- Financial materiality assesses how sustainability issues affect the company's performance and risks (the "outside-in" side).
- It identifies risks, dependencies and opportunities (notably climate-related) bearing on the business model.
- It complements impact materiality to form double materiality.
- Financially material issues must be disclosed, documented and audited.
As part of the preparation for the European CSRD directive, we are producing a series of articles on Double Materiality. We continue with an article dedicated to Financial Materiality, and to the risks, dependencies and opportunities that the company must identify as material.
While all aspects of the acronym ESG (environment, social, governance) must be taken into consideration when identifying material themes for the company, today we are zooming in on the topic of climate, to illustrate our article.
To understand the origins of Double Materiality, you can consult our previous article.
What is financial materiality?
Financial materiality, in the context of ESG reporting, represents sustainability topics (or even ESG themes) that are important for the value of the company in the short, medium and long term.
This perspective (in comparison to the Impact materiality which we will develop in a future article) includes all the risks and opportunities related to sustainable development that may positively or negatively affect the development, performance and position of the company in the short, medium or long term and therefore create or erode its corporate value.
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What are the risks of climate change for businesses?
The risks of climate change to a company's financial performance can be classified as physical risks or transition risks.
Transition risks
Transition risks are business risks that arise from the transition to a low-carbon and climate-resilient economy. They include:
| Transition risk type | Example |
|---|---|
| > Political risks | For example because of energy efficiency requirements, carbon pricing mechanisms that increase the price of fossil fuels, or policies to encourage sustainable land use. |
| > Legal risks | For example, the risk of litigation for not having avoided or minimized negative impacts on the climate, or for not having adapted to climate change, or even climate regulation may mean that some of its products and services are no longer relevant. |
| > Technological risks | For example, if a technology that has a less damaging impact on the climate replaces a technology that is more damaging to the climate. |
| > Market risks | For example, if the choices of consumers and businesses shift towards products and services that are less harmful to the climate. |
| > Reputation risks | For example, the difficulty of attracting and retaining customers, employees, business partners, and investors if a business has a reputation for harming the climate. |
Physical risks
Physical risks are risks to the business that arise from the physical effects of climate change. They include:
| Physical risk type | Description |
|---|---|
| > Acute physical risks | They are the result of particular events, especially meteorological ones, such as storms, floods, fires or heatwaves, which can damage production facilities and disrupt value chains. |
| > Chronic physical risks | They result from longer-term climate changes, such as temperature changes, rising sea levels, reduced water availability, loss of biodiversity, and changes in land and soil productivity. |
Dependence on natural capital
Many businesses are dependent on natural capital. If natural capital itself is threatened by climate change, the business will be exposed to climate-related risks, including physical risks.
Businesses should therefore carefully consider their dependencies on natural capital when identifying and reporting on their climate-related risks.
For example, an agricultural production business may depend on various natural assets such as water, biodiversity, and land and soil productivity, all of which are vulnerable to climate change.
Such a company is therefore expected to explain these dependencies when reporting on its climate-related risks.
Climate-related opportunities
Climate-related risks can often be converted into opportunities by businesses that offer products and services that contribute to climate change mitigation or adaptation.
Adapting to climate change is about anticipating the negative effects of climate change and taking appropriate measures to prevent or minimize the damage they may cause.
It includes business opportunities such as:
| # | Opportunity |
|---|---|
| 1 | New technologies allowing for more efficient use of limited water resources or the construction of new defences against floods, for example. |
| 2 | Climate change mitigation which refers to efforts to reduce or prevent GHG emissions. |
| 3 | Renewable energies or building development and more energy efficient transport systems are examples of business opportunities associated with mitigation. |
| 4 | The taxonomy of sustainable economic activities, proposed by the Commission as part of the action plan on financing sustainable growth, aims to identify and classify climate-related opportunities. |
