Demystifying Double Materiality: What is it and why does it matter?

In the world of corporate finance and sustainability reporting, the concept of “double materiality” has gained increasing prominence in recent years. While the term may sound complex, its core principles are surprisingly straightforward. In this article, we will delve into the concept of double materiality, cutting through the jargon to reveal its significance and implications for your company.

What is Double Materiality?

First and foremost, materiality corresponds to an organization’s fundamental economic, environmental and social priorities. At its core, double materiality represents a dual perspective on materiality, an essential concept in corporate reporting referring to the aspects of a company’s actions which are relevant to report. Companies, Society and Environment are simultaneously affecting each other. Double materiality, in sustainability reporting, is a framework that recognizes two primary dimensions in assessing materiality for a company: the impact of sustainability issues on the company and the impact of the company on sustainability issues.

1・Internal dimension: Impact on the company

The first dimension of double materiality delves into how sustainability issues can affect the company itself. This involves a comprehensive evaluation of the risks and opportunities that environmental, social, and governance (ESG) factors may pose to the company’s financial performance and long-term sustainability. It underscores the acknowledgment that events such as climate change, social unrest, or regulatory shifts can wield substantial influence over a company’s bottom line. A ‘single materiality’ framework like TCFD stops at this level of materiality.

2・External dimension: Impact on sustainability issues

The second dimension takes a broader view, assessing the company’s role in shaping sustainability issues on a global scale. It recognizes that companies play a pivotal role in influencing environmental and social outcomes through their operations, supply chains, and the products or services they provide. This dimension revolves around considering how a company’s actions contribute positively or negatively to global sustainability goals. ‘Double materiality’ frameworks include both the above internal and this external level of materiality.

How will Japanese companies be impacted?

Japanese companies, like their global counterparts, can reap significant benefits from embracing the concept of double materiality. This framework can be especially important for Japanese businesses for several reasons, ranging from market competitiveness to risk management and responsible global citizenship. Here are some ways Japanese companies can benefit from and why double materiality is essential for them:

1. Enhancing Competitiveness and Market Access : Japanese companies can gain a competitive edge in both domestic and international markets by adopting double materiality. Investors and consumers worldwide are increasingly prioritizing environmental and social responsibility. By demonstrating a commitment to sustainability and transparency through double materiality reporting, Japanese firms can attract responsible investors, secure partnerships, and access markets with stringent sustainability requirements.

2. Risk Mitigation : By assessing their impact on sustainability issues and vulnerabilities to them, Japanese companies can identify and mitigate risks proactively. Climate change, supply chain disruptions, and regulatory shifts can all pose significant threats to businesses. Double materiality enables Japanese companies to develop resilience strategies and adapt to changing environmental and social landscapes.

3. Stakeholder Engagement and Reputation Building: Double materiality encourages transparency and stakeholder engagement. Japanese companies can use this approach to build trust with consumers, investors, and the broader community. It allows them to demonstrate their commitment to responsible business practices and long-term sustainability.

In conclusion, double materiality is not just a buzzword but a strategic approach for Japanese companies to thrive in a rapidly evolving business landscape. By embracing this concept, they can enhance their competitiveness, mitigate risks, access capital, meet regulatory requirements, and demonstrate their commitment to sustainability. Japanese companies that prioritize double materiality can position themselves as responsible global citizens while reaping the tangible benefits of sustainable business practices.

Double Materiality in International Regulations: CSRD

The competitiveness and market access benefits of reporting to double materiality standards are codified in the soon-to-be mandatory Corporate Sustainability Reporting Directive (CSRD). CSRD is a significant component of the EU’s sustainability reporting framework. It builds upon the EU Non-Financial Reporting Directive (NFRD) and is set to be phased in for accounting periods starting in 2024.

One of the central features of the CSRD is its emphasis on the concept of double materiality. This principle requires companies to consider two key dimensions when reporting on sustainability:

Financial Materiality: Companies must report on sustainability matters that are financially material, meaning they have a direct impact on the company’s financial performance, development, and position. This perspective is of particular interest to investors as it relates to the value and stability of the company.
Environmental and Social Materiality: Companies are also required to report on sustainability issues that impact external factors such as the environment, society, employees, and other stakeholders. This perspective is of interest to a broader range of stakeholders beyond investors, including citizens, consumers, business partners, communities, and civil society organizations.

In total, CSRD is expected to cover 49,000 companies, a substantially larger number than the 11,600 companies covered by the NFRD . All companies, including Japanese companies, with subsidiaries in the EU and/or listed on a European market, will be required to report to CSRD standards. For more on CSRD, what it is and who it affects, please check out our EU CSRD article, linked below.