The implementation of the first uniform European legally binding standards for ESG reporting – the European Sustainability Reporting Standards (ESRS) – is becoming more and more concrete. Following their adoption by the EU Commission on July 31, 2023, EFRAG has now published in-depth “Draft Implementation Guidance on ESRS Materiality Assessment” on August 23, 2023. The guidance is intended to support businesses in carrying out their materiality assessment.
To comply with the ESRS, companies are required to conduct a double materiality assessment to define the scope and content of their ESG data collection and reporting.
In this article, we will deep dive into the ESRS double materiality assessment:
Why is it important?
How to proceed?
And how to make the materiality assessment a success?
Recap: Double materiality in the CSRD
Before we take a closer look at ESRS materiality assessment, let's briefly review double materiality.
Double materiality is a concept introduced by the CSRD that must be applied in the materiality assessment according to ESRS. It provides criteria for the determination of whether a sustainability matter is material to an organization and its stakeholders – and therefore if it must be included in an organization’s sustainability report.
The principle of double materiality drives companies to approach sustainability from two different perspectives:
Financial materiality: includes all external sustainability impacts that could internally affect the company’s future profitability
Impact materiality: includes all impacts of the company's business activities on its stakeholders, including impacts on society and the environment
A sustainability matter meets the criteria of double materiality if it is material from either one or both perspectives.
| 💡 Learn more about double materiality in our insight article: What is double materiality in the CSRD? |
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What is an ESRS materiality assessment and why is it needed?
The ESRS can be divided into sector-agnostic and sector-specific standards. In the case of the sector-agnostic standards, a distinction is made between the general cross-cutting standards and the topic-specific cross-sector standards, e.g., covering the topics of climate change, pollution, biodiversity, workforce, affected communities, and business conduct.
Disclosure in accordance with the general cross-cutting standards is mandatory for all companies subject to reporting requirements. However, your company is not required to report on all ESG topics described in the topic-specific ESRS, but only on those that are specifically material to your company. For this reason, your company needs to perform a materiality assessment to determine which sustainability matters are material for it and which are not. By focusing only on the sustainability matters that are material to your company and its stakeholders and environment, the report is ensured to be meaningful and concise.
In this context, sustainability matters can have the dimension of a topic (e.g., “Own workforce”, ESRS S1), sub-topic (e.g., “Working conditions”), or sub-sub-topic (e.g., “Health and safety”).
To determine the material sustainability matters, your organization needs to identify its material impacts, risks, and opportunities (IRO) – and exclude the ones that are not material.
Material impact = sustainability-related (positive or negative) impacts that a company exerts on its environment and stakeholders through its business operations
Material risk and opportunities = sustainability-related financial risks and opportunities that arise from dependencies on natural, human, and social resources
Important note: The materiality assessment serves to identify not only the direct material IROs of your company itself but also those that arise from direct and indirect business relationships in the upstream and/or downstream value chain.
4 steps to conduct your ESRS materiality assessment
The ESRS double materiality assessment can be broken down into four steps – with steps 1 to 3 comprising the actual assessment, and step 4 being the reporting:
Step 1: Understand the context and define a stakeholder engagement strategy
Step 2: Identify a list of potential material sustainability matters and IROs
Step 3: Determine the final list of material sustainability matters
Step 4: Report the materiality assessment process and outcome
Step 1: Understand the context and define a stakeholder engagement strategy
The first step consists in analyzing your company’s business activities, business model, business relationships, and upstream and downstream value chain. This will provide you with all relevant insights needed to conduct the materiality assessment. The analysis can be based on:
your company’s business plan, strategy, and financial statements
your products and services and the geographic location of these activities
your company’s business relationships upstream and downstream your value chain
media reports
peers’ analysis and existing sector-specific benchmarks
publications on general sustainability trends or scientific research
You should also define the time horizon for your materiality assessment (short-, medium-, or long-term).
Then, elaborate a stakeholder engagement strategy on how to involve your stakeholders in the materiality assessment process. For that, define a list of key groups of stakeholders that are or could be affected by your upstream and/or downstream operations. Subsequently, consider at which exact stage of the materiality assessment process you want to involve your identified stakeholders. For example, stakeholder engagement can take place by validating the list of potential material matters.
Step 2: Identify a list of potential material sustainability matters and IROs
To compile a list of potential material sustainability matters and related IROs, your company can both
(a) leverage from existing knowledge, e.g., existing due diligence processes, or feedback received from existing stakeholder engagement processes,
and/or (b) collect new insights on material sustainability matters and IROs.
To draw on new insights, the ESRS specify two possible approaches:
“Top-down” approach: Derive IROs from the list of potential material sustainability matters by assessing their respective impacts (acutal or potential, negative or positive), risks, and opportunities.
“Bottom-up” approach: Derive the list of potential material sustainability matters from the IROs which are identified at a granular level by grouping these IROs into topics or sub-topics.
Possible starting points could be the list of sustainability matters covered by ESRS, the internal Enterprise Risk Management system, or the output of due diligence processes.
The outcome is a list of potential material matters and their related IROs. For those sub-topics or sub-sub-topics that are not material on an individual basis, aggregation at a higher level (topic or sub-topic) is possible if that higher level is classified material.
Step 3: Determine the final list of material sustainability matters
The next step is to determine the final list of material sustainability matters based on an assessment of the materiality of the IROs. For that, apply the double materiality approach:
1. Impact materiality assessment
Go through the list defined in step 2 and apply appropriate quantitative and/or qualitative thresholds to assess the materiality of current and potential impacts.
For actual negative impacts, determine scale, scope, and its irremediable character (“severity”), and for potential negative impacts, estimate the likelihood of occurrence and map it to the relevant time horizon.
For actual positive impacts, determine scale and scope for potential positive impacts, estimate the likelihood of occurrence.
In this step, stakeholder engagement is particularly essential as key stakeholders could assess, validate, and ensure completeness of the final list of material matters.
2. Financial materiality assessment
Go through the list defined in step 2 and apply appropriate quantitative and/or qualitative thresholds based upon anticipated financial effects in terms of performance, financial situation, cash flows, access to and cost of capital are used.
Sustainability risks and opportunities are assessed based on their likelihood of occurrence and their potential dimension of financial effects (“magnitude”).
After applying the defined thresholds, aggregate the results of impact and financial materiality assessment. The result is your final list of material sustainability matters with material impacts that will lead to material risks and opportunities.
Step 4: Report the materiality assessment process and outcome
Following the materiality assessment process, your company needs to disclose
the assessment process, according to ESRS 2 IRO-1
and its output, according to ESRS SMB-3 and ESRS 2 IRO-2
Generally speaking: Once a sustainability matter has been identified as material, you have to refer to the requirements in the respective topical ESRS to identify the information to be disclosed on the matter.
4 pieces of knowledge to succeed with your ESRS materiality assessment
Interoperability between the ESRS and the GRI standards
In a joint statement from September 4, 2023, EFRAG and GRI have confirmed a high level of interoperability between the ESRS and the GRI standards. For this reason, the two institutions also state that existing GRI reporters will be well prepared for reporting under the ESRS. In other words: If your company already reports according to the GRI standards, you will find much important information in your GRI report that you can use in your materiality assessment.Navigation of value chains under ESRS
Companies are required to consider not only their own activities but also those of their direct and indirect suppliers as part of the ESRS materiality assessment. To provide more clarity on this, EFRAG also provided Draft Implementation Guidance on Value Chains. The Value Chain Guidance outlines how to navigate value chains under ESRS and CSRD. View the document here.Involvement in strategic decision-making
Materiality assessments provide valuable insights into a company's business operations and value chain. To maximize the benefit from these findings, incorporate them into strategic decision-making and make sure they are shared throughout the organization
Expectations about potential material issues
It can be helpful for your company to first form an expectation about the potential material topics. This can serve as an initial point of orientation and help to set priorities in advance, if necessary.
Next steps of the ESRS materiality assessment
The current status of the “Draft Implementation Guidance on Materiality Assessment” is a valuable source of long-awaited insights, but there is room for more clarity.
In the EFRAG meeting on August 23, 2023, the Sustainability Reporting Board (SRB) suggested changes both in terms of content and procedure. Therefore, it is important to note that the current Implementation Guidance on ESRS materiality assessment is by no means final and is still subject to change or adjustment.
For more information view EFRAG’s Draft Implementation Guidance on Materiality Assessments.