Evolution of the Materiality Concept: EU, US and Kenya cases

Materiality is a fundamental concept in accounting and financial reporting that has been around for over 100 years. It refers to the significance or relevance of information in decision-making processes.

The United States Securities and Exchange Commission (US SEC) defines information as material if “there is a substantial likelihood that a reasonable person would consider it important”. In other words, information is material if its omission or misstatement leads to judgement that would have been changed by its inclusion or correction. In practice, materiality helps determine what information should be included in financial statements and what can be omitted without misleading investors and shareholders.

Importantly, materiality is not static – what is material for one company may be immaterial for another, depending on factors such as the company's size, industry and specific circumstances. Additionally, materiality is dynamic – what is immaterial today might become significant tomorrow, especially considering the evolving impacts, uncertainties and increasing risks associated with shifting social expectations, changing regulations and climate change. 

The Emergence of Double Materiality

The concept of "double materiality" has gained prominence, especially in sustainability and ESG reporting. The European Union (EU) adopted the Sustainable Finance Disclosure Regulation (SFDR) in 2019, and the US SEC finalized the revised climate disclosure rules on March 6, 2024. In Kenya, the Nairobi Securities Exchange (NSE) released the ESG Disclosures Guidance Manual in 2021. But what is all the “buzz” around double materiality?

Double materiality expands the traditional concept of financial materiality to encompass both the financial impacts on a company and the company's effects on society and the environment. Double materiality entails two aspects: 

• Financial materiality (outside-in perspective): How sustainability issues affect a company's financial performance and value.
• Impact materiality (inside-out perspective): How a company's activities impact the environment, society, and economy.

This dual perspective acknowledges that companies should report not only on sustainability issues that affect their bottom line but also on their broader impacts. Double materiality reporting is practical for the following reasons:

1. Risk management – integrating sustainability impacts with enterprise risk management offers a deeper insight into both challenges and opportunities.
2. Investor relations – reporting on double materiality can attract capital from sustainability conscious investors.
3. Enhanced corporate transparency – double materiality enables companies to meet stakeholder demands for greater transparency about wider environmental, social and economic impacts of their decisions, thereby enhancing trust and reputation.
4. Alignment of sustainability strategy – incorporating double materiality into a company's reporting ensures consistent growth and business continuity aligned with sustainability commitments.
5. Regulatory compliance – several jurisdictions, such as the EU, mandate that reporting entities conduct double materiality assessments.

Current Regulatory Landscape: EU and US Approaches

The EU has been at the forefront of incorporating double materiality into its sustainability reporting standards. As the first major step, the SFDR adopted by the EU in 2019 mandates that investors disclose not only risks to themselves but also the adverse impacts on both the planet and society.[4] The Corporate Sustainability Reporting Directive (CSRD), introduced in 2023, institutionalized the concept of double materiality. It mandates that reporting entities disclose their environmental and social impacts, thereby establishing a legal compliance requirement.[5] To complement the CSRD, the European Sustainability Reporting Standards (ESRS) outline the reporting standard and methodology.

In contrast, the US has taken a more focused approach. The SEC's climate disclosure rules, adopted on March 6, 2024, primarily emphasize financial materiality. These rules require companies to disclose material climate-related risks and their impacts on business strategy, results of operations, and financial condition. While the SEC rules do not explicitly adopt the double materiality concept, they do require disclosure of material Scope 1 and Scope 2 greenhouse gas (GHG) emissions for larger companies, hereby indirectly addressing some aspects of a company's environmental impact.

The differing approaches between the EU and US highlight the ongoing global debate about the scope of corporate sustainability reporting and the extent to which companies should be required to disclose their broader societal and environmental impacts.

Materiality in the Kenya Context

Currently, ESG disclosure in Kenya remains voluntary. However, the NSE released the ESG Disclosures Guidance Manual in 2021, which offers detailed illustrations, steps and standards to assist companies listed on the NSE in reporting their ESG-related risks and impacts. This manual explains the concept of materiality and provides tools for materiality assessment and reporting, developed with reliance on the Global Reporting Initiative (GRI) Framework.

A notable and progressive aspect of the manual is its coverage of the nature, importance and application of double materiality. The document states:

"Listed companies are [...] encouraged to assess the impact of ESG issues on their organizations [...] in addition to their organizations' own ESG impacts on society [...] when determining material ESG impacts for disclosure”.

Looking ahead, the NSE plans to develop a responsible investment index, drawing on best practices and advancements in ESG reporting and materiality assessment. In addition, the Capital Markets Authority (CMA) expressed support for the adoption of technology in ESG data collection to enhance transparency in ESG reporting. This is in line with CMA’s ambition to leverage technology to enhance efficiency of the capital markets value chain.

Our Recommendations

To navigate the dynamic ESG regulatory environment effectively, EED Advisory recommends that businesses:

• Stay abreast of global trends, regulatory changes and compliance mandates in the ESG landscape, considering variations across jurisdictions;
• Foster ESG awareness at all organizational levels, starting with the company’s leadership;
• Establish a comprehensive Governance, Risk and Compliance (GRC) framework across their organization to bolster and uphold its ESG efforts.

Author: Alisa Reiner

Role: Analyst, EED Advisory