. So it is the context to start with in order to understand impacts and the potential business opportunities, based on the megatrends and root causes we discuss in the Embedding ThriveAbility Programs. The sustainability context principle in the guidelines makes this crystal clear, and then one can only be shocked about the recent KPMG study results (as mentioned in the blog post). Even more eminence for the need to understand ThriveAbility ;-) Greets, Ralph

       
  2. Andrew Kluth

    April 27, 2014 at 09:40

    Hi,
    Really interesting commentary. It would be excellent if you are able to reference the various reports and publications you mention so that interested readers can interrogate the questions you raise even more deeply.
    Several commentators have started to pick up on the issues arising from different definitions of materiality. It’s not clear whether it is possible to produce a materiality assessment of any reasonable length and complexity that fully supports the GRI, IIRC and SASB interpretations.

     
    • aheadahead

      April 27, 2014 at 12:09

      Andrew, thanks for your comments. I am offering links to More|HEADS|ahead on the right side of the blog. Have a specific look at Blogs from CSR-Reporting (Elaine Cohen) and Dwayne Baraka’s blog, you will find numerous links to what I am discussing here. Dwayne has write a whole book in the Dō Short series of books on CSR and is giving webcasts and seminars in the rollout of his books. He is also the one who mentioned the ‘war on materiality’. The KPMG study is easily findable on the web, as well as the European Commissions communication. Best regards, Ralph

       
      • Andrew Kluth

        April 27, 2014 at 12:47

        Dear Ralph,

        Thank you for these comments. I had wondered in my initial post whether to mention Elaine and Dwayne, as their work has been particularly noteworthy (and Dwayne’s post on materiality was driven in part by a dialogue he and I had on the confusion arising from the different interpretations.) I didn’t do so as I wanted to see whether you had drawn ideas from other sources as well and didn’t want to lead your thinking in any way.

        The real test will be to see how reporting evolves and how the bulk of reporters chooses to interpret the new reporting regulation and guidance. Perhaps it will be worth revisiting this in a year’s time when GRI G4 at least should be bedding in.

        Regards,

        Andrew

         
      • aheadahead

        April 27, 2014 at 13:00

        Hi Andrew,
        I agree that time will tell, but as I say at the end of the blog: there’s no cooking book (although many would want this), and that is why I am hammering on the need to have a way more in-depth look in how to define sustainability context as the precondition for defining materiality. The KPMG study – as per my interpretation – tells me that the sustainability context isn’t properly assessed, which in consequence leads to the shortcomings in defining materiality, involving stakeholders and setting longer term targets. It is therefore not strange for me to now see that hype on materiality (step 2 to me) is happening, simply because step 1 – a proper assessment of impacts – has been neglected although the sustainability context principle already existed in G3 since 2006. It is the most neglected principle, but is in fact the core piece to define WHY companies should report and how (I am saying that as the one who lead the principles work stream at GRI in the development of G3). Best regards, Ralph

         
  3. Edwin

    April 28, 2014 at 13:25

    Dear Ralph,
    Great analysis and in line with our findings from 2012: You need a strategic framework that helps you understand your North star and your sustainability context first before you can identify what is material to your organization and value chain. Only then you can be strategic about incorporating that understanding in your strategic innovation and in your (sustainability) reporting and stakeholder dialogue.

    We believe our research (based on G3.1) had some influence on the GRI G4 process. As you have pointed out so clearly there is still room for improvement and GRI was not designed for implementing sustainability, but for sustainability reporting.

    As you know the Natural Step Framework for Strategic Sustainable Development (or FSSD) is a great tool to truly become an industry leader e.g. IKEA, Scandic, Nike, Interface. To learn more about the integrated process we designed, here is the link to the research: http://www.future-proofinc.com/2012/11/27/award-ceremony/. As one of the research expert panel members, Elaine Cohen also wrote a short article about it which can also be found on our website.

    Keep up the good stuff and hope to meet soon.

     
    • aheadahead

      May 2, 2014 at 10:19

      Dear Edwin, thanks for your response, and I remember your studies from 2012. As mentioned in one of the comments more below The natural Step Canada is working with Bob Willard on the Future-Fit Benchmark, and Andrew Upton works with a group on ‘Strongly Sustainable Business Models’. Just two out of many prompters of the rise of tools for purpose-driven reporting in a world that strives towards a green & inclusive economy. Hope to meet you soon, probably at one of the further Reporting 3.0 Platform Transition Labs in Berlin or the Global Conference of the Platform, taking place October 6/7, communication starting soon.

       
      • Edwin

        May 19, 2014 at 09:54

        Dear Ralph, yes the http://futurefitbusiness.org initiative is a great way to go beyond comparing with the past (performance) and peers (traditional benchmarking) as it now will compare and allows you to report on progress and ‘Mind The Gap’. It is great to already be taking part in the review of the future-fit business benchmark for which the public comment period will start this summer. The lab and platform sound interesting too, will look into it, thanks.

         
  4. douwe jan joustra

    April 28, 2014 at 17:50

    Hi Ralph,
    Excellent analysis in your blog. It seems to be quite complete, though I think that there are some major tendencies that influence companies and their reporters on GRI. The first and most important is the new attention for the circular economy as promoted by several Dutch organizations and companies as well as by the Ellen MacArthur Foundation in a joint venture with McKinsey. The first reflex of companies is the acknowledgement of the importance of resources and resource management. This brings around discussions on ‘Materials passports’ and the ‘Resource Roundabout’ in the Netherlands. This reflex is a notable development.
    The second is the ‘Resources initiative’ in the European Parliament, by people like Gerben Jan Gerbrandy, who is special rapporteur on this issue. Europe makes resources more and more important. Third is of course the volatility of prices in the Worldmarket and the question of availability on the long run.
    Three elements that emphasize the importance of resources and materialization. My impression is that these might have a far more noticeable influence than we might think. See our report on Business in the Circular Economy (in Dutch): http://www.ondernemenindecirculaireeconomie.eu and the publications of the Ellen MacArthur Foundation.

    Thanks for your extensive and impressive analysis!

     
    • aheadahead

      April 28, 2014 at 20:55

      Douwe, I do agree on the importance of circular thinking and commend the work of various players in the field, they do help to give context focus for those aligned to those principles. These are important work pieces to create new boundaries of an economic system’s logic. The question in how far it will help producing material reports remains to be seen! Greets, Ralph

       
  5. rogerlburritt

    April 30, 2014 at 15:34

    Reblogged this on Professor Roger Burritt.

     
  6. Cornis van der Lugt

    April 30, 2014 at 16:18

    Great update Ralph! Having been member of those GRI working groups that refined the reporting principles and developed the boundary / later materiality protocols over the years, I found myself nodding in agreement many times. Two questions: (i) How do you suggest dealing with the possible tension between materiality and comparability? Or do you think there is no real issue here? Can “material” information be so organization-specific that we loose benchmark-ability with others? “Material” can also be so stakeholder group specific that it is no longer strategic! (ii) For a company to consider the “sustainability context” and define “science-based indicators”, what credible sources of information (e.g. on recognised thresholds) would you refer the company to? I recently saw a climate study that considered companies’ contribution to national GDP in defining “science-based” reduction targets. Presumably one also has to consider its contribution to the national GHG envelope, and the national (politically agreed) GHG reduction target! Where does the company start, with issues A, B, C…?

     
    • aheadahead

      May 2, 2014 at 08:54

      Dear Cornis, great to hear from you! We definitely can form a headbangers team in nodding, looking at what is needed on the way forward. To comment on your questions: (i) I think there is a real issue here between materiality and comparability! Saying it bluntly, there is a danger that comparability is compromised by the materiality focus, and the opportunity missed to define science-based indicators in G4 would have been a brilliant way to counterbalance this. You know my plea for a much stronger focus on sustainability context. Reading the text of this principle in G4 you will realize that these are the most important sentences of the whole Guidelines, they define in my view what the scope and purpose of reporting need to be, and the indicators don’t follow suite. In consequence, lesser aspects are most likely reported due to the materiality focus with quite a stretch in the indicator section, and target setting is left to the organization instead of linking it to a (not yet existing) set of indicators that would give us science-based targets as an anchor for comparability. (ii) I just gave a keynote and moderated a workshop of the Reporting 3.0 Platform Transition Lab on ‘Closing the Sustainability Context’ in Berlin, with WBCSD, Interface, GFN, GNF as speakers. There is a whole arsenal of starting points: Stockholm Resilience Centre (with a whole armada of other institutes chipping in and backing it up), GFN (that in my view now urgently needs to take the next development step towards product-based foot printing), Natural Capital Coalition (formerly TEEB), and The Natural Step together with Bob Willard are at the moment creating a Future-Fit Benchmark which carry science-based or per capita goals for companies. The methodologies of E-P/L and S-P/L (the latter less explored) add scope going beyond existing ‘less bad’-proof indicators. I also liked Andrew Winston’s article in the April Harvard Business Review on how to create a resilient company, he demands long-term target setting as well, based on science-based goals. The workshop in Berlin showed that at this moment we need to create the enablers that showcase that we are in fact able to create this new generation of indicators (which then support comparability at least in this areas of reporting, balancing out the strong focus on materiality), before we create the necessary reporting for that. Clearly a call to build a community of the willing to do so, the 130 people in the Sustainability Context Group (of which you are a member as well) would be a starting point, but I will surely also flag it again and again through the Reporting 3.0 Platform, of which I am the content curator. Hope that helps!

       
  7. Mark McElroy

    May 2, 2014 at 22:06

    Great analysis, Ralph! I had occasion to comment on this very topic a couple weeks ago in a discussion I was having with Cynthia Clark, Director of the Institute of Corporate Governance at Bentley University, who had asked me to explain the “context-based” perspective on materiality. Here is what I wrote to her in response:

    “In a nutshell, sustainability context determines materiality. Such context, in turn, consists of information about: (1) who an organization’s stakeholders are, (2) what the vital capitals are that an organization is either already having impact on or ought to be having impact on in light of who its stakeholders are, (3) what the limits of, or demands for, such vital capitals are, and (4) who else, if anyone, is co-responsible for their maintenance. This information then gives rise to company-specific standards of performance for what their impacts on vital capitals would have to be in order to be sustainable.

    “Sustainability context thereby determines materiality because it: (1) reveals the impacts companies are already having that might put vital capitals and/or stakeholder well-being at risk, and (2) reveals the impacts organizations ought to be having, but may not be, that again relate to vital capital maintenance and stakeholder well-being. In sum, if an organization is or ought to be having impact on a vital capital that is of importance to a stakeholder’s well-being, that impact is material and must be addressed in measurement, management and reporting.

    “Notice here the difference between the comparatively narrow ‘decision making’ (by investors) interpretation of materiality found in the financial world, and the broader ‘well-being’ (of stakeholders) interpretation found in the sustainability world. My own view is that we should tend towards the latter and avoid the former, since the latter is more appropriately inclusive of all stakeholders, not just shareholders, and also openly acknowledges the importance of vital capitals for human well-being, not just investment-related decision making. Indeed, organizations that narrowly define materiality in terms of investors only could very well comply with it even as they ignore their (sometimes negative) impacts on vital capitals of importance to the well-being of other stakeholders. That’s an unsustainable interpretation of materiality if ever there was one!”

    Hope this helps!

    Regards,

    Mark

     
    • aheadahead

      May 3, 2014 at 13:33

      Dear Mark, thank you for this very precise description of the need for sustainability context in order to define materiality. You mention the vital importance of capitals, and I commend the IIRC to having brought up the capitals in their general model of integrated reporting (after you also offered a model in your book). During the pilot project of the more than 100 companies and additional 20 or so financial institutions it became clear that a lot of research for good definitions, description of boundaries and pure counting logic (where counting makes sense) still has to be built up to fully utilize the capitals logic in accounting and then subsequently in defining materiality and then actual reporting. It is for that reason that V1 of the IIRC’s Framework somehow plays down the importance of the capitals simply as ‘a way of inspiration’ and to make sure ‘not to forget certain potential impacts’ when cocooning back into the company and think how they can all work better together, leading to ‘integrated thinking’ around the middle piece in IIRC’s picture, the business model. After several workshops around materiality that I addressed or moderated and after the Reporting 3.0 Platform Workshop on ‘Closing the Sustainability Context Gap’ last week in Berlin I realize that we first need to continue to close the ‘stereotype mindset gap’ about not being able to convince management (and sometimes even other external and internal stakeholders) that context is important. I now so often heard that a) there needs to be a clear commitment top-down that work on context should be done, b) the research on capitals first needs to be done to be able to work on ‘cooking books’ on how companies can then utilize this, c) stakeholders themselves need to pressure companies to make the micro-macro-links, and d) incentive structures should be given to those going the extra (that’s how they see it) mile. Only then more companies would dare to think bold about the possibilities to offer an ambition of potentially becoming net positive. But at this moment I fear most companies are more busy with the ‘standards confusion’ and how that affects their existing reporting regimes (that’s why Reporting 3.0 will address this very topic in the next Transition Lab on June 27 in Berlin). However, as described in my blog that now lead to these many comments, I do have a bit of hope that G4’s ‘triangular logic’ of impact-materiality-boundary will put some more pressure on companies to dive deeper.

       
  8. Jessie Henshaw

    July 29, 2014 at 22:22

    It looks like a real advance! There’s still the little matter of GRI metrics being based on “counting up” what businesses can trace rather than “dividing up” between businesses what the economy is responsible for, to assure full accountability.

    An advanced scientific method for measuring the total material impacts of business value trees is what I and my co-authors introduced in 2011. It seems to find anywhere from 2 to 10 times the real of impacts of businesses consuming economic services that presently being counted by other methods, both the benefit and the shock.

    That’s because it uses a natural science method of *dividing up the whole* (so you can be sure the accounting of responsibilities closes) instead using an economic method of adding up only the easily traceable parts. That’s a simply HUGE difference, and as we get over the shock it’s make a huge difference in the material results of sustainability accounting too.

     

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