Double Materiality in Sustainable Investing: The Subtle Art of Influence

A Practical Approach with Consultancy Expertise

In the world of sustainability, the term “double materiality” has become something of a buzzword, shimmering with the promise of holistic insights into environmental, social, and governance (ESG) impacts. But the complexities of its application become evident when examined through the lens of an investor. Unlike a traditional corporation, an investor doesn’t just answer to a singular board or a focused group of stakeholders. Instead, they operate within a vast ecosystem of portfolio companies, stakeholders, and societal expectations, all of which create a unique challenge when conducting a double materiality assessment.

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The Context of Double Materiality

At its core, double materiality expands the traditional definition of materiality in two directions: inward and outward. On one hand, it examines how ESG issues affect the financial performance of a company (known as financial materiality). On the other hand, it explores the company’s impact on the world around it (impact materiality). For an investor managing a diversified portfolio, understanding both dimensions is a tall order, and it requires reconciling sometimes competing objectives.

The Web of Influence

An investor typically sits at the center of a network of companies, each with varying degrees of ESG maturity and risk exposure. The crux of the problem lies in the fact that while traditional materiality assessments focus solely on the organization conducting them, an investor must assess materiality across the spectrum of their portfolio holdings. Here’s where the influence paradox emerges.

As an investor, your organization doesn’t directly control each portfolio company, nor can it mandate uniform ESG policies. The influence an investor wields varies across holdings: from majority-owned companies where ESG expectations can be set and measured, to minority investments where influence is often limited to a voice rather than a vote. This disparity creates a challenge in applying double materiality principles consistently.

Large vs Small Investing Organizations 

The paradox of influence in double materiality assessments plays out differently for investors with small teams versus large teams. Small teams often have the advantage of agility and can make decisions more quickly. They can also develop closer relationships with portfolio companies, fostering stronger alignment and engagement. However, their limited resources can make it challenging to conduct comprehensive materiality assessments across a diversified portfolio.

On the other hand, large teams with dedicated ESG professionals and data analysts have the capacity to conduct more in-depth assessments and leverage sophisticated tools. They can also allocate specialized resources to different portfolio segments, ensuring a tailored approach. However, the sheer size and complexity of their portfolios can make it difficult to achieve a cohesive view of materiality across the organization. Additionally, larger teams may face bureaucratic hurdles and slower decision-making processes, which can hinder their ability to respond quickly to emerging ESG issues.

As a small organization, it’s important to note that the day-to-day operations may have lower impacts on the environment and society than their investments, adding to the decision-making challenge. Small organizations should consider this when conducting materiality assessments and making investment decisions.

Navigating the Influence Paradox

  1. Mapping the Ecosystem: The first step for any investor is to conduct a thorough mapping of their portfolio to identify where influence lies. Start by categorizing portfolio companies based on ownership stake and governance structures, identifying those where your influence can be effectively leveraged.
  2. Customized Materiality Frameworks: Develop adaptable materiality frameworks tailored to different influence zones, industry, and geographic context. For majority-owned or highly influenced companies, align materiality assessments with investor ESG priorities. For minority stakes, advocate for better transparency and support them in aligning their own assessments with global standards.
  3. Engagement Over Enforcement: The power of influence doesn’t solely rest on ownership stakes. Effective engagement strategies—like dialogues, collaborative initiatives, and proxy voting—can drive change even in minority-held investments. Investors should prioritize constructive engagement to guide portfolio companies toward better ESG practices. Even in situations involving minority stake ownership, we must not discount the immense impact that a single question can generate.
  4. Data Aggregation and Storytelling: Unlike traditional companies that produce a single sustainability report, investors must aggregate ESG data across disparate entities. By creating comprehensive dashboards and narratives that highlight both financial and impact materiality across the portfolio, investors can communicate the broader sustainability story to stakeholders.
  5. Industry Collaborations: Industry-wide collaborations offer a way for investors to amplify their influence beyond direct holdings. Initiatives like Climate Action 100+ and the Principles for Responsible Investment (PRI) provide frameworks and coalitions that help standardize ESG expectations across sectors.

Redefining Materiality Outputs for Investors

One of the most significant challenges investors face when conducting double materiality assessments is how to consolidate the results into coherent, actionable outputs. Should they conduct separate assessments for themselves and their portfolio companies, or is a blended approach more appropriate?

Multiple Materiality Assessments vs. Blended Approach

The choice between separate assessments and a blended approach hinges on the investor’s objectives and the nature of their portfolio.

Separate Assessments

Conducting separate materiality assessments involves evaluating material topics for the investor organization itself and conducting distinct assessments for each portfolio company. This dual approach allows for a deep dive into specific issues at both levels:

  • Investor-Level Materiality Assessment: Focuses on how ESG issues directly impact the investor organization, considering stakeholder expectations, regulatory requirements, and the investor’s overall impact footprint. This assessment typically identifies broader themes like responsible investment policies, transparency, and engagement strategies.
  • Portfolio Company Materiality Assessments: Involves working with individual portfolio companies to assess their material topics. Here, the investor’s role shifts to guiding companies toward best practices and helping them identify issues crucial to their industry and stakeholders and generate sustainable returns: financial, environmental and social.

Steps to Implement Separate Assessments

To implement separate materiality assessments at the investor and portfolio levels, you can apply the standard Double Materiality Assessment process outlined in our SaaS Framework:

  • Step 1: Planning the Assessment
    1. Establish objectives and scope
    2. Build a strong assessment team
    3. Allocate resources and develop a timeline
  • Step 2: Identifying Relevant Topics
    1. Review internal factors (policies, risk assessments, sustainability reports)
    2. Consider external standards, trends, and stakeholder inputs
    3. Create a preliminary list of relevant topics
  • Step 3: Conducting Stakeholder Engagement
    1. Identify key stakeholder groups
    2. Engage stakeholders through surveys, interviews, and workshops
    3. Consolidate and analyze input to understand stakeholder priorities
  • Step 4: Assessing Double Materiality
    1. Evaluate impact materiality (severity and likelihood of impact)
    2. Conduct financial materiality assessment (effect on financial position and cash flows)
    3. Develop a prioritization matrix based on impact and financial materiality
  • Step 5: Validating the Results
    1. Internally review results with senior management and relevant departments
    2. Conduct public consultation to gather additional insights (optional)
    3. Present results to the board or governing body for final review and approval
  • Step 6: Integrating Findings into Investment Process and Reporting
    1. Draft a materiality matrix to visually plot prioritized material topics
    2. Develop methodologies for integration and management of material topics into each phase of the investment lifecycle – from screening to exit
    3. Integrate findings into sustainability or integrated reporting
    4. Highlight how the organization addresses material topics and manages risks and opportunitie
  • Step 7: Continuous Monitoring and Improvement
    1. Develop a plan for ongoing monitoring and improvement
    2. Regularly review and update the materiality assessment
    3. Continuously evaluate and enhance the stakeholder engagement process

Read the full Materiality article for more details. 

Advantages

  • Clear differentiation between the investor’s own material topics and those of portfolio companies.
  • Tailored strategies can be developed for engagement and influence at the portfolio level.
  • More granular insights into ESG risks and opportunities across different sectors.

Challenges

  • Time-consuming and resource-intensive, especially for diversified portfolios.
  • May require significant data-sharing and cooperation from portfolio companies.

Blended Approach

A blended approach involves creating a unified materiality matrix that integrates both the investor’s direct material issues and those across their portfolio companies. This requires synthesizing data from individual assessments into a cohesive framework that reflects overall priorities.

Steps to Implement a Blended Approach

  1. Portfolio Segmentation: Group portfolio companies based on sector, influence, and ESG maturity levels.
  2. Unified Framework: Develop a common framework that aligns investor priorities with key ESG issues across segments.
  3. Data Aggregation: Aggregate materiality data from individual assessments into a centralized matrix.
  4. Prioritization: Prioritize issues based on their combined financial and impact materiality across the portfolio.
  5. Stakeholder Engagement: Conduct investor-level stakeholder engagement to validate the matrix and refine prioritization.

Advantages

  • Offers a high-level view of ESG risks and opportunities across the portfolio.
  • Streamlines reporting by providing a unified story for stakeholders.
  • Facilitates strategic alignment between investor policies and portfolio company practices.

Challenges

  • Risk of oversimplifying material issues due to data aggregation.
  • Potential dilution of sector-specific insights.

Best Practice: A Layered Matrix

To capture the best of both approaches, investors should consider a layered materiality matrix that incorporates both individual and blended assessments:

  • Layer 1: Investor Materiality Matrix
    This top-level matrix identifies material topics directly relevant to the investor organization itself, such as responsible investment policies, regulatory compliance, and transparency.
  • Layer 2: Portfolio Materiality Matrix
    The second layer integrates key material topics across portfolio companies, highlighting sector-specific and cross-cutting issues. It provides a high-level view of portfolio risks and opportunities.
  • Layer 3: Segment-Level Matrices
    These matrices offer more granular insights by segmenting portfolio companies based on industry, ESG maturity, or ownership influence. Segment-level matrices provide a bridge between investor-level priorities and individual portfolio company materiality.

Crafting a Coherent Narrative

By adopting a layered matrix approach, investors can produce comprehensive materiality assessments that capture the nuances of both their own organization and their portfolio companies. This structure enables investors to craft a coherent sustainability narrative that resonates with stakeholders, providing clear insights into where influence can be best leveraged to drive sustainable change.

For investors seeking to de-risk their portfolio while fostering value creation at the portfolio company (portco) level, a structured approach to materiality assessment is essential. By understanding the ESG issues that matter most to both investors and portcos, investors can prioritize engagement efforts, support portfolio companies in addressing material risks and opportunities, and ultimately enhance long-term value creation. This not only mitigates potential financial risks but also positions portcos for sustainable growth and resilience in an increasingly ESG-conscious market.

Ultimately, the double materiality assessment for an investor isn’t just a sustainability exercise—it’s a storytelling challenge. The investor’s story weaves together the ESG ambitions of dozens or even hundreds of portfolio companies into a coherent narrative of sustainable impact. And it’s this narrative that ultimately differentiates responsible investors in a rapidly changing world.

Continuing with the SaaS Framework

This discussion on Materiality is part of our comprehensive “Sustainability as a Strategy (SaaS)” approach. To gain a complete understanding of how these elements integrate and complement each other to fortify your organization’s sustainability initiatives, we encourage you to read the complete SaaS article. Explore the entire framework to discover how each component works synergistically to enhance your company’s sustainability practices and ensure long-term success in a rapidly evolving business environment.

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