Assessing materiality and verification of sustainability disclosures

Thu 15 Feb 2024

In environmental, social and governance (ESG) reporting, materiality is crucial for enhancing transparency and accountability in sustainability and climate-related disclosures. Importantly, it helps identify and report on matters that are deemed significant, emphasizing their relevance to stakeholders. 

Materiality comes in various forms. Financial materiality focuses on sustainability issues impacting financial performance, aligning with annual financial reporting criteria. In comparison, impact materiality considers a company’s effects on stakeholders and broader society, encompassing social and environmental impacts. Double materiality involves both financial and impact considerations. 

According to the latest Mazars’ survey Sustainability practices stocktake: How banks and insurers have progressed, most banks and insurers in the survey adopt the double materiality approach for sustainability reporting, but challenges persist. While this approach offers a comprehensive view of sustainability performance, it requires a nuanced understanding of both financial and impact-related material issues. In the context of reporting requirements, financial services companies also need to assess the challenges associated with adopting a particular materiality concept.

Strong support for double materiality from regulators

Double materiality has garnered strong support from European Union (EU) regulators and is considered best practice for non-financial information disclosure. The upcoming European Sustainability Reporting Standards (ESRS), which is being phased in for reporting periods commencing since 1 January 2024, mandate the adoption of double materiality. This signifies a significant shift towards harmonising sustainability reporting practices and aligning them with the double materiality approach, particularly within the EU and its associated regulatory framework. 

Despite the EU and subsequent industry push for double materiality to become the norm within sustainability reporting, there is still a way to go in establishing global standardisation and adoption of the concept. For example, the IFRS Sustainability Disclosure Standards requires companies to disclose information about sustainability-related risks and opportunities that could reasonably be expected to impact the company’s prospects, such as cashflows and access to finance or capital. 

Key consideration points when verifying sustainability disclosures

The ability to produce sustainability-related disclosures and financial statements simultaneously poses challenges, especially regarding data availability and verification. New regulations exacerbate these issues for banks and insurers.

However, there is no one-size-fits-all approach to the verification of sustainability disclosures. Financial institutions employ various methods, including internal audit and independent third-party specialists depending on their size and regional preferences, highlighting the diverse landscape of sustainability verification in the industry. 

Based on survey results, the data reveals that the verification of sustainability disclosures is distributed relatively evenly between external parties and internal audit departments within banks and insurers. Each approach, whether internal or external verification, offers valid and tangible benefits. 

For financial institutions that have yet to initiate the verification process, several considerations come into play. Before choosing between internal and external verification, companies must assess their readiness. For external verification, evaluating the robustness of reporting processes to ensure they can withstand external scrutiny is crucial. 

Internal verification requires effective collaboration across relevant parties responsible for sustainability-related disclosures. The responsible individuals or committees must be comfortable with the information produced and published. Additionally, the risk department, compliance teams and internal audit can contribute by assessing risks, process mapping and designing effective controls. These considerations underscore the importance of careful planning and collaboration when verifying sustainability disclosures, whether internally or externally.

ESG disclosures are pivotal for understanding how firms address sustainability and climate-related risks and opportunities. Meeting the challenges of sustainability disclosures not only requires a clear understanding of materiality but also depends on the institution’s specific circumstances and preparedness for the verification process. Careful planning is now required to understand options available and how different approaches impact sustainability disclosures.

Financial services firms are facing growing expectations for sustainability-related disclosures from both regulators and various stakeholders. Striking a balance between meeting these disclosure expectations and managing the associated challenges is a critical endeavour.