Many commentators have questioned why the FRC has not provided more guidance. Richard Moriarty, CEO of the FRC is clear that this would be inappropriate. Boards know their organisations best. And they should know what is important. Its for directors to make the critical judgement of what commitments and disclosures matter most to stakeholders. And to use this to establish the guiding principles of scope and materiality that determine the work that is required to assess and maintain internal control systems.

Materiality and double materiality

The concept of materiality is well understood by most interested parties in the context of financial disclosures and commitments. Where a reported disclosure has the potential to impact or change the decision of a user (most commonly investors) it is considered to be material. External auditors have devised a mechanism for putting a financial value to this using percentages of revenue, profitability or asset values.

However, non-financial reporting, disclosures and commitments are not so straightforward. How do you think about statements that are not quantifiable e.g. the commitments you make about behaviours toward vulnerable customers under the Consumer Duty Act? And how do you think about materiality when the consequences of risks or controls not operating are to do harm to people or the environment? A more sophisticated approach is required.

Increasingly we are seeing a discussion of double materiality. This considers not only the traditional definition of materiality above, but also attempts measures the impact that the company has on other outcomes that matter to the stakeholders of the company. These stakeholders might be the workforce, suppliers, customers, regulators or society as a whole. S172 of the Companies Act introduced this thinking with the requirement to consider the needs of a wider group of stakeholders. The new Code creates a practical extension of this.

What does a structured approach to materiality look like?

Determining how to work with this wider definition of materiality must start with a Board level debate. We have created the following eight-step framework:

1. Identify who your critical stakeholders are. Whose decisions, if impacted, would represent a material concern? Who do you need to maintain the confidence of to deliver you strategic objectives? Who has the potential to create reputational harm?
2. Be clear on what matters to these stakeholders. Which of the multitude of commitments you make in financial and non-financial terms really matter? Will they change their decisions or engagement with your company if these commitments are not accurate or change? 
3. Capture your mandatory legal, regulatory and ethical obligations. Beyond the issues that individual stakeholders are concerned about where do you have an obligation to ensure disclosures are accurate and balanced? Are there additional ethical considerations?
4. Review your existing risk appetite. Does the way you talk about risk appetite and tolerance adequately inform you of what is important? Are there critical measures that need to be embedded in your materiality evaluation and assessment?
5. Workshop the impact of changed information. How would your stakeholders respond? Can you use scenarios to identify where risk appetite understanding and evaluation needs to change?
6. Create a materiality matrix. Can you visualise stakeholders and map from the top down what matters sufficiently to change their decisions? Do you need to also include additional non-negotiable legal and regulatory obligations?
7. Map your commitments and disclosures within the matrix. How are your financial, operational, compliance and regulatory disclosures and commitments incorporate within this matrix? Is there anything that is not properly reflected?
8. Map your control frameworks and move into a controls assessment analysis. How does this understanding of materiality translate into the next phase of work required to meet the UK Corporate Governance Code expectations?

Accountability and consequences

There is a clear question associated with this. Where does ownership of the process lie? We are clear that accountability and responsibility for the judgements lies with the Board. However, there is a need for expert facilitation. Here there is an obvious role for internal audit: this is where the greatest professional expertise will generally be found (particularly outside financial services organisations). Safeguards need to be incorporated to ensure independence is not compromised. 

We may get more guidance and learn from best practice over time. But in the meantime, there is a pressing need for Boards to lean into this discussion and to recognise the consequences it has for their teams. 

Addressing this early will allow for effective planning and be more efficient. It might also reveal something of significance to the wider organisation. Where are the unknown, unknowns that matter?