Draft Materiality Assessment Implementation Guidance - our key takeaways
The EFRAG Sustainability Reporting Board will meet on 23 August to discuss the proposed Materiality Assessment Implementation Guidance for public input.
In this article you will find a summary of our key takeaways from this guidance.
Why do we need to assess materiality?
The materiality assessment is the process by which the undertaking determines material matters and material information to be reported on in its sustainability statement.
The assessment is not limited to the undertaking’s own operations as it also includes its upstream and downstream value chain.
Given that the double materiality considers both impact materiality and financial materiality, the undertaking needs to identify whether a topic, sub-topic or sub-sub-topic is material from any of the two perspectives, or both.
If the undertaking identifies a large number of impacts, risks and opportunities, it may prioritise them over time in a certain order for management purposes.
However, for reporting purposes this prioritisation should not result in material impacts, risks and opportunities being excluded; in particular, when they are not addressed or fully addressed by the undertaking through policies, targets and action plans.
This is because the undertaking is expected to report on all its material impacts, irrespective of whether actions have been undertaken or are planned to address them.
The ESRS also include a requirement to disclose the materiality assessment process (ESRS 2 IRO-1), whereby the undertaking describes the materiality assessment process put in place to identify the information to report on.
This disclosure provides transparency on the materiality assessment performed, including judgements made by the undertaking throughout the process (for example, on the use of thresholds to assess materiality).
Determination of the information to be reported
The determination of the information to be reported depends on whether the information relates to (a) policies, actions and targets; or (b) metrics.
For policies, actions and targets, information shall be disclosed according to the Disclosure Requirements, or it shall be stated that the undertaking does not have policies, actions and/or targets.
For metrics, it is possible to omit them when they are assessed as not material based on the materiality assessment. Such an omission is in itself useful sustainability-related information.
Omitting datapoints derived from EU legislation based on materiality requires stating explicitly that they are not material.
ESRS 2 Disclosure Requirements which address cross-cutting matters are to be reported on in all cases (irrespective of the outcome of the materiality assessment).
The datapoints in the Minimum Disclosure Requirements (MDR in ESRS sections 4.2 and 5) have been defined to depict the relevant information that a user would require to assess the policies, actions and targets in relation to a material matter.
The proposed Materiality Assessment Implementation Guidance
The proposed implementation guidance is non-authoritative and accompanies ESRS but does not form part of it.
This means that if anything in this guidance appears to contradict any requirement or explanation in ESRS, ESRS takes precedence.
Moreover, the issued draft guidance acknowledges that market practice is currently developing for double materiality assessment and that there is no single solution for all undertakings in terms of designing processes and adopting methodologies.
ESRS do not mandate how the materiality assessment shall be conducted by an undertaking, or how the process should be designed.
No one process would suit all types of economic activities, location(s), business relationships or value chains (upstream and/or downstream) of all the undertakings applying ESRS.
An undertaking, based on its specific facts and circumstances, shall design a process that is fit for purpose considering the requirements of ESRS 1 Chapter 3, and what needs to be disclosed regarding the materiality assessment and its outcome (see ESRS 2 IRO-1, IRO-2 and SBM-3).
Therefore, the ESRS provide several aspects that an undertaking takes account of when designing its materiality assessment process.
The materiality assessment should meet the requirements of ESRS 1 (see chapter 3 and paragraphs AR 6 to AR 16).
Two approaches: top-down and bottom-up
Two approaches are proposed - top-down and bottom-up - based on the list in ESRS 1 paragraph AR 16, that summarises the sustainability matters covered by ESRS.
“Top-down” approach:
Starting with the list of topic / sub- topic / sub-sub topic in ESRS 1 paragraph AR 16, assess the existence of the related potential material impacts (actual / potential, negative or positive), risks or opportunities.
Note that any material entity-specific topics need to be taken into account, in addition to the list in AR 16.
“Bottom-up” approach:
Step 1 - Identification of the list of potential material matters on the basis of the impacts, risks and opportunities which are identified at a granular level.
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Step 2 - Group these impacts, risks and opportunities into topics or sub-topics, which become the list of potential material matters to be compared with the classification defined in ESRS 1 paragraph AR 16.
In some cases, the undertaking may, for those sub-topics (or sub-sub topics) that are not material on an individual basis, aggregate them at a higher level (topic level or sub-topic level), if that higher level is material due to another sub-topic (or sub-sub topic) being material at the level below.
The outcome of this is the definition of a list of potential material matters (topics and sub-topics) and their related impacts, risks and opportunities.
Stakeholder engagement
Stakeholder engagement entails seeking input and feedback to understand the concerns and the evidence of actual and potential impacts of the undertaking on people and the environment and it helps to substantiate the importance of the sustainability matters from the lenses of the affected stakeholder groups.
Note that stakeholder concerns and evidence of actual and potential impacts are in focus here, not ranking the relative importance of different sustainability matters.
Impact materiality assessment
To assess the materiality of impacts, ESRS 1 paragraph 42 states that an undertaking shall apply criteria set under ESRS 1 chapter 3.4 using appropriate quantitative and/or qualitative thresholds.
Impact materiality is determined by severity for actual negative impacts and severity and likelihood for potential negative impacts.
Severity is based on factors that are scale, scope and irremediable character for negative impacts; and scale and scope for positive impacts.
Therefore, these factors should be the basis for determining the thresholds.
Also, when defining the threshold, the undertaking may consider the overall number of potential impacts across environmental, social and governance.
ESRS 1 does not prescribe how to set such thresholds.
Moreover, such thresholds are not set to define how to sequence or prioritise the actions but rather to define a “cut off” for information to be disclosed as material.
When setting up the threshold, attention should be paid to any supportable evidence that provides as much objectivity as possible to the materiality conclusion.
However, reasonable quantification of the potential impacts may not always be available to support the materiality assessment.
It is to be noted that if one of the factors scale, scope and irremediable character is significant, the impact would become “severe”.
Typically, there is an interrelation between these factors; hence, the greater the scale or scope of an impact, the less it is remediable.
For impact materiality, an assessment performed under GRI constitutes a good basis for the assessment of impacts under ESRS.
A due diligence process, as defined in the international instruments, can help an undertaking both
Financial materiality assessment
Material risks and opportunities for the undertaking generally derive either from impacts or from dependencies (on resources and/or relationships).
To assess their materiality, appropriate quantitative and/or qualitative thresholds based upon anticipated financial effects in terms of performance, financial situation, cash flows, access to and cost of capital are used.
Sustainability risks and opportunities are assessed based on
Therefore, the undertaking shall go through the list of potentially material risks and opportunities and apply an objective set of thresholds for likelihood and magnitude.
When applicable, the undertaking may compare those to the ones used in its ERM processes (when the latter covers also sustainability risks) and estimate the likelihood of occurrence of the risks and opportunities or their related financial effects accordingly.
In addition, the undertaking shall consider the list of potential material impacts to assess whether they are sources of current or potential risks and opportunities.
For financial materiality, an undertaking that applies ESRS is expected to be able to comply with the identification of the risks and opportunities to be disclosed under IFRS-S (note that EFRAG’s paper does not state the inverse to be true).
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