Double materiality in ESG: why it matters for investors and businesses

Published on January 17, 2025 by Rakesh Biswal and Shikha Agarwal

Introduction

The double-materiality approach takes into account both financial and non-financial aspects of a business. As outlined by the European Commission, it considers a two-way relationship, as summarised below:

Financial materiality:This aspect examines how sustainability issues might affect a company’s financial performance, for example, how climate change could be a risk or opportunity that impacts its financial performance.
Impact materiality:This perspective focuses on the company’s impact on the environment and society. It considers both positive and negative effects, such as carbon emissions or community development initiatives.

The European Corporate Sustainability Reporting Directive (CSRD) requires companies to report on their sustainability-related impacts, risks and opportunities (IROs) to bring more transparency to sustainability reporting and reduce greenwashing.

Why double materiality is important for investors

As a sustainability driver addressing various global challenges relating to the environment and society, ESG-based impact investing has gained prominence across the world in recent years. The global impact investing market is expected to have reached USD28.4tn in 2024, according to Grand View Research, and to continue to witness increasing demand for sustainable investment. This investing ecosystem aligns investment decisions based not just on a company’s profitability but also on its ethical and sustainable aspects. This approach helps determine the resilience of its strategies in the rapidly evolving space of sustainability and ESG.

Similar moves by regulators have supercharged the importance of ESG in investment by imposing more comprehensive ESG disclosure requirements. For example, the EU has several regulations mandating such disclosures, including the Sustainable Finance Disclosure Regulation (SFDR) and the CSRD. These frameworks call for increased transparency of companies, enabling investors to evaluate risk in relation to emerging overarching standards. Double materiality is a CSRD-mandated disclosure that helps investors understand the IROs aligned with ESG criteria, such as carbon taxes, internal carbon pricing, climate change and social inequality, that could have financial consequences. Through double-materiality assessments, investors can evaluate more accurately whether a company integrates ESG considerations into its business strategy, operations, value chain and R&D initiatives. Investors also leverage double materiality to understand how a company aligns its ESG ecosystem with stakeholder concerns and expectations. Failure to meet these legislative requirements could mean financial penalties for companies, while those who excel could gain a competitive advantage.

Double materiality and its relevance for business

Double materiality is important for businesses not only from a compliance perspective but also for holistically evaluating a business’s IROs by linking its financial performance with its environmental and social ramifications. Thus, the approach enables firms to look beyond financial profit/loss by incorporating non-financial attributes into their fundamental business performance.

The double-materiality process necessitates extensive stakeholder engagement, helping businesses develop trust and enhance their transparency and accountability. It improves their responsiveness to stakeholder concerns and expectations. It also helps them keep abreast of emerging trends, with continued engagement with stakeholders enabling them to stay updated in the evolving ESG space and foresee major risks that could seem trivial at present. Thus, the double-materiality process helps firms become more resilient, robust, transparent, responsive and trustworthy.

Adoption and implementation of the approach enables firms to improve their brand image and strengthen their relationship with stakeholders by creating long-term value for them. This approach helps firms go beyond the conventional way of assessing financial and non-financial aspects of business and reform their business strategy across the value chain in line with long-term ESG goals. Consequently, the approach establishes a firm as a thought leader contributing to the transition towards a socially-inclusive, low-carbon economy for a more sustainable and equitable future.

Challenges in implementing double materiality

Identifying relevant ESG factors: The ESG factors of companies play an important role for stakeholders. A company must identify the right ESG factors that directly impact both its short-term and long-term performance. Many companies face difficulties in doing so. For example, a food-production company may prioritise sustainable sourcing as a materiality issue, whereas a company in the financial sector may prioritise data privacy and workforce management.
Data collection and reliability: Many companies face challenges in ensuring data accuracy and reliability due to inconsistencies in data sources and data metrics. A survey found that 79% of investors find data inconsistency in companies' ESG reporting. The main challenge relates not to collecting data but to ensuring its credibility so as to assure stakeholders.
Dynamic nature: The concept of double-materiality assessment is dynamic in nature. It requires ongoing evaluation and identification of materiality issues. Hence, organisations need to update their materiality issues and identify the impact on their operations frequently. They also need to respond to the information, which may necessitate adjustment and gradually developing their operating environments.

Incorporating double materiality into current reporting frameworks:

Double-materiality assessment requires companies to disclose both the impact of sustainability issues on their operations and effects on the society and environment in which they operate. The European Financial Reporting Advisory Group (EFRAG) suggests that the effective implementation of double materiality necessitates substantial changes to internal processes, which can be resource-intensive.

Strategies to overcome these challenges

Develop a clear plan: Develop an appropriate roadmap that describes every step of the double-materiality assessment process. This structured approach helps management identify the materiality issue correctly and reduce complexity and workload.
Engage with stakeholders: Actively engage with stakeholders including investors, customers, employees, suppliers, communities and regulators, so as to understand their viewpoints and issues. This would ensure a proper evaluation of financial and environmental/social factors. The engagement would help develop more impactful ESG initiatives and increase transparency.
Collaborate: The collaboration of departments including finance, sustainability, risk management, legal and communications in the assessment process ensures the different viewpoints are considered and the assessment is integrated with the overall business strategy.
Use international frameworks and standards: The double-materiality assessment should be conducted in accordance with established frameworks such as the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB) in order to streamline reporting processes.
Ensure continued monitoring and review: Conduct periodic audits to ensure data integrity and credibility. Monitoring and reviewing the materiality assessment process is vital, as it could have a positive impact on the company’s financial performance and environmental and social issues.

Opportunities for investors

Adopting the double-materiality approach benefits both investors and businesses.

Enhances risk management: The double-materiality assessment enables a business to recognise the associated risks and opportunities. The traditional materiality issue examines the impact of climate change on financial outcomes. In contrast, double materiality evaluates how a company’s activities contribute to climate change, potentially leading to reputational, regulatory or operational challenges. This process identifies the company’s risks and helps implement appropriate measures, enabling investors to understand the potential sustainability risks and opportunities associated with the company.
Improves investor trust: Conducting a double-materiality assessment helps identify ESG issues and their impact on the company’s operations and finances. Investors could incorporate this in their investment decisions.
Facilitates innovation and a competitive advantage:The assessment helps identify both financial and societal impacts. A company is encouraged to devise measures to reduce its dependence on biodiversity and its ecological footprint and improve social outcomes. This could lead to new business opportunities, including developing new products, services and business models aligned with sustainability principles. This would boost investor interest in investing long-term and mitigate sustainability risks.

Opportunities for businesses

Enhanced transparency and accountability: A double-materiality assessment enhances a company’s transparency and accountability and strengthens its relationships with investors, customers, employees and other stakeholders. It increases the transparency of the company’s financial performance and ESG factors, building trust and credibility. It ultimately leads to more robust and lasting relationships with all stakeholders associated with the company.
Risk management: Assessing ESG factors and their impact on the company’s financial performance can help identify potential risks in the short and long term, enabling it to mitigate these effectively.
Increased investor confidence:Companies that demonstrate a commitment to double-materiality assessment attract investors looking for sustainable and responsible investment opportunities. Reporting on ESG-related issues and their financial impact on the company increases investor confidence and helps them make investment decisions.

Conclusion

The double-materiality approach has become crucial in the investing and business landscape. It helps companies align with stakeholder and investor expectations, building a more responsive and resilient business ecosystem. This enhances their sustainability quotient and leads to a holistic risk assessment and mitigation process. In a nutshell, the dynamic nature of the double-materiality approach links business success with environmental and social wellbeing.

How Acuity Knowledge Partners can help

We help clients adhere to regulatory compliance requirements and enhance transparency by supporting them in conducting double-materiality assessments and seamlessly integrating these into their reporting disclosures. Leveraging our in-house tools, methodologies and frameworks, we are uniquely positioned to help clients collect and manage the data required for such assessments and effective stakeholder engagement.

With our deep understanding of the ESRS framework and the rationale behind conducting double-materiality assessments, we also provide our clients with strategic advisory services to align their business strategies with ESG considerations, enabling them to mitigate risk and capitalise on emerging opportunities.

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About the Authors

Rakesh Biswal

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Rakesh works as a Senior Associate at Acuity Knowledge Partners' Buy-side Investment Research team. He has six years of experience in ESG, sustainability and Climate Change field. At Acuity, Rakesh is working in multiple ESG engagements which includes UNPRI reporting, Climate-related risk assessment and SFDR regulations. Before his tenure at Acuity, he was employed by S&P Global and ESG Book. Rakesh holds a post-graduate diploma in management with a specialisation in accounting.

Shikha Agarwal

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Shikha has been with Acuity Knowledge Partners for the last 2 years. She has 6 years of experience in climate change and ESG. At Acuity, Shikha has worked in SFDR and EU taxonomy. Also, she provides specialized ESG issuer research to a large US based asset manager. Along with this, Shikha has also assessed and written PCD documents, formulated anti-corruption and anti-bribery action plans, and collated PAIs for multiple funds of leading asset managers based in Europe and the US. Prior to joining Acuity, she has worked with Tata Power and PwC. Shikha holds an MBA degree from the Xavier Institute of Management.