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By Donato Calace
2015, and the concept of materiality has emerged, quickly becoming essential for stakeholder engagement exercises and topic mapping while appearing as a keyword in consultants’ pitches. Sustainability professionals around the world clambered to understand the term and the process, outlined by standard setters like GRI and IIRC.
Being a concept borrowed from the accounting and auditing domain, materiality represented the perfect idea to foster the integration of non-financial issues in the mainstream business thinking and decision making. It sounds professional, financially relevant, familiar to investors and auditors.
However, sustainability professionals struggled to sell to their boards the idea of taking non-financial materiality beyond the mere purpose of creating a nice looking visualization in their reports – after all, in most cases it was being approached on the basis of opinions, feelings, trends and whispers. Not robust enough to be applied as strategy compass or in risk identification and assessment.
In other terms, despite its roots in the accounting field, non-financial materiality was (and still is in many cases) determined through a simple aggregation of stakeholders’ opinions on shortlists of topics arbitrarily pulled from internal and external “hunches”, Instead of focusing on systematically provide evidence demonstrating that certain issues have financial, legal, strategic, competitive, or reputational impact.
In short, materiality was considered an art, exclusively relying on internal and external stakeholders’ beliefs, preaching more than explaining why a certain issue should be in the corporate agenda.
But that was before regulators and investors weighed in to require mandatory and consistent reporting on non-financial matters. Mandatory obligation to report on non-financial issues means legal responsibility for the board, which in turn raises the need for disclosure, instead of communication, on non-financial matters.
Technology advancements in the field of big data, natural language processing and artificial intelligence enable new solutions for these emerging needs,improving not just the way we can approach materiality, but also how we think of it: as a science.
“We believe, alongside our clients and other leading companies, that materiality analysis should be evidence-based and backed up by solid objective data, rather than being a representation of someone’s opinion,” explained Datamaran CEO Marjella Alma. “This is a serious exercise that influences corporate strategy, there shouldn’t be a room for subjectivity.”
The data is available
Tjeerd Krumpleman, Head of Business Advisory, Reporting and Stakeholder Engagement at ABN AMRO – third largest bank in the Netherlands – explained why they moved away from a manual materiality process. “ We found that the manual method wasn’t very scientific and it was time-consuming.
Figuring out which material topics to use and who to send the surveys to was one of our biggest challenges. Another challenge was what happens is we overlook a source? This could be new regulation, for instance.Overall, it is easy to end up with questions to the legitimacy of the actual materiality assessment because there are no real standards to follow.”
Zurich Insurance, Switzerland’s largest insurer, previously relied on surveys primarily for their materiality analysis, but survey-only approach didn’t provide a clear picture of the issues. Linda Freiner, Group Head of Sustainability at Zurich Insurance, explained: “It was more of an inside-out perspective than an outside-in perspective, which is extremely important for getting a more accurate and less subjective view of material topics.”
The problem, she says, is that surveys always bring out what you ask for, so you are not broadening your field of vision. “If I go to our average customer and ask what are the global issues that you think Zurich Insurance should be looking at, it would not be quite right,” she explained.
“They would not have a feeling nor an understanding of the issues we as a company are looking at, which is quite a complex exercise. That is why it is important to use a data-driven approach to understand and capture stakeholder opinions correctly."
Another problem associated with how materiality analysis is done is that sometimes it is emotional or driven by someone’s preferences rather than strategic decisions. If a company is really to make a difference, it has to invest in understanding what is it that matters most to their stakeholders internally and externally and where is it that your business can make the biggest change and have the deepest impact.
Freiner explained further why Zurich is also shifting away from survey-only approach. Besides the problem with perception, the main challenge with surveys it is the amount of information needed from the respondents. It is simply unrealistic. “We are asking for a lot of information from someone who is not working in this area on a daily basis. This is one of the main limitations of the survey-only approach.”
Dutch financial services and banking corporation The ING Group (ING) is also leveraging a data-driven approach to materiality analysis, as Nishant Parekh, sustainability consultant, explained: “In 2018 we complemented our quantitative (survey-based) approach with digital data-driven analysis; we integrated our materiality process with Enterprise Risk Management (ERM). At ING, we look at materiality from a broader business lens than just sustainability and always have board-level oversight on our process and outcomes.”
The lack of a standardized approach coupled with the need to comply with a range of non-financial disclosure standards makes it difficult for companies to overcome the challenges mentioned above. It will not be easy to move away from seeing materiality assessment as an art.
However, companies want a scientific method and are demanding a more robust use of data. Some may argue that an artistic license will be required when looking at millions of potentially relevant data points from thousands of sources, because “how can all these sources be fully covered?”
Materiality analysis has become key for strategy, and companies are clear in their message. There is no longer any room for artistic licence. “Materiality analysis findings are being used to guide the implementation of our sustainability ambition in order to focus solution development on the most material issues for creating shared value”, commended Freiner.
A push from the companies
Companies need to get an objective and informative set of issues that will influence the development of business further. I have seen many companies dedicating a lot of resources to the process and the outcome achieved was still incomplete. These companies could not claim that they were well informed and had complete and up-to-date picture of issues that business needed to get to grips with. That is why there is an urgency to go with a fact-based approach to materiality analysis.
There is a difference between getting a feeling for public sentiment by reading some social media posts and analyzing millions of them using Natural Language Process (NLP) techniques and artificial intelligence. One is an art, one is a science.
As an early adopter of the Enterprise Risk Management (ERM) frameworks by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), ING has integrated sustainability into its risk teams. The bank’s sustainability direction is an integral part of their wider corporate strategy called Think Forward. ING wants to put its data to work, so the strategy is driving a move to a more robust materiality analysis.
“Integrating with Enterprise Risk Management makes the overall process more efficient. It also ensures different teams are using consistent information in their respective analysis. Adding a dynamic element—analyzing topic velocity and stage of development—helps better anticipate future business risks and opportunities” said Parekh.
ESG Data Disclosure
Regulators are taking a tougher stance on ESG disclosure according to The Global Insights Report 2018. Since 2013, there has been a 72% increase of the number of recorded regulations concerning non-financial issues. And this trend looks set to continue.
Besides the increase in the number of mandatory regulations, such as the EU Non-financial Reporting Directive, there is a growth of voluntary initiatives. The Task Force for Climate-related Financial Disclosure (TCFD) was developed to help companies provide consistent disclosure around climate-related financial risks and opportunities.
COSO and the World Business Council on Sustainable Development (WBCSD) joint efforts aim to provide practical guidance on assessment and management of ESG risks as part of Enterprise Risk Management (ERM). These coalitions request companies to disclose on material ESG issues, as well as the how and the why.
A shift in technology
The recent developments in technology mean that data that was previously too big to be analyzed by humans can be harnessed to provide companies the much needed data-driven, efficient and credible approach to materiality. Santander UK, in their last sustainability report highlighted the importance of technology.
“We used the power of artificial intelligence to take a data-driven approach to our materiality matrix assessment, providing us with a broader and deeper insight into the issues that matter most to our external stakeholders.“ - the report suggests.
Technology will have the power to replace the dated and expensive manual process for benchmarking, materiality and risk analysis as well as issues monitoring that is time and resource effective. Datamaran, a software that specializes in non-financial risk management uses Natural Language Processes (NLP) to read reports like a human but at unprecedented speed.
Materiality: the new science
Raising investors and regulators scrutiny on the materiality determination process specifically, and new technology coupled with available ESG data, have highlighted that the time is ripe for organizations to make materiality data-driven, allowing for a better understanding of what ESG issues are material for them.