What is Financial Materiality?
Financial materiality - or simply ‘materiality’ - is a historical accounting principle. The term refers to any information that might impact the judgement of an investor. In short, if it is information that could affect an investor's decision, you can consider it material.
Financial materiality of ESG measures financial impacts and risks on the business that relate to sustainability.
More and more, institutional investors are turning to sustainable investing options. Businesses who do not address sustainability in their reporting will increasingly struggle to access capital.
What is a Financial Materiality Assessment?
A Financial Materiality Assessment is a process to determine how external sustainability issues could impact your business financially. You can also refer to it as an ‘outside in’ or ‘inwards’ approach to materiality.
This assessment measures and ranks potential economic effects of environmental, social and governance (ESG) issues on your company.
Through this process, you can strategically allocate resources to address the risks with the greatest financial impact. It helps align sustainability initiatives with business goals, ensuring that efforts in sustainability are also managing financial risks and driving financial performance.
Examples of financial material issues include:
Climate change: The impact of climate change on a company's insurance costs, energy costs, and supply chain.
Data privacy: The cost of complying with data privacy regulations and the cost of responding to data breaches.
Human rights: The cost of remediating human rights abuses in a company's supply chain.
Why should I do a Financial Materiality Assessment?
Conducting a Financial Materiality Assessment is not just a compliance exercise. It’s a strategic and proactive approach to managing risks, enhancing transparency, and building trust with stakeholders - all of which drives overall business performance and growth.
Benefits to the company
Make strategic decisions by identifying financially material factors. This keeps the focus on key aspects that impact financial performance so you can effectively prioritise resources.
Boost investor confidence in your company. Clearly defining what is financially material enhances transparency and fosters investor confidence.
Recognise and manage financial risks. Assessing financial materiality allows businesses to proactively manage risks & minimise impact on financial performance.
Communicate effectively with stakeholders using your Financial Materiality Assessment results. This enhances relationships with investors, customers, etc.
Allocate resources effectively and with confidence. Understanding the financial significance of material topics helps in optimal resource allocation & improving overall efficiency.
Meet regulatory compliance requirements and reduce the risk of regulatory issues.
Stand out in the business world by understanding key financial factors. By doing so, a business can attract investors and gain customers who appreciate responsible practices, leading to long-term success.
Improve financial reporting to be more accurate and relevant. A Financial Materiality Assessment enhances the quality of financial statements and disclosures.
Enhance your reputation and build competitive advantage. Companies that actively assess financial materiality and align their strategies with sustainable practices are likely to build a positive reputation. This can lead to increased brand value and customer loyalty.
ESG reporting standards requiring Financial Materiality
Sustainability Accounting Standards Board (SASB)
The Sustainability Accounting Standards Board (SASB) provides a set of industry-specific standards for disclosing financially material sustainability information. SASB's framework helps companies identify and prioritise sustainability topics that are most likely to impact their financial performance and stakeholders' decision-making processes.
Accounting reports typically focus on a company's current financial status and performance. SASB standards address the sustainability gap by defining operational metrics specific to industries. These metrics target material sustainability topics that can impact a company's financial value - either now or into the future.
International Sustainability Standards Board (ISSB)
The ISSB was launched in 2021 by the International Financial Reporting Standards (IFRS) Foundation, a globally recognized authority in financial reporting standards. The ISSB's primary objective is to develop a comprehensive set of international sustainability standards that can be integrated with financial reporting, providing investors and stakeholders with a clearer picture of a company's sustainability performance and risks.
The IFRS Sustainability Disclosure Standards are based on the well-established guidelines put forth by the Task Force on Climate-related Financial Disclosures (TCFD). Companies that have already adopted TCFD recommendations are in a favourable position to begin implementing the IFRS Sustainability Disclosure Standards.
Task Force on Climate-Related Financial Disclosures (TCFD)
In 2017, the Task Force on Climate-Related Financial Disclosures (TCFD) unveiled guidelines for disclosing climate-related financial information with the aim of supporting companies in offering improved data. The goal was to enhance market transparency and enable better capital allocation decisions.
Today, the TCFD recommendations are being transitioned into the IFRS standards under the ISSB.