Understanding the Value Chain's Role in Materiality Analysis

Understanding and managing the complexities of a value chain is critical for businesses striving to meet the Corporate Sustainability Reporting Directive (CSRD) requirements.

The new sustainability standards emphasize the importance of identifying and assessing material impacts, risks, and opportunities (IROs) across both upstream and downstream value chains as part of a comprehensive materiality analysis.

Without a broader perspective, sustainability reports risk being incomplete — many key impacts, risks, and opportunities (IROs) occur beyond a company’s direct operations.

By integrating full value chain insights, companies not only comply with CSRD and ensure their reports are accurate, but also prioritize sustainability efforts where they matter most.

Capturing the Value Chain with the Materiality Analysis

A well-structured materiality analysis is essential to identify and assess the most significant IROs within the value chain. The process should focus on areas where material IROs are most likely to occur and be tailored to the company’s specific circumstances:

• Step 1: Understanding the context
• Step 2 and 3: Identifying and assessing material IROs

1. Understanding the Context

The first step is to understand the company’s value chain, including:

• Actors and activities: Identify the key players, their size, sectors, activities, and geographical locations.
• Connections to strategy: Assess how the company’s strategy and business model link to upstream and downstream value chain impacts.
• Potential risks: Map areas of heightened risk or limited visibility, such as deeper supply chain tiers or high-risk materials.

If reliable geographic information on the value chain is unavailable (e.g., beyond the first tier), the company may map IROs linked to global supply chains for materials, products, and services relevant to its operations.

For example, a furniture manufacturer using materials like wood and foam should analyze sustainability issues tied to their origin (e.g., deforestation, poor labor conditions) and end-of-life (e.g., recyclability).

2. Identifying and Assessing Material IROs

Companies must identify actual and potential IROs across the VC and determine their materiality. When direct data from value chain actors isn’t available, secondary sources like industry reports, government data, or sector proxies can be used to estimate impacts.

Types of Involvement in Value Chain Impacts

Materiality assessments should distinguish the company’s involvement in value chain impacts:

• Causing: Directly responsible for an impact.
• Contributing: Indirectly involved, such as through purchasing practices or sourcing.
• Linked: Connected to impacts through business relationships.

For instance, using materials like palm oil or coltan might contribute to systemic environmental or social issues, even if impacts occur deep within the value chain.

Incorporating Life Cycle Thinking

Environmental standards under ESRS emphasize life cycle assessment as part of the materiality analysis. For example:

• Assessing the environmental footprint of products (ESRS E2 and E3).
• Evaluating life cycle impacts from production to disposal (ESRS E5).

By combining a clear understanding of the value chain with targeted materiality assessments, companies can ensure they capture the most significant sustainability issues, align with regulatory requirements, and prioritize meaningful action.

Disclosing Information about the Value Chain

Disclosing value chain information happens in two parts:

1. during the materiality assessment process, and
2. as part of the materiality assessment’s outcome.

BP-1: General basis for reporting

The sustainability statement must disclose the extent to which it covers the company's upstream and downstream value chain, in addition to metrics (ESRS 2, paragraph 5(c)).

SBM-1: Mapping the value chain

To identify where material IROs may arise, the company must map its value chain, describing its own position and covering key suppliers, distribution channels, and customers (ESRS 2, paragraph 42(c)). This mapping can also draw on sustainability due diligence processes to identify potential "hot spots" and risks, such as those linked to specific countries or industries.

IRO-1: Value chain in the materiality analysis

The company should explain how the value chain was considered in the materiality analysis, detailing the process and methods used to identify and prioritize IROs from business relationships in the value chain (ESRS 2, paragraph 53). This includes assessing risks, opportunities, and dependencies on natural and social resources.

SBM-3: Disclosing the outcome

The company must disclose material IROs found in the value chain, including where these impacts are concentrated, whether they stem from the company’s activities or its business relationships, and how the company plans to address them (ESRS 2, paragraph 48). It should also discuss how these impacts may influence the company’s strategy or business model, and any actions taken or planned to manage them. This ensures transparency on how the company influences or is affected by value chain IROs.

Integrating the value chain perspectives into the company’s materiality analysis ensures compliance while allowing companies to strategically address sustainability issues that impact their business model and strategy.

With value chain-focused materiality analysis, businesses can improve accountability and contribute to sustainable development in a way that aligns with ESRS expectations.