Latest update on June 5, 2024
In a nutshell:
- The materiality assessment forms the foundation for understanding the impact of sustainability matters
- Financial materiality assesses risks and opportunities affecting the company's financial performance, while impact materiality assesses effects on people and the environment
- Thresholds for materiality are determined by factors like scale, scope, and irremediability
In times of increased corporate responsibility, achieving sustainability involves purposeful decisions and forward-thinking strategies. As businesses prepare to adapt their sustainability reporting to the Corporate Sustainability Reporting Directive (CSRD), a foundational first step is required — the materiality assessment.
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.
Defining the Process for the Materiality Assessment
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 (Corporate Sustainability Reporting Directive), 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.
Designing the Materiality Assessment
According to EFRAG, the design of your materiality assessment should identify all material impacts, risks and opportunities and, in turn, exclude those that are not material to your company.
An ideal process should prepare for the following steps:
- Understand the context and define a strategy for stakeholder engagement
- Identify a list of sustainability topics and their impacts, risks and opportunities
- Assess the materiality of the identified impacts, risks and opportunities to determine a final list of sustainability topics to be included in the reporting
👉 If you would like to learn more about the steps for implementing the double materiality assessment, you can jump directly to our Practice Guide about the Double Materiality Assessment.
Engaging Stakeholders in the Assessment
Stakeholders are involved in the process to gain an understanding of the actual and potential impacts of the company on people and the planet. Their input and feedback provides an explanation of the importance of sustainability issues from the perspective of the concerned stakeholder groups.
Setting Thresholds for Materiality
Financial Materiality
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 (1) affect your company’s ability to use resources needed for business operations or the quality and costs of those resources and (2) 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 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).
Material risks and opportunities are assessed according to how likely they occur and the potential extent of the financial effects related to the short-, medium-, and long-term.
lmpact Materiality
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 assess the impact materiality of impacts, you need to use suitable quantitative and qualitative thresholds based upon the impacts’ anticipated effects.
The criteria for the materiality assessment 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
Impact materiality is then determined by the severity of actual negative impacts and severity and likelihood of potential negative impacts.
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.
👉 For implementation examples related to the thresholds, check out our in-depth Practice Guide about the Double Materiality Assessment, where we explain how to perform the materiality assessment under CSRD.
