Voluntary ESG “Materiality” Assessments — Legal Considerations and Dos and Don’ts

Paul A. Davies, Sarah E. Fortt, and Betty M. Huber are partners and Global Co-Chairs of Latham & Watkins’ Environmental, Social, and Governance practice. This post is based on a Latham memorandum by Mr. Davies, Ms. Fortt, Ms. Huber, Mr. Green, Ms. Grewal and Mr. Pierce. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) by Lucian A. Bebchuk and Roberto TallaritaDoes Enlightened Shareholder Value add Value (discussed on the Forum here) and Stakeholder Capitalism in the Time of COVID (discussed on the Forum here) both by Lucian A. Bebchuk, Kobi Kastiel and Roberto Tallarita; Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy – A Reply to Professor Rock (discussed on the Forum here) by Leo E. Strine, Jr., and Corporate Purpose and Corporate Competition (discussed on the Forum here) by Mark J. Roe.

ESG and Legal Liability Risks

As ESG continues to grow in importance, regulators, investors, and other stakeholders have increasingly sharpened their scrutiny of companies’ ESG actions and reporting. ESG-related disclosures have already triggered claims based on public reporting (or the absence of public reporting) in both formal and informal venues. Additionally, public watchdog groups will likely double down on their attempts to bring about ESG reform via litigation geared towards marketing and other representations. A well-conducted ESG materiality assessment serves as a key step in a company’s process of understanding the ESG risks and opportunities relevant to its business and stakeholders, and in managing possible ESG-related legal liability risks.

While “ESG materiality assessment” has become a term of art, companies should take care to clarify that the term materiality in this context is intended to reflect priority ESG issues, and specifically flag that the term does not carry the same meaning as it does under securities and other laws in the US or other jurisdictions.

Why ESG Materiality Assessments Are Helpful

A growing number of companies are looking to establish, or continue to develop, their ESG strategies, whether due to pressures from stakeholders, regulations requiring more ESG disclosure, or a desire to capitalize on the current opportunities available to ESG-leading companies. Given the number of issues that fall under the ESG umbrella and the vast differences in reporting between industries and jurisdictions, determining the most relevant ESG factors for a company can be daunting. Materiality assessments have become popular tools to inform and prioritize ESG factors based on a company’s key stakeholders and their expectations. By focusing on key priorities, a company can build a more effective ESG strategy.

Even companies that have formed ESG strategies and regularly publish ESG disclosures find that materiality assessments are useful tools for prioritizing, reaffirming, or refreshing their ESG approaches. Current best practice is to refresh the ESG materiality assessment at least every two years.

Finally, companies looking to attract investors that see ESG as an advantage find that materiality assessments can facilitate the development of ESG key performance indicators (KPIs) to measure and track their progress in high-priority areas.

Structuring an ESG Materiality Assessment

The process of conducting an ESG materiality assessment typically entails the following:

  1. Defining the company’s approach to materiality, including what definitions of materiality will be used and how they will be used. Increasingly companies are expected to address both the qualitative and quantitative aspects of their definition(s) of materiality
  2. Benchmarking against peers, competitors, ESG-leading companies, regulatory requirements, and/or prevailing disclosure frameworks, such as relevant industry standards from the Sustainability Accounting Standards Board (SASB, now administered by the IFRS Foundation), the Global Reporting Initiative (GRI), the United Nations Sustainable Development Goals (SDGs), and the Task Force on Climate-related Financial Disclosures (TCFD)
  3. Identifying ESG issues relevant to a company by reviewing internal and external sources
  4. Prioritizing ESG risks and opportunities by consulting with internal and external stakeholders
  5. Finalizing the prioritization of ESG topics by sharing with internal leadership
  6. Developing an ESG strategy, plan, or approach

Typically, a third-party expert is retained to develop and/or conduct the assessment. A third-party expert can add credibility to the process, reducing the likelihood or perception that the company is focusing on the issues it already manages sufficiently, and thereby mitigating possible allegations of greenwashing. An ESG expert can also assist in interviewing internal and external stakeholders, as some stakeholders may be hesitant to share their views openly and honestly directly with the company.

A company’s approach to materiality, both within the context of ESG and outside of it, can have significant legal implications. Therefore, companies should also have their materiality assessment process reviewed by their outside ESG counsel, or consider having ESG counsel assist in the initial conducting of the assessment.

 

 

 

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