Double Materiality Assessment under CSRD – 1 Best Guidance on Implementation

Double Materiality Assessment under CSRD – 1 Best Guidance on Implementation

Overview Double Materility Assessment

  • The double materiality assessment involves three steps: (1) understanding context, (2) identifying material topics and their impacts, and (3) assessing materiality, leading to the preparation of a final list for sustainability reporting
  • Reporting needs to cover the assessment process and the outcomes in accordance with ESRS 2 IRO-1, ESRS 2 SBM-3, and ESRS 2 IRO-2
  • CSRD’s materiality assessment aligns GRI’s impact focus, integrates IFRS from ISSB for financial materiality, and considers international due diligence outcomes
  • EFRAG has drafted a set of guidelines for carrying out a double materiality assessment in accordance with the CSRD regulations

Note:

GOV = Governance: the governance processes, controls and procedures used to monitor and manage impacts, risks and opportunities;

SBM = Strategy: how the undertaking’s strategy and business model(s) interact with its material impacts, risks and opportunities, including the strategy for addressing them;

IRO = Impact, risk and opportunity management: the process(es) by which impacts, risks and opportunities are identified, assessed and managed through policies and actions; and

MT = Metrics and targets: how the undertaking measures its performance, including progress towards the targets it has set.

Double Materiality: determining both the importance of sustainability issues on the company’s performance (i.e. financial materiality) and the external impacts of the company’s activities on the economy, the environment, and people (i.e. impact materiality).

EFRAG (European Financial Reporting Advisory Group) has provided an Implementation guidance for the materiality assessment.

  • Impact materiality
    Includes impacts connected with the undertaking’s own operations and upstream and downstream value chain, including through its products and services, as well as through its business relationships.
  • Financial Impact Materiality
    Requires disclosing all sustainability/ESG issues that are likely to significantly affect your company’s financial health and operational performance. For this, you can rely on non-monetary and monetary quantitative as well as qualitative datasets.

Double Materility Assessment – How to do it?

EFRAG describes three main steps for conducting a materiality assessment:

  1. Understand the context and define stakeholder involvement
  2. Identify potential material topics and their impact, risk and opportunities
  3. Assess the materiality of the identified impacts, risks and opportunities to determine the final list of material topics

The aim of these steps is to obtain a list of material impacts, risks and opportunities to report on.

In the following, you can find an over view of the steps to perform a materiality assessment:

Double Materiality Assessment under CSRD

Step 1 in Double Materility Assessment – Understand the Context and Define a Strategy for Stakeholder Involvement

1.1 Analyze your company’s activities, business model, business relationships and value chain (upstream and/or downstream)

  • Review your company’s business plan, strategies, financial statements, and investor-related information (if applicable)
  • Map business activities and products/services in relation to their geographic locations
  • Map the type and nature of economic relationships and the upstream and/or downstream value chain
  • Identify the scope of information for the reporting regarding your company’s own operations and the value chain

1.2 Analyze your the legal and regulatory environment

  • Factor in relevant EU and sector specific regulation
  • Analyze media reports, peers and benchmarks, as well as other publications and scientific articles on sustainability developments

1.3 Define a time frame for your materiality assessment

  • Short-, medium- or long-term

1.4 Define how you plan to engage stakeholders

  • Analyze current stakeholder-directed activities (exchange with other departments, such as communication or investor relations)
  • Identify key stakeholders and categorize them according to the nature of the relationship, activity, or product and service
  • Define when to involve stakeholders in the materiality assessment process (e.g., at the stage of validating the list of potential sustainability topics, or scaling the severity and time horizons of impact materiality)

Step 2 in Double Materility Assessment – Identify Potential Material Topics and their Impacts, Risks and Opportunities

If applicable, base this process on previously conducted analyses and processes, including

  • Existing materiality assessments based on other frameworks (e.g., GRI, The non-profit organization Global Reporting Initiative (GRI) has developed a worldwide used sustainability reporting framework. The GRI framework consists of around 120 disclosure points in three different sectors: GRI Universal Standards, GRI Sector Standards and GRI Topic Standards)
  • Existing due diligence processes
  • Previous feedback and inputs from stakeholders (e.g., surveys for customer or employee satisfaction)
  • Comparisons with benchmarks in the sector

Create a list of potential material sustainability matters (topics / sub-topics / sub-sub topics) and identify the related impacts, risks and opportunities, leveraging your previous analyses and processes.

2.1 Top-down:

Identify the list of sustainability topics and then assess whether material impacts (actual / potential, negative or positive), risks and opportunities exist

Two approaches:

  • Start with the overview of topics covered by the ESRS with regard to the Environmental, Social and Governance Standards (based on AR 16) and complement this list with topics from previous analyses, or
  • Start with the list of topics from existing enterprise risk management systems, or the due diligence processes and complement this list based on a comparison with the topics covered by the ESRS (based on AR 16)

2.2 Bottom up:

Identify the list of sustainability matters based on impacts, risks, and opportunities at a detailed level. Categorize them into topics and sub-topics and compare them to the topics covered by the ESRS (based on AR 16)

Step 3 in Double Materility Assessment – Assess the Materiality of the Identified Impacts, Risks and Opportunities

This process involves assessing both impact materiality and financial materiality based on the list of potentially material topics with the aim of determining the final list of material topics.

Impact Materiality Assessment

To assess the impact materiality of the previously identified list of potentially material topics, EFRAG advices you to:

  1. Apply the objective criteria defining impact materiality (see chapter 3.4 of ESRS 1)
  2. Use suitable quantitative and/or qualitative thresholds (see below)

Go through the identified list of potentially material topics and their risks and opportunities and use the determined thresholds for the criteria of scale, scope and irremediability, as well as the likelihood of occurrence. Differentiate between the different types of impact:

  • For impacts categorized as actual negative impacts assess the severity of each impact by assessing scale, scope and irremediability.
  • For impacts categorized as potential negative impacts, additionally estimate the likelihood that the impact occurs in relation to the time horizon.
  • For impacts categorized as actual positive impacts, apply the criteria of scale and scope.
  • For impacts categorized as potential positive impacts, additionally estimate the likelihood that the impact occurs in relation to the time horizon.

Based on your stakeholder engagement strategy, your key stakeholders may be involved in this step and evaluate, validate or ensure the completeness of the final list of material impacts.

‍The perspective of stakeholders is particularly valuable to determine the scale and irremediability of impacts, as well as to estimate their likelihood of occurrence.

Examples for Assessing Materiality for Actual Impacts

Actual impacts can be determined based on severity of an impact (as a result of scale, scope, and irremediability) and categorized on a range from low to high impact. All impacts with a severity over a certain threshold would then be considered material topics to a company.

More specifically, an example of an impact which affects scale could be a negative impact which leads to a violation of human rights or non-compliance with a certain law/regulation. Scope, on the other hand, can be determined more quantitatively by assessing the number of people or regions affected by an impact, such as the number of people a negative impact would affect.

Steps to conduct:

  1. Determine the scale of impact
  2. Determine the scope of impact
  3. Determine the irremediability of impact (for negative impacts only)

Examples for Assessing Materiality for Potential Impacts

Different from actual impacts, potential impacts are measured by considering both the severity of an impact and the likelihood, or potential, of that impact to be made.

Likelihood of an impact can be measured qualitatively or quantitatively depending on the type of impact, for example, the likelihood of a human rights violation to occur.

However, ESRS 1 also states that severity takes precedence over likelihood when identifying material matters related to human rights impacts.

See below, for an illustrative example thresholds for the materiality of potential impacts, again all topics in the dark squares would then be considered material topics:

EFRAG Materiality Assessment guidance

Steps to conduct:

  1. Determine the severity (based on the above criteria)
  2. Estimate the likelihood of occurrence

Financial Materiality Assessment

To assess the financial materiality of the previously identified list of potentially material topics, EFRAG advices you to:

  1. Apply the objective criteria defining financial materiality (see chapter 3.5 of ESRS 1)
  2. Use suitable quantitative and/or qualitative thresholds (see below)

The quantitative and/or qualitative thresholds for anticipated financial effects can relate to the performance, financial situation, cash flows, access to and cost of capital of the company.

Criteria for assessing financial materiality

  • Likelihood of occurrence and
  • Potential magnitude of effects in the short-, medium-, and long-term

Go through the identified list of potentially material risks and opportunities and use an objective set of thresholds for the criteria of likelihood and magnitude. When you already have enterprise risk management processes in place that cover sustainability risks, base your estimations on a comparison between both. Define if the impacts are sources of actual or potential risks and opportunities.

Watch out!

The scope of assessing financial materiality for a company’s sustainability reporting goes beyond the scope of assessing the information to be included in the financial reporting.

You can build on the criteria and thresholds used to prepare your financial reporting, when defining the thresholds for financial materiality for sustainability reporting. However, the time horizons as well as the basis for preparation differ.

It may be helpful to involve the different departments and functions in your company as well as investors and other financial stakeholders (e.g., banks) for the assessment and validation of the identified material topics. This way, you can ensure that your list of risks and opportunities is complete.

Steps to conduct:

  1. Estimate the likelihood of occurrence
  2. Determine the magnitude

Watch out!

Consolidate impact and financial materiality and consider their interaction. The result is one final list of material topics which is the basis for the preparation of the sustainability statement.

‍How to Report based on the Double Materiality Assessment

Reporting must encompass the assessment process and the outcomes in accordance with requirements stated in ESRS 2 IRO-1, ESRS 2 SBM-3, and ESRS 2 IRO-2.

Following the materiality assessment process, the company is required report on:

  1. The process to identify and assess its material impacts risks and opportunities (ESRS 2 IRO-1)
  2. Material impacts, risks and opportunities and the interaction with its strategy and business model (ESRS 2 SBM-3)
  3. Disclosure requirements in ESRS covered by its sustainability reporting (ESRS 2 IRO-2)

How Does the CSRD Materiality Assessment Align with Existing Frameworks?

While the ESRS are based on double materiality, the GRI framework concentrates on the impact materiality dimension (see GRI 3: Material Topics 2021 standard), which is the same for ESRS and GRI.

Therefore, the GRI materiality assessment is a good starting point for the ESRS double materiality assessment, as it provides a good basis for impact materiality and there are several synergies between the two frameworks that can be leveraged.

Moving from sustainability reporting based on the GRI framework to sustainability reporting based on ESRS requires the addition and integration of financial materiality.

In this regard, sustainability reporting under ESRS expects the compliance with IFRS disclosures that reflect the financial materiality in the ISSB standards.

According to EFRAG implementation guide, ISSB (International Sustainability Standards Board) and ESRS align, in principle, with regard to the definition of financial materiality. Thus, the same assessment process should be able to support the identification the risks and opportunities for financial materiality concerning both IFRS and ESRS.

Further, EFRAG states that:

  • The materiality approach of IFRS S1 and financial materiality in the ESRS are aligned
  • The assessment of financial materiality in ESRS 1 paragraph 48 aligns with IFRS S1 paragraph 1
  • The criterion for the materiality assessment is expected to rely on decision-usefulness, which is also used in IFRS S1

The IFRS considers only users’ needs of investors in the assessment whereas the ESRS assessment equivalently considers both investors and other stakeholders. However, the two perspectives are expected to be equivalent in terms of the financial materiality under ESRS.

Moving from reporting based on IFRS to sustainability reporting based on ESRS requires the addition and integration of impact materiality.

International Due Diligence and ESRS

Materiality assessments must take into account the outcomes of the due diligence process in alignment with the definition in the international instruments of the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises.

Due diligence processes can help a company to directly identify affected stakeholders, which must also be considered when carrying out a materiality assessment. In addition, the criteria from the international instruments support the prioritization of actions under consideration of the severity and likelihood of the impacts.

The due diligence process can help a company to identify and assess potential/actual negative impacts and realize the severity and likelihood of certain topics which could potentially be material for a company. 

Double Materility Assessment

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