Double materiality assessment

What are the recommendations for smaller companies that have never done sustainability reporting before on how to get started?

The double materiality assessment is the best first step, it helps you understand what to focus on. The other advantage is the strategic output. Identifying material impacts, risks, and opportunities will establish which disclosure requirements your company will need to report on. Furthermore, these material impacts, risks and opportunities will specify the key relationships between your business and sustainability and thereby act as the key elements by which to establish a coherent sustainability strategy. 

Conducting the double materiality assessment will enable you to conduct an appropriate gap analysis against the ESRS disclosure requirements relevant for your company, which should be conducted sequentially after or in parallel with the double materiality assessment. 

Companies can also prepare for the ESRS in advance of the results of their respective DMAs. Since the General Disclosures described in ESRS-2 will be mandatory for all companies, and reporting on emissions (in line with the GHG Protocol) will remain important for nearly all businesses, companies should start by ensuring they are able to disclose these requirements already. You may prepare in advance by executing the following steps: 

1. Assigning resources to be responsible for ESRS compliance
2. Confirming sustainability reporting governance
3. Implementing an ESG data management system 
4. Measure and track scope 1, 2, and 3 emissions and engage the broader organisation

By succeeding on these steps, will kickstart the organisation in tackling the other disclosure requirements and to get comfortable with the ESRS standards in general. 

How would the impact materiality assessment be conducted in terms of what to assess and how can we determine from an impact point of view if we have a material impact on climate?

Impacts need to be assessed in terms of their severity and their likelihood. Actual impacts are assumed to have a likelihood of 100%, while potential impacts will have likelihoods <100%. 

The severity of an impact is in turn determined based on the assessment of the impact’s scale, scope and irremediability. Assessment of these criteria can be informed by a variety of sources including: information already available in the company’s environmental management system, environmental impact assessments, saliency assessments, life-cycle-analyses (LCAs), etc. It may also be informed by assessments by those intimate with these impacts, internal subject matter experts or qualified external advisors. Assessments may also be informed by secondary research, such as cross-sectoral benchmarking studies. 

The advice we tend to receive when speaking with auditors about the threshold for materiality is that a reasonable person should come to the same conclusion. So if you look at a company that has a fleet of hundreds of container ships that are burning bunker fuel, a reasonable person would not agree that you don’t have a material impact on climate change. Comparatively, there might be a company that produces effectively no emissions because it’s just a few people working on computers in Scandinavia where they get green electricity, a reasonable person would probably come to the conclusion that they don’t have a material impact on climate change. 

In between those two extremes, there is a lot left for interpretation. However, when it comes to setting a reasonable threshold, it’s about being honest with yourself and your people and ultimately about where your values are in your management team.

The double materiality assessment is more rigorous than gut feel, assessing impacts by scale, scope, and other factors. Specific numbers lead to informed decisions, but there’s no one-size-fits-all answer.

Data points and disclosure requirements

The topic related disclosure requirements are now all linked to the results of the double materiality assessment. Will companies still have to source data on all disclosure requirements since their value chain will ask for information for the reporting? 

If the relationships your business has with its respective value chain creates or materially contributes towards negative impacts, then your business should be registering these impacts and disclosing the relevant related requirements. The authorities expect that at the onset, companies may not have full transparency deep into their upstream and downstream value chains, but there is an expectation that there will be increased transparency and awareness emerging over time, driven by the ESRS among other drivers. There will definitely be this rippling out effect in terms of capturing data through the value chains. 

From a data point of view, how do companies meet those supply chain requirements? 

It depends on how far you have come already and how engaged you are with your supply chain and value chain. As mentioned earlier, the ripple effect will create an impact and influence on many companies in the value chain. It’s about understanding their struggles of gathering this sort of data and including them in your processes and what you need to report on instead of putting all the weight on them since most of them are struggling. Allow yourself to collaborate and create industry initiatives and find different resources. That’s where different industries and companies can come together, which historically has been a successful approach. We will see similar patterns in this value chain reporting as well, since it will be necessary in order for them to be able to meet those reporting requirements.

What is the justification for reshuffling the S1 disclosure requirements grace period? 

Our interpretation is that now that they have provided the additional grace period for the smaller firms, they have then reversed a few of them. There is a rationale for some of those being in the grace period because smaller firms would have a difficult time to adhere to them. All smaller companies, with less than 750 employees, now have one year for all of S1. Therefore the bigger companies should be focusing on the most important one, such as adequate wages, workforce character or employee characteristics. This is most likely the rationale as to why some of it has been removed from the grace period, since you get the full one year for the smaller companies. 

The other additions most likely have to do with the fact that there has been lobbying from companies arguing that there are challenges to report on all the data that they have not been capturing in the past. The additions that were added on top of the old ones can be interpreted as a handout to make the reporting process a bit more manageable for the companies.

What disclosure requirements remain mandatory?

General disclosures (ESRS 2), is the only portion that is mandatory for all companies – given the final draft of the standards. And then additionally, depending on the results from your double materiality assessment, topics that are deemed material are also required. On top of that, there may be additional disclosures that will be mandatory for your company stated in EU-, or country-specific laws. The ESRS requirements do not bypass or circumvent other preexisting EU laws (besides the NFRD). Datapoints related to pre-existing EU laws are described in Appendix B in the ESRS 2.

We are moving from mandatory to materiality assessment determined disclosures. How will it impact the ambition levels of companies? And what do you expect this to do to the willingness of the board to invest?

Using “voluntary” might not be entirely accurate, as there are rigorous assessments and audits based on laws. For example, non-compliance on material emissions will face enforcement. There’s some regulatory arbitrage, but the window for such actions is limited.

The EU plans to have a hub where all this data from companies reporting via the CSRD will be published and available. So investors and other stakeholders will be able to do a clear assessment across industries and between companies on what they are reporting, and what their targets and ambition levels are. This means there will be a lot more transparency and not a lot of room to hide for companies reporting on climate from the materiality point of view.

Are there any mechanisms to assess the accuracy or quality of data points shared in a CSRD report?

The ESRS states that when preparing sustainability statements, companies shall apply both fundamental and enhancing qualitative characteristics of information. By checking against these characteristics, the company can get a sense of the quality of the data. The fundamental qualitative characteristics are namely that the information is: relevant and in faithful representation. The enhancing qualitative characteristics are: comparability, profitability and understandability.  These characteristics are defined in Appendix B of ESRS1.  

“Companies shall apply fundamental and enhancing qualitative characteristics of information.”

Ted Paulus – Senior Director at Position Green

There will be a requirement for limited assurance of your data reporting under the ESRS/CSRD – and this bar is expected to be elevated to reasonable assurance in the future. The communicated goal for the EU is to move to a more complete level of assurance over time. This means you will need to have some form of limited assurance of your reporting and at that level that is where the assuring party, the third party, will be taking some responsibility to ensure that your data can be validated.

Part of the ESRS 2 is putting increased emphasis on the application of thresholds for materiality. Setting thresholds allows for a greater degree of comparability year-to-year. By setting such thresholds one is able to internally assess whether there has been any significant changes over time, which can assist with assurance. Documenting the sources of information which have informed assessments of each individual’s impact, risk and opportunity is also very helpful to support the rationale for such assessments.

Relationship to other standards and frameworks

What is the key difference between the IFRS standards and the ESRS in terms of materiality? What are the differences between the November 2022 and the June 2023 drafts of the ESRS in terms of how they harmonise with the ISSB standards?

The International Sustainability Standards Board (ISSB) is an affiliate to the International Accounting Standards Board (IASB), which has developed the IFRS. The ISSB is responsible for developing the IFRS Sustainability Disclosure Standards.

Although there has been communication from both the ISSB and EFRAG claiming that they have been working together towards harmonising the two sets of standards where possible, there are likely some areas that will remain different and unique. In particular, an important concept in financial disclosures is that of “material information” – for which the IFRS has a different definition than does the ESRS in relation to financial materiality. The ISSB relies solely on the IFRS definition of materiality which is:

“Information is material if omitting, misstating or obscuring it could reasonably be expected to influence investor decisions.”

This definition may, at times, be at odds with the ESRS concept of double-materiality. 

There is an expectation that there will be an interoperability document to provide guidance to companies in how to best satisfy both sets of standards in their reporting. 

Still, there are a lot of similarities. For example, the S1 and ESRS 2 relate a lot to the risk and opportunity. S2 can be connected to the climate portion and similar questions. You will definitely see similarities in the type of data that you will need to disclose, but perhaps from a different perspective and more heavy on the financial side. 

It’s a big question for national governments outside of the EU in terms of how they implement it. For example, in New Zealand we have seen discussions particularly about the double materiality whereas Australia have been looking at the ISSB single materiality route. Our advice is to check what is going on in your market if you are outside of the EU to understand what your local regulators are looking at.