Adopting a materiality mindset

Published: 19 October 2023

10 minute read

In our latest in-conversation, Philip Fitzgerald, Director of the FRC Lab and Michelle Cardwell, a project Manager in the FRC Lab to talk about their recently published report looking at materiality in company reporting. They discuss how materiality can be used as a lens to communicate how companies can communicate what really matters to their business and their stakeholders.

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To another in conversation podcast here at the FARC and today I'm joined by Philip Fitzgerald, our Director of the FRC Lab and Michelle Cardwell, a project manager in RSRC Lab, because we've recently published a report focusing on materiality in company reporting. So thank you Phil and Michel for joining me. Thanks. Thanks for having us. If I start with you, what motivated you and the guys to focus on materiality? Is this an important issue that we're seeing right now? I think it's a very important

two and one many companies are very focused on at the moment. And and why is that? Well, I think annual reports for many companies, I think there's a recognition that they've become longer and more complex and particularly the information in the front half of the annual report. Investors have demanded more information to help them decide where to allocate their capital and other stakeholders have also called For more information to help them decide where to give their custom. What we wanted to do with this is think about how materiality could be used

as a lens in which the company can really communicate or what are the most important matters to them, to their business model, what are the most important risks and opportunities and have that thread going through the annual report. Now of course we recognise there are regulations which companies need to think about when they're deciding what to disclose, but it's also really important that they're able to communicate the key matters that are important to them as a business, but also their stakeholders as well. So that was really the driver for this, to see how companies

really developing their materiality assessments to communicate effectively what's key to the business. So it sounds like it's something that's probably needed or at least wanted across our different stakeholders, which is fantastic. So Michelle, I'm gonna move on to you now because you led on this report. We're obviously encouraging people to read the report on the FRC website, but could you summarise the key recommendations that you found for our listeners? What we've really seen with our materiality report, you know is materiality can be quite a powerful tool

that companies can use when helping them report clearly and a really compelling way. We've had a lot of conversations across the project. We've talked to investors, we've talked to companies and advisers and what we've sort of pulled together for this report is a set of three tools that they can use to apply materiality or apply a materiality mindset when reporting. So the first of these tools is about thinking of the investor needs and decision making. Reporting frameworks define materiality as a factor of information, so information is typically understood to be material.

Omitting, misstating, or obscuring. It could reasonably be expected to influence the decisions of the primary users of financial reporting. So understanding really how your users are going to think about information and how it impacts decision making is quite key. So the first tool we thought about was Drive from our conversations from investors, which aims to understand what core information they look for and how they use that when they're making decisions on where to allocate capital. The second, in our toolkit, is about taking a holistic approach to materiality. So we spoke with

companies to understand how they're thinking about materiality and present and they were looking at it broadly in three separate lenses around quantitative thresholds, qualitative aspects of reporting and now more often in specific sustainability related aspects. So these three lenses there they can be really useful, but what's quite important is to see how they join up and they overlap and to look at this holistically from a business model and strategic point of view. So this second set, our toolkit really looks at how companies can leverage what they're already doing,

bring those things together to look more holistically at materiality. And then finally at the last bit that we focused on is about how you might embed that materiality mindset and reporting. So we've discussed with companies about what sorts of tips they might have and how they could improve their reporting from materiality point of view. And we've collated this into tips that are much more focused in terms of the specific reporting and disclosure aspects for companies. And the combination of these three things we think will help companies to better apply material D to take materiality mindset as they report. I think it's quite interesting

ways. You've just used their materiality mindset and it might not be something that our listeners have heard before. What do you mean when you're talking about a materiality mindset? Yeah, I think this materiality mindset is a really interesting coming from companies. And I think it's a sort of framing point of view for boards and management to really take a more focused and proactive way about thinking about and using materiality both in reporting, but from a strategic point of view. And that's the sort of looking at it holistically and connecting the parts of the business and how it operates and focusing on what's really important as well as the needs of the readers.

You've mentioned there that we've got these three areas and the tips that we go into in the report. So when you were doing your research for this, what areas did you come across that you thought were you could see improvement when assessing materiality and deciding what to disclose? Yeah. So these three areas that companies are typically looking at. So from a quantitative threshold, from qualitative aspects of the business and sustainability reporting, they really can be quite useful for companies, right. So they they often underpin things like financial reporting, controls, other aspects of

the narratives that are are in the end of report. But they interrelate a lot and they're quite dependent and looking at them in isolation for a company doesn't give the whole story. It's reality is about this sort of holistic review of the company. And So what we saw in companies is that one thing they could easily do is to join up these assessments better. You know see a lot of these things are quite informal, but if you were to bring together these processes, you'd have a better view of the history of the company as a whole. So Michelle mentioned the board when she was talking about some of the tips that we set out in the report.

What role do you think the board has in overseeing materiality boards and management understand their business best and the value drivers in depth. And whilst of course they've got to think about what users are going to do with that information, actually they're the ones who are best placed to say, well, this is important to the business. This is the thread if you like or the key communication aspects that we want to get across in our reporting. And I think to communicate clearly and compellingly, boards and management really have to apply judgement and determine what

information is material for reporting. They have a key role in bringing all of the aspects of the company together to do a really good holistic materiality assessment. So Michelle, we'll just just mentioned there that the Board should be thinking about how the end user is going to be using the information. How should companies be thinking about the needs of investors when they're making materiality judgments? So the reporting standards and guidance that underpin reporting it, it makes it clear that the investor information needs and decision making is key

for understanding what's material information. But this can be challenging for companies because there's no single archetypal investor. Investors have different strategies and approaches. But if you think about what they have in common and you think about their common information needs and their common objective, which is to make a return on their investment, you could pull out the sort of things that are broadly useful information for them. The questions we've heard from investors include questions like how does a business generate value, What's the future strategy?

What are the potential risks there? And really as Phil said that the board and management their best place to to be able to answer those and to understand what aspects of those are really important and investors tell us that's really important to them. They really want to understand management and the board. Their view, that's key for them to sort of assess and understand whether they want to make an investment in that entity, right. So this is about the board understanding investors, investors understanding the thought processes of management. It's a nice round circle that you mentioned a little bit earlier on as well.

One of our steps was taking a holistic approach to materiality and I think that goes across financial and ESG topics. That sounds like it could be quite complex. How can companies actually go about doing that in practise? Yeah, I think doing that in practise, well, it's complicated actually. Companies are well placed to start doing this because they already have quite a lot of formal and informal assessments from materiality. The thing that we so often is that these could be separate or not always well joined up. Some things are more or less documented or or formalised,

but I think one starting point they can do is to to get the right people together and evaluate what they're already doing and how they can join up those things and also assess where those gaps might be. I think it's really key from a practical starting point, bringing the right people together, so diverse teams across the organisation has been really helpful. For the companies we spoke to, those who are doing this well, they found if you bring in those different voices, they express a wide range of views across the organisation. But they can also sort of give you a sense check on from a completeness point of view. You know, are you missing anything

crucial And they'll know what's being done. And by connecting those dots you can see where the gaps are in terms of what you're assessing, you know, assessing materiality, it's it's not an easy task but you know it's it's quite worthwhile. This holistic view that you can build up from the company can lead into wider conversations and and helps develop and refine controls and processes. The report has a number of tips and steps that companies might find useful that we've pulled together from our conversations with other organisations during this project. Some people listening,

I'll be thinking, well, it sounds like it's quite a lot of information. And I know something that we're keen to see is these reports not getting longer and longer and longer in perpetuity. Do we give any advice to companies on cutting down clutter in their annual reports?

Yeah, absolutely. And that is a common challenge that companies told us about. It's quite hard to sometimes remove information when it goes in, but we've got a few practical tips in there that companies we spoke to told us about. So for example, one company we spoke with, they talked about how important senior buy in was for them to be able to reduce their report. Their CEO set a target of a 25% reduction. And from a finance team's point of view, that was really helpful for messaging for all of the different people involved in the report. And it helped to sort of share the burden

and made sure everyone bought into the process and in it together. We had others who told us that, you know, sometimes they start from a blank sheet of paper. Now that might sound really hard because the annual reports are complex, so some way of making it manageable. Some companies actually just pick certain sections and then on a rolling basis go through their annual reports. Others told us that when they're handing over templates, they actually delete the text from the previous year. And that helps remove that temptation to sort of just roll language forward and add onto the bottom. It was a really helpful thing they said.

But I guess when we were talking about removing clutter and cutting down page count is we just need to say you know it's it's still important to remember that the annual report and accounts still needs to meet all your legal and regulatory obligations. We've spoken about getting a lot, a lot of information, the holistic view of the organisation I think which could be really helpful. I mean how come this materiality process and the materiality mindset link up with the broader strategy and risk discussions that are happening across the organisation? Yeah, absolutely. So materiality is intrinsically linked to the business

and strategy and identifying what matters is this is a useful input for strategic planning but also for identifying and refining controls and processes. So I think one of the areas that could help with linking it to strategy is you know when you're, when you're thinking about materiality is challenging yourself and asking from a sort of completeness point of view, how are these issues connecting to your business model and strategy, to your commitments, your future plans. You know, how consistent are the things you're talking about with what the board is talking about. Are they the same sorts of metrics and data they review

and internal budgets and risk registers, those aspects of it, How are they tied in with the processes and then how do they feedback from it as well? Are there lessons learned? So we sort of see this as a cycle that can feed into it and that the materiality assessments should be very much reflective of the conversations, the strategic conversations across the organisation think taking this holistic view of it, you know, it helps identify issues. They're not only of interest to investors, but they're really helpful from how the business runs more effectively

and sustainably. It can feed into developments of the rest of the organisation. But there's a lot to think about there and and much more in the report itself, which again, I would encourage anyone listening to go and read on the FRC website. Phil, I'm gonna turn back to you. And because there is a lot to take away. What 1 tip would you like people to take away from this report? So I think materiality is an incredibly complex thing to do and this report is not going to give all the answers. But what I really want companies to take

on this is to really start articulating how you've covered your materiality assessment across the piece that, you know, joining up these processes, as Michelle has talked about and really putting that to boards. To think about materiality across the whole piece and articulate that I think that's what we're really sort of challenging companies to do. And this is really the starting point for very much a focus on this materiality mindset that we're going to be having at the FRC. Fantastic. Well, it sounds like with this being the starting point, there's more to come,

in which case I look forward to speaking to you both on that as it comes through. But thank you so much for joining me and thank you to our listeners. Thank you. Thank you.