Vanishing Materiality in Sustainability Reporting
I have a problem with sustainability reporting. Actually, I have a lot of them, but one at a time.
Materiality, as used in sustainability reports, has, more often than not, become a complete throwaway exercise in order to achieve a rubber stamp of approval (or “in accordance”) from one of the various reporting guidelines or to demonstrate a form of “engagement” with audiences that actually doesn’t exist. All of the reporting guidelines, all risk management approaches, all major management systems have some sort of materiality process embedded in them, so we all know that materiality is a critical function to running an effective business. But when it comes to sustainability reporting, companies figure that a token approach leading to no meaningful action is sufficient. What gives?
Here is the materiality process that I encounter more and more frequently as sustainability reports proliferate and grow stale:
- First, the company will look over the list of indicators (what do we or our stakeholders care about?) from one or more voluntary reporting guidelines such as the GRI or SASB, regardless of whether these indicators have any relevance to their business. In many cases, these guidelines will be the major, of not the only, place where the company will search for potentially material issues.
- Second, the company will throw these indicators onto a two-dimensional matrix and ask a set of internal stakeholders (read: employees) to plot the indicators on the matrix. This is the equivalent of conducting a Ouija Board session of prioritization — the hand that pushes hardest directs the order of issues. Frequently, there are no criteria to guide this prioritization. Even more frequently, the overriding criteria is to meet and report against all of the indicators in those reporting guidelines so that the company can claim to be “in accordance” (or other language) regardless of whether those indicators have anything to do with the company and in direct opposition to the guidelines themselves (which suggest materiality should determine the selection of indicators).
- Once the matrix feels comfortable to the company’s sustainability team, it is shipped off to the executives to either rubber stamp or to have issues retroactively, and irreversibly, re-prioritized based on the personal experience of these executives.
- Finally, the matrix of prioritized issues is finalized, published in the sustainability report, and then…nothing. No commitment to management or target-setting against high-priority issues or expectation of performance data.
The sum value of the above materiality process to the company and its stakeholders is zero.
But materiality in sustainability can, and should, be valuable. There are so many values that a robust materiality process can contribute:
- Identifying current externalities to which there is a significant risk of internalization (think carbon).
- Focusing limited resources and management time on issues that are actually more important.
- Justifying spend on issues and opportunities to senior leadership in a consistent and defensible manner (also termed strategic direction).
- As a tool to create actually engagement with external stakeholders that do not usually have a voice inside the company.
- Identifying multipliers whereby a relatively small investment can create impacts that are orders of magnitude larger (in terms of both cost efficiencies and revenue)
- Generating reputational value with increasingly interested and savvy investors as well as employees who will have to go to bat for the company in times of crisis.
- Creating a platform for innovation in sustainability to not only identify issues, but also solutions to these issues.
To achieve these sorts of values requires a much different approach to materiality. There is no secret here. The five-step process below should be obvious to practitioners, and yet it is not coming through in sustainability reports, so something is not working:
- Draw on a lot of information sources to create your menu of potential indicators and then quickly pare it down. The reporting guidelines are just the beginning! Ratings, standards, certifications, assessments, social media, employee surveys, media tracking, scenario building, research reports, scholarly articles and even blogs of drivel like this one, all provide useful lists of potential indicators. As you get them, drop them into buckets. Many like the social, environmental and economic buckets, but I find these are too broad and don’t let you throw issues away quickly that are not relevant.
- Good materiality is built on a foundation of good scoring criteria. It is hard to overstate how important this step is. Criteria here refers to, “Why is an indicator important?” For example, if we want to assess importance to the company, how do we break that question down? Perhaps assessments of business continuity, regulatory compliance, impact on revenue, ability to attract talents, etc. would be good aspects to measure. But we can go well beyond internal and external importance. We can develop criteria for the probability of impact, the timeline to potential impact, degree of stakeholder influence who cares about the potential impact, degree of control that the company has on the issue (is this an issue where the company has control, influence or neither), physical scale of the issue (local, regional, global), and on and on. I am not saying that a matrix is wrong, only that it should be the tip of the materiality iceberg.
- Determine the priority of indicators using the criteria The third step in the process is to prioritize indicators. Many, many companies will splash the indicators up on a matrix and then use a consensus of people around the table to move them around the board. It is an interesting exercise and there is no denying that the people around the table have wisdom in these matters. But that wisdom needs to be organized using the criteria or else some other factor will prevail (such as the loudest, most senior or last person to speak). If the collective wisdom suggests that the criteria are not giving an accurate answer, then change the criteria, not the position of indicators on the board. Once you trust the criteria, they can help to guide the company in new and unexpected directions that the people around the table may not have seen coming. At this point, you have a valuable materiality process. Oh, and by the way, as long as you are polling people to test the criteria, get some external voices in as well! At the end of the day, the criteria are the important aspects of materiality, not the position of the indicators on the board.
- Metrics, metrics, metrics The fourth step is to assign metrics to the indicators that will be measured (presumably anything important). I teach a class on sustainability metrics, and I have one prevailing message (hint to any of my students facing the final exam): the metric should reflect the reason that the issue is important. For example, let’s presume that climate change is an important indicator to your company. Is it important because of operational efficiency? Then the metric should be something around energy. Is it important because of upcoming regulation and market mechanisms? Then the metric should reflect the regulatory or market requirement. Is it important because of reputation? Then the metric should reflect the measure that people are reviewing in order to assess performance (e.g. CDP CLI).If you undertake a consistent materiality process including criteria and scoring, then you will know why an indicator scores high and therefore what type of metric best targets the value that you want to achieve. Of course, for many indicators, there will be many reasons it is valuable, and therefore many metrics required. This is yet another reason that companies must look beyond the reporting guidelines which will, in the interest of comparability, suggest a one-size-fits-all metric). Convenience (and comparability and capability) are all important considerations for metrics, but if a company chooses metrics based purely on convenience and comparability to peers, then that company is probably making many poor decisions in its management of sustainability issues.
- Set outputs and commitments from the materiality process So you have gone through the materiality process and an issue pops up as important. What does that mean? Does that mean you disclose performance data? Manage performance? Set targets? Embed in employee scorecards? Add to internal audit calendar? Without some sort of commitment, the materiality process loses any legitimacy. I have seen many good efforts at materiality die because they had no commitment attached and it was eventually seen as a sideline to actual decision-making.
At this point you might be saying, “No, no, we have committed to disclosing our top priority issues in the sustainability report.” Good for you, but there are problems. What about issues that need action but are not yet ready to be discussed in public? What about issues that need better data before reporting? What about issues that are resolved and good for the report, but not overly important to management and risk mitigation? Worse yet, a commitment to reporting and nothing else means that nothing will happen. You won’t act on identified issues. Your performance will slip and next year the issue will drop out of your report because the news is bad. Issues that you identified five years ago will sneak up on you and bite you on the…. You get the point.
To be fair, a lot of the blame for the current state of affairs in materiality must be laid at the feet of the audiences that read these sustainability reports. In a variety of ways, stakeholders give credit to companies that adhere to the letter of the law under reporting guidelines. So if a company reports as in accordance to the GRI, we applaud, check off a box and move on, no matter how vacuous or meaningless the processes are that allowed the company to reach this conclusion. This is simply lazy. Materiality that is meaningless to a company is just as meaningless to an investor, a community member, a regulator, an employee or an advocacy group. The only difference is that while we external stakeholders ascribe some level of credibility to these pointless materiality matrices, the companies that conduct them at least have the good sense to base absolutely no decisions on them.
Todd Cort, PhD, is a faculty member at the Yale School of Management and Yale School of Forestry and Environmental Studies. He also serves as the faculty co-director for the Yale Center for Business and the Environment (CBEY) and adjunct faculty member with the Columbia University Earth Institute. He previously served as director of sustainability advisory services for TUV Rheinland and Det Norske Veritas, where he consulted on sustainability matters including metrics, risk management and auditing practices.
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