Fundamentals of Double Materiality According to CSRD

Companies today are faced with a growing responsibility to act sustainably — transparent reporting, well-founded decisions and long-term strategies are essential for this. The first, fundamental step in preparing sustainability reporting in accordance with CSRD (Corporate Sustainability Reporting Directive) is to analyze the company's dual materiality.

This assessment serves as the foundation for understanding the relevance of the Environmental, Social, and Governance (ESG) topics related to your business operations, including business relationships and the value chain. 

To support you on your company’s double materiality assessment, the following information based on EFRAG’s documentation delivers you a compact overview over the key aspects relevant for your materiality assessment.

Formal Procedure for Determining Double Materiality

A materiality assessment is a formal process by which companies identify important (“material”) Environmental, Social and Governance (ESG) matters and related information to be disclosed in their sustainability reporting. This method allows you to prioritize ESG topics in a more objective way, by involving the stakeholder perspective on your company’s operations, products, and services.   

Conducting a materiality assessment is central to reporting according to the CSRD, which requires you to disclose relevant and truthful information on the impacts, risks, and opportunities (IROs) related to ESG topics. 

The aim of the double materiality assessment is to determine the topics that are considered material from the perspective of impact materiality (external) or financial materiality (internal), or both, reflecting their interrelations.  

The materiality assessment is not limited to your company’s own operations, as it also includes its upstream and downstream value chain.

Make sure you are familiar with the general requirements of the CSRD standards, especially outlined in ESRS 1. 

The criteria for the CSRD materiality analysis are set under ESRS 1, however, the General Requirements Standard does not explicitly explain how to set thresholds for determining materiality. 

Therefore, EFRAG offers an implementation guideline on how to determine material topics based on due diligence processes, and the scale, scope, irremediability, as well as likelihood of a given topic. These thresholds help you identify the ‘significant effects’ according to the ESRS.

Let's unravel a few definitions:

Severity can be defined by the scale, scope and irremediable character for negative impacts or scale and scope for positive impacts.

• Scale refers to the gravity of an impact
• Scope refers to the area and the number of people affected by an impact
• Irremediability, which is only applicable for negative impacts, refers to the ability to restore the affected people or place after the negative impact

Financial Materiality of CSRD

Assessment of Financial Materiality (Financial Perspective)

From a financial perspective, a sustainability topic can be considered material if it generates risks and opportunities that have material financial effects or are expected to have material financial effects on the company. 

Material risks and opportunities derive from impacts or dependencies on natural, social and human resources that may

• affect your company’s ability to use resources needed for business operations or the quality and costs of those resources, and
• affect your company’s reliance on relevant business relationships on appropriate terms.

Both past or future events may trigger these risks and opportunities, which go beyond the consolidations when preparing financial statements.

To assess the financial materiality of potentially material issues, EFRAG refers to:

(1) The application of the objective criteria for defining financial materiality (see chapter 3.5 of ESRS 1)

(2) The use of appropriate quantitative and/or qualitative thresholds

Thresholds for Financial Materiality

To assess the financial materiality of risks and opportunities for your company, you need to use suitable quantitative and qualitative thresholds based upon the anticipated financial effects. These effects may concern the performance, financial situation, cash flows or access to and cost of capital used (over the short-, medium- or long-term).

Criteria for assessing financial materiality:

• Likelihood of occurrence and potential magnitude of the short
• Potential magnitude of the short, medium and long-term impact

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.

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

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.

lmpact Materiality of CSRD

Assessment of Impact Materiality (Impact Perspective)

From an impact perspective, a sustainability topic can be considered material if it relates to the company’s impacts on people or the environment. This may involve material actual or potential, positive or negative short, medium or long-term effects on the company.

To analyze the materiality of the impact (Impact Materiality) of the previously identified list of topics, EFRAG refers to:

(1) The application of the objective criteria for defining impact materiality (see chapter 3.4 of ESRS 1)

(2) The use of appropriate quantitative and/or qualitative thresholds

Thresholds for Impact Materiality

Impact materiality is determined by the severity of actual negative impacts and severity and likelihood of potential negative impacts.

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.

For negative impacts, the starting point for determining a threshold should be the scale (how grave) and scope (how widespread). In other words, a threshold can be defined by the gravity of an impact and how many people in an area it will impact. 

Overall: If one factor (scale, scope or irremediability) is significant, the impact would become “severe”. Typically, the greater the impact with respect to scale and scope, the greater the irremediability. 

Examples of how to implement the thresholds can be found in our detailed Practice Guide about the Double Materiality Assessment, where we explain how to perform the materiality assessment under CSRD.