By Matt Mooney
In the world of corporate sustainability practitioners, “double materiality” can be one of the most foundational and yet most confusing concepts—and that’s saying something.
At a high level, double materiality is not all that complex. It refers to two different criteria for assessing sustainability topics for significance and relevance to an organization:
- Financial materiality – the upside (opportunities) and downside (risks) that sustainability topics have on an organization, sometimes referred to as “outside-in”
- Impact materiality – the effects of an organization’s activities on people and the environment, sometimes referred to as “inside-out”
Analyzed together, they constitute a double materiality assessment (DMA).
What can make double materiality and a DMA challenging are three common pitfalls:
- Abstract concepts: Assessing financial and impact materiality can require a lot of brainpower to consider different scenarios and stakeholder perspectives. Sustainability practitioners may also be less familiar with financial materiality.
- Treatment as a compliance exercise: As a requirement of the European Sustainability Reporting Standards (ESRS) and associated Corporate Sustainability Reporting Directive (CSRD) that also links to the GRI Standards, organizations often see a DMA as a limited checkbox for reporting rather than as a strategic management tool for decision-making.
- Lack of a clear path to action: Even when a DMA is done well, organizations often lack a clear plan for how to use the new insights to guide decision-making.
Below are some ways to tackle each of these pitfalls to help clarify what double materiality is and why it matters.
What is Financial Materiality?
Financial materiality is a concept rooted in finance and risk management functions. It is often defined by a quantitative threshold (usually using company profit as the metric) that establishes the level at which a topic becomes significant enough to require management attention.
This concept is very relevant for publicly traded companies which have regulatory requirements to disclose any financially material information or misstatements that could reasonably influence an investor’s decisions.
In the context of double materiality, financial materiality focuses on sustainability-related risks and opportunities that could affect a company’s profitability. Risks represent the downside effects (such as cost increases or revenue decreases) while opportunities represent upside effects (like cost decreases or revenue increases).
What should a financial materiality threshold be? Larger, publicly traded companies usually have established systems for defining financial materiality thresholds driven by regulatory compliance. These systems are managed by finance, Enterprise Risk Management (ERM), and audit teams.
Smaller, private companies often have less formal systems and thresholds, though a common benchmark is 5% of profit-before-taxes.
Either way, a company’s finance and risk leaders are key stakeholders to inform and participate in any financial materiality analysis in a DMA to be consistent with company standards and maximize credibility.
Avoid the “Checkbox” Trap—and Make it Actionable
One of the most common traps for sustainability teams is treating a DMA as a compliance “checkbox” exercise for ESRS or GRI. This mindset often results in a rushed process that fails to deliver insights or additional value.
There are a few approaches that can help avoid this trap:
- Connect to top business priorities: If growth is a big theme, look for how sustainability topics could be slowing that growth down, such as the inability to have good answers for customer RFPs. If costs are a big topic, look for sustainability links to decrease costs or avoid future costs.
- Use real examples to generate buy-in: Identify tangible pain points associated with sustainability — like a lost customer, recent fine, or employee retention challenges — and show how those examples connect to larger impacts, risks, or opportunities for the organization.
- Engage key stakeholders early: Plan to involve cross-functional internal teams (such as finance, risk, operations, and sales) as well as any priority stakeholder voices (such as customers, NGOs, and community groups) from the start. Their input provides essential credibility and helps translate IROs into actionable steps.
- Define actionable next steps: Don’t stop at a list of topics—identify owners, what good looks like, and how to embed each material IRO into management systems and decision-making processes.
Why It Matters
Ultimately, double materiality and DMAs are meant to improve the decisions of an organization’s leaders to include both financial and impact-based considerations. Done well, a double materiality assessment (DMA) can reveal valuable key insights for managing a company:
- Clarify which sustainability topics (like climate change) matter most to the organization and pinpoint the specific aspects that make them significant.
- Identify critical integration points and gaps between business functions (such as between sustainability and sales teams) so that material IROs are managed cohesively and not in silos.
- Provide a clear purpose and prioritization for a company’s sustainability program that helps tell its unique sustainability story.
This kind of clarity and integration about why and how sustainability is relevant to your company is important, particularly amid the current backlash on ESG and other topics. The detail from a good DMA shifts the conversation away from ideological debates and toward discussion about how to build a strong, more responsible business.
To learn more about how a DMA can be valuable for your company, contact 3R.