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Navigating Double Materiality: A Step-by-Step Guide to kick-off the ESRS-compliant reporting

Here we outline practical steps for companies venturing into their double materiality works.
Julia Perfilova
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In our previous article, Navigating Regulatory Compliance under CSRD, we delved into the recently adopted Corporate Sustainability Reporting Directive (CSRD) - a law dictating what companies should be reporting - and the European Sustainability Reporting Standards (ESRS), the corresponding reporting requirements detailing how the information should be disclosed.

The core idea of the CSRD is to revolutionise sustainability reporting. According to the recently published GRI’s CSRD Essentials, more than 42,500 EU-based companies are required to report on both how sustainability issues affect corporate performance and how business activities impact society and the environment. This transformative approach ensures that companies are accountable for sustainablity risks and opportunities affecting their financial outcomes and for their broader environmental and social footprint.  

The concept of double materiality, which embraces a twofold perspective on corporate sustainability, forms the backbone of ESRS-compliant reporting. This principle requires that companies disclose information necessary to understand the following:  

A > the impact the company has on environmental, social, and governance matters (an “inside-out” perspective or “impact materiality”); and  

B > how sustainability matters affect a company’s development, performance, and position in the market (an “outside-in” perspective or “financial materiality”).  

Drawing from the identified topics relevant to the company and its value chain through the lens of double materiality, companies must report on the corresponding disclosure requirements and data points outlined in the topical ESRS standards. This ensures a comprehensive and insightful sustainability report that reflects the company's impact on the world and how sustainability factors influence the business.  

Therefore, double materiality analysis, the cornerstone of the ESRS, is one of the first steps in approaching the CSRD.  

ESRS 1 General Requirements outlines the critical expectations for companies' materiality assessments. It emphasises the importance of considering the value chain and engaging with stakeholders to understand the direct and indirect (i.e., mediated by the business relationships in upstream and downstream operations) impacts of the company on affected stakeholders and the environment. The European Financial Reporting Advisory Group (EFRAG) developed the Materiality Assessment Implementation Guidance on 22 December 2023 to aid companies in their double materiality journey. This resource details the practical steps companies should undertake and defines the approach to assessing the materiality of impacts, risks, and opportunities (IROs) identified throughout their value chain.

In general, the double materiality analysis consists of the following four steps:

1 > Mapping the organisational context: In the initial stage, each company should thoroughly analyse the business context in which it operates. This involves examining the business model, key activities along the value chain, their geographical locations, and the relevant legal framework. Additionally, companies should identify stakeholders within the value chain. Under the ESRS, these stakeholders can be categorised into affected stakeholders—those impacted by the company's operations, including the environment and employees—and users of sustainability statements, such as banks, shareholders, and investors, who are interested in both the financial and sustainability performance of the company.

2 > Identifying impacts, risks, and opportunities along the value chain: After mapping the activities in the value chain, a company should consider the IROs associated with it. Frameworks such as the OECD Guidelines for Multinational Enterprises (MNE Guidelines) and the UN Guiding Principles on Business and Human Rights (UNGPs) can also help perform this exercise. The ESRS does not require the consideration of every actor in the value chain, but the analysis shall cover the operations to the extent that no material information is excluded. To assist companies in meeting these requirements, EFRAG issued the Value Chain Implementation Guidance. Consulting key affected stakeholders on this step is crucial for understanding how your company's activities impact them. Engaging with the affected stakeholders is beneficial in properly considering the most severe impacts. Where stakeholder engagement is not possible, discussions with representatives of stakeholders in a company’s departments with knowledge of stakeholder perspectives or scientific and analytical research on impacts on sustainability matters can replace direct consultation.

3 > Setting the thresholds for impact and financial materiality and performing the assessment: In this step, the identified IROs should be prioritised using company-specific thresholds for severity and likelihood for impacts, and, thresholds for likelihood and (potential) size of the financial effect for risks and opportunities. A consultation with key stakeholders and engagement with external users of sustainability reporting and other experts can help assess the severity and likelihood of impacts and can help determine, validate and ensure completeness of the outcome of the materiality assessment. Ultimately, a company should list the relevant sustainability topics based on the material IROs. The Disclosure Requirements in the relevant topical standards should be reflected in the ESRS report. Additional entity-specific disclosures should be included if the topical ESRS does not cover a matter of material sustainability.

4 > Reporting on the double materiality process: The ESRS requires transparency regarding how the double materiality assessment is performed. Therefore, it is strongly recommended that companies document the process while performing it.

A high-quality materiality assessment can significantly benefit a company by highlighting its impact and identifying the most urgent risks and promising opportunities. This process also helps set a strategic sustainability direction, prioritise critical issues, and allocate resources to key areas for improvement.

The following steps include:

1 > Performing a Gap Analysis: Evaluate the current data availability required for reporting and review existing processes for collecting, processing, and disclosing this information.

2 > Improving Processes and Data Collection: Where necessary, enhance existing procedures, adjust policies, and set sustainability-related targets.

3 > Communicating Your Work: Ensure your efforts are presented in an ESRS-compliant report.

Stay tuned to keep up with the rapidly evolving sustainability reporting requirements!

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