Ed. note: Advisory Board Member Donato Calace prepared this short series on designing and implementing a process for double materiality assessment. Today covers the background.
The April 2021 proposal for the Corporate Sustainability Reporting Directive (CSRD) adopted by the EU Commission sets common European reporting rules for more than 50,000 companies to report sustainability information in a consistent and comparable manner, in alignment with the EU Taxonomy. Companies must also report according to mandatory EU sustainability reporting standards and conduct a double materiality assessment.
Despite being a new perspective to look at materiality, there is already evidence of companies implementing double materiality in their assessments. References to the term “double materiality” in annual corporate reports increased 10x since 2018, even though not mandatory. In light of the requirements introduced with the CSRD, this trend will only increase in the coming years.
These two posts explore the background of and best practices in conducting double materiality assessments, proposing a process based on 5 steps. The full research Datamaran conducted on double materiality assessments can be found here.
What is Double Materiality?
Double materiality was first introduced by the EU Commission as part of the 2019 Non-Binding Guidelines on Non-Financial Reporting Update (NFRD). Under this concept, ESG issues create risks and opportunities that are material from a financial or an impact perspective, or both. For this reason, as the Directive explains, “companies have to report about how sustainability issues affect their business and about their own impact on people and the environment.”
From an impact materiality perspective, nitrogen oxides (NOx) emissions from fuel combustion can be material as a negative effect (harm) to sustainable development of an organization. Stakeholders interested in this perspective include NGOs, civil society, local communities, public institutions (e.g. governments setting public policy goals in relation to sustainability), and investors (e.g. investors focused on impact strategies, or required to report on the sustainability impacts of their investment portfolios as a result of the EU Sustainable Finance Disclosure Regulation (SFRD) or EU Taxonomy).
From a financial materiality perspective, NOx emissions can have a direct monetary impact due to expenses related to emissions controls or violations of air pollution regulations. Investors and capital providers are stakeholders interested in this perspective, although it can be argued that employees and society at large have an interest in knowing about impacts that can affect the financial health or the broader enterprise value of an organization.
It is easy to see how the two perspectives are interrelated, as for example an investor concerned about (or legally required to take into account) the impact of NOx emissions may decide not to invest in an organization based on the volume of their emissions, eventually affecting the ability of such company to attract capital or the cost to access capital.
Introduction to the Process
A double materiality assessment does not require two separate assessments or matrices. It requires gathering evidence, assessing, and explaining why issues are material from the “impact” (stakeholders) perspective and/or from the “financial” perspective. It is important to note that both dimensions (impact and financial) are not constrained to matters that are within the control of the reporting entity but can also concern the value chain (both downstream and upstream).
In particular, the EFRAG proposal for EU Sustainability Standards indicates that:
- Impact materiality concerns “inside-out” impacts of the company’s own operations and its value chain. This is assessed as severity and likelihood (where applicable) of actual and potential negative impacts; scale, scope, and likelihood of actual positive impacts, urgency derived from public policy goals and planetary boundaries.
- Financial materiality, or the outside-in perspective, is based on “evidence that [sustainability] matters are reasonably likely to affect [an organization’s] value beyond what is already recognised in financial reporting.” More specifically, the determination of financial materiality can use non-monetary quantitative, monetary-quantitative, or qualitative data. In other words, the financial materiality test that applies to sustainability-related information is different from the materiality test used for financial information in financial reports. (e.g. statements in annual reports on the likes of “economic events are recognized based on their relative importance, and that for financial statements of year X materiality was determined on the basis of X% of consolidated earnings”).
Tomorrow’s post will present the 5-step process.
 EFRAG’s report ”Proposals for a relevant and dynamic EU sustainability reporting standard”, p. 8