Double Materiality Demystified: A Deep Dive into CSRD Standards

Europe has taken the lead in the dynamic realm of corporate responsibility by instituting a standardised approach to sustainability reporting for all companies operating within the region by means of the Corporate Sustainability Reporting Directive (CSRD). At the heart of this directive lies the European Sustainability Reporting Standards (ESRS) which derives from the CSRD, consists of a set of 12 comprehensive standards. These standards, which include both cross-cutting and topical guidelines, are a game-changer for businesses that want to adhere to ESG principles in their reporting.

Considering that the topics relevant to an organization can vary between industries, and sometimes even within the same industry, it becomes crucial for each organization to ascertain the specific topics that hold significance for its operations. This is the function of the assessment of double materiality. In this blog, we will discuss the ESRS and CSRD, and the practical implications of double materiality for ESG-aligned reporting organizations.

What’s the difference between Materiality Assessment and Double Materiality Assessment?

There are thousands of companies across the world publishing Sustainability/ESG Reports. Many of these have done a materiality assessment to determine which topics are important for them to report on. So what’s the difference between the traditional materiality assessment and the double materiality assessment mandated by the CSRD?

In traditional materiality assessments, organizations determine their material topics either by consulting with internal stakeholders, or to some extent, the external stakeholders. Further, there was no standard set of requirements to determine if the organization has satisfactorily performed a materiality assessment. The double materiality assessment, while not precisely defining the process to perform the materiality assessment, sets out certain expectations.

Double materiality assessment consists of “impact” as well as “financial materiality”, as defined below in the ESRS:

“a sustainability matter is material from”:

1. “An impact perspective when it pertains to the undertaking’s material actual or potential, positive or negative impacts on people or the environment over the short-, medium- and long term. Impacts include those 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.” (ESRS 1 paragraph 43\=); and
2. “a financial perspective if it triggers or could reasonably be expected to trigger material financial effects on the undertaking. This is the case when a sustainability matter generates risks or opportunities that have a material influence or could reasonably be expected to have a material influence, on the undertaking’s development, financial position, financial performance, cash flows, access to finance or cost of capital over the short-, medium- or long term.” (ESRS 1 paragraph 49). “The financial materiality assessment corresponds to the identification of information that is considered material for primary users of general-purpose financial reports in making decisions relating to providing resources to the entity. In particular, information is considered material for primary users of general-purpose financial reports if omitting, misstating or obscuring that information could reasonably be expected to influence decisions that they make on the basis of the undertaking’s sustainability statement” (ESRS 1 paragraph 48).

It is important to have objective criteria in determining which topics are material. A company has to comprehensively consider the impacts, risks and opportunities associated with each topic before determining their materiality. While the organization may apply its own judgement in determining material matters, there needs to be a clear explanation of the same, to enhance transparency. If climate change is not assessed to be a material topic, there should be detailed supporting evidence for it. For other topics, the undertaking can briefly explain the process behind the selection.

The process for determining materiality should consider the entire value chain of the organization, both upstream and downstream, as well as its own operations.

Once the topics have been finalized, if the topics are covered under the ESRS topical standards, the requirements of the relevant standards will have to be complied with. If the topic is not a part of the topical standards, then the entity can choose to disclose any relevant, material information related to that particular topic.

Approach

While ESRS has not defined a specific approach to performing a double materiality assessment, the following steps can be broadly followed:

1. Understanding the context

The process can start with a current state assessment, where the company engages internally to determine which are the important environment, social and governance matters within its operations and business activities. In this step, key stakeholders can also be identified.

2. Identification of impacts, risks and opportunities

In this step, the organization can consider the list of sustainability matters in ESRS 1 AR 16, as well as topics from industry associations, publications or even peers. Through this, the objective is to arrive at a set of topics relevant to the organization.

3. Assessment & Determination of material topics

This is the most crucial step in the process. Once the relevant topics have been determined, they need to be assessed. As part of the double materiality assessment, this will need to be done from two dimensions – Impact, and Financial. Both quantitative and/or qualitative metrics can be used for assessment.

For impact assessment, the impact of each of the selected topics on the organization and its key stakeholders need to be considered. This can be done by engaging with the stakeholders, and collecting their opinions on this. Stakeholder engagement is an integral part of the impact materiality assessment process as defined in the ESRS.

Each of the topics could also have associated risks and opportunities. For this, the organization needs to closely assess the financial impact of the selected topic, which will lead to an understanding of the risks and opportunities. The existing ERM framework, if available, can also aid in this process.

After determining the impact and financial materiality of the topics, they will need to be consolidated. There can be a correlation of the impact materiality and financial materiality in some of the topics. The most impactful and financially material topics are considered to be the material topics for the organization.

4. Reporting

As per the ESRS, the materiality assessment process and outcome need to be reported. It includes information such as the methodologies and assumptions applied, the focus and extent of the processes, inputs, and where certain judgements have been made and the use of thresholds. The requirements are covered in the standards as follows:

1. ESRS 2 IRO 1 covers the description of the process used to identify and assess the material impacts, risks and opportunities
2. SBM 3 covers the material impact, risks and opportunities and their interaction with strategy and business model
3. IRO 2 Disclosure requirements in ESRS covered by the undertaking’s sustainability statement

Once the material topics have been finalized, the corresponding requirements mentioned in the various standards need to be reported. If there are topics outside of the scope of the standards, they may be reported using entity specific disclosures. The undertaking is not required to disclose all the topics in the standards, only those which are material.

Leveraging other sources

• GRI standards – If an organization has been using the GRI standards for the materiality assessment, they are well set for the double materiality assessment, particularly the impact assessment. The impact assessment process of the GRI aligns with the same for ESRS, hence it can be used to the same effect. The financial materiality, however, will need to be done separately. Further, the entity- specific topics identified for assessment using the GRI standards can be used as the starting point for performing the double materiality assessment.
• ISSB standards – If an organization uses the ISSB standards to determine materiality, the process is aligned with the financial materiality assessment of ESRS. The definition of financial materiality is aligned in the 2 standards. The financial materiality assessment process used in ESRS can be used to identify the risks and opportunities, which forms the starting point of determining material disclosures in the ISSB standards.

Conclusion

With the EU introducing a game-changer in the materiality assessment process of companies by including both impact as well as financial materiality assessment, it becomes crucial for organizations to understand the nuances of this process. It is highly recommended to start the process as soon as possible, since this would inform the entire reporting of the sustainability statements as per ESRS. You can also use the help of software such as IRIS CARBON® to simplify this process.