Understanding Double Materiality Under ESRS: A Practical Guide for Businesses

With the Corporate Sustainability Reporting Directive (CSRD) rapidly approaching, businesses across the EU are gearing up to comply with the European Sustainability Reporting Standards (ESRS). One of the most critical yet complex components of ESRS is double materiality—an approach that evaluates sustainability from two key perspectives: financial and impact materiality.

The European Financial Reporting Advisory Group (EFRAG), which has played a central role in drafting the ESRS, provides valuable guidance for conducting double materiality assessments. This article outlines the key steps, best practices, and practical considerations for implementing double materiality using insights directly from EFRAG’s guidance.

What is Double Materiality?

In line with EFRAG’s interpretation, double materiality under ESRS requires companies to assess:

1. Financial Materiality: How sustainability issues impact the company’s financial performance, business model, and cash flows.
2. Impact Materiality: How the company’s activities impact the environment, society, and the economy, irrespective of whether those impacts have financial consequences for the company.

The two dimensions are interrelated but distinct. A sustainability issue may be material under one dimension but not the other. For example, a company’s carbon emissions may not pose immediate financial risks, but their environmental impact might be substantial, making it a key disclosure under impact materiality.

EFRAG’s Practical Guidance for Double Materiality Assessments

EFRAG’s guidance emphasizes a systematic, data-driven approach for conducting double materiality assessments. Below are the practical steps for implementing double materiality, aligned with EFRAG's recommended methodology.

1. Preparation and Scoping

EFRAG Guidance:

• Materiality boundaries must cover the full scope of the company’s value chain, not just direct operations. Companies need to consider both upstream (e.g., suppliers) and downstream (e.g., product use) impacts.
• EFRAG advises starting with a clear definition of sustainability issues that are relevant to the industry and aligning them with the broader EU sustainability goals, such as the European Green Deal.

Practical Steps:

• Engage Senior Management and Stakeholders: Begin by securing executive support and forming a cross-functional team that includes sustainability, finance, operations, and legal experts.
• Determine Scope: Define the boundaries of your materiality assessment, ensuring it covers your full value chain as recommended by EFRAG. This involves analyzing operations, supply chains, and product life cycles.
• Align with Broader Frameworks: Map your materiality process against global standards (GRI, SASB) and EU objectives (e.g., circular economy, climate neutrality by 2050) to ensure you’re covering key sustainability topics.

2. Identifying Material Sustainability Issues

EFRAG Guidance:

• EFRAG suggests identifying potential material issues by leveraging existing frameworks (such as GRI, TCFD, and SASB) as well as sector-specific insights from the EFRAG Sector-Specific Standards.
• Companies should combine quantitative data (e.g., emission levels, resource use) with qualitative inputs (e.g., stakeholder feedback) to identify both financial and impact materiality.

Practical Steps:

• Conduct a Materiality Assessment: Begin by conducting a thorough analysis of sustainability issues based on both financial and societal impacts. This should include: Internal Reviews: Analyze business activities, risk management frameworks, and sustainability goals to identify potential financial risks. Stakeholder Engagement: EFRAG encourages engaging a wide array of stakeholders (investors, regulators, employees, suppliers, and local communities) to gather input on the company’s material issues.
• Utilize Materiality Tools: Employ materiality mapping tools and sector-specific EFRAG standards to map out which sustainability issues are relevant to your industry. For example: Climate-related issues may be financially material for energy companies but might be more impact-driven for service sectors. Human rights issues may carry substantial impact materiality for companies with global supply chains.

Best Practice: Use a materiality matrix to rank sustainability issues based on financial and impact materiality. The matrix helps visualize which issues are both financially and impact material, offering clarity on priority areas for reporting.

3. Stakeholder Engagement

EFRAG Guidance:

• EFRAG emphasizes stakeholder inclusiveness as key to the double materiality process. Companies should actively engage stakeholders throughout the process, not just at the outset. The goal is to capture the material issues that are significant to stakeholders, even if they do not directly impact financial performance.

Practical Steps:

• Identify Key Stakeholders: Identify and engage with a broad range of stakeholders, including investors, employees, customers, NGOs, regulators, and local communities.
• Continuous Engagement: Create channels for ongoing dialogue with stakeholders, rather than one-off consultations. This can include surveys, interviews, focus groups, and industry roundtables.

Best Practice: Ensure the engagement is dynamic and responsive to changes in stakeholder priorities, especially as new sustainability risks emerge, such as regulatory changes or shifts in consumer expectations.

4. Data Collection and Quantification

EFRAG Guidance:

• Robust data collection is central to materiality assessments. EFRAG advises combining quantitative data (e.g., carbon emissions, water usage, diversity metrics) with qualitative insights (e.g., community impacts, social considerations).
• Data should be granular and specific enough to support the materiality assessment but should also align with sectoral standards and general ESRS guidelines.

Practical Steps:

• Leverage Existing Tools: Use tools such as Sustainability Accounting Standards Board (SASB) metrics, Task Force on Climate-related Financial Disclosures (TCFD) indicators, and EcoVadis assessments to collect relevant data.
• Data Sources:
• Address Data Gaps: EFRAG suggests that if data availability is a challenge, companies should clearly disclose these limitations in their reports while working to improve data quality over time.

Best Practice: Establish systems for continuous data monitoring to track changes in material issues over time, allowing for timely updates to the materiality assessment.

5. Integration into Reporting

EFRAG Guidance:

• Comprehensive Reporting: According to EFRAG, companies must disclose how material ESG issues affect their strategy, financial performance, and impacts on society. This includes reporting on material topics that have both financial and impact materiality, as well as those that only fall under one category.
• Clear Disclosures: Companies must also clearly explain the methodology used to assess materiality, including the data sources, stakeholder inputs, and any assumptions made during the process.

Practical Steps:

• Align Reporting with ESRS Standards: Ensure that your sustainability reporting is fully aligned with the detailed disclosure requirements set out by ESRS. This includes providing specific data and qualitative explanations for both financial and impact materiality.
• Transparency: EFRAG encourages companies to disclose not only their materiality assessment process but also data gaps, limitations, and areas for future improvement. Being transparent about challenges adds credibility to the reporting.

Overcoming Common Challenges

EFRAG’s Recommendations:

• Data Gaps and Limitations: EFRAG advises being transparent about any data limitations encountered during the materiality process. Companies should outline how they plan to address these gaps over time.
• Balancing Financial and Impact Materiality: EFRAG acknowledges that balancing both dimensions can be challenging, especially in industries where financial risks may be low but impact materiality is high. In these cases, focus on aligning with broader societal goals and sector-specific guidance from EFRAG.

Practical Tips:

• Use of Technology: Leverage digital platforms (e.g., Sphera, Enablon) for real-time tracking and data collection.
• Cross-Departmental Collaboration: Encourage cross-functional teams to ensure the materiality process is comprehensive, with input from all relevant departments (finance, sustainability, operations).

Conclusion: EFRAG’s Role in Shaping the Future of Sustainability Reporting

Conducting a double materiality assessment under the ESRS framework requires thoughtful preparation, robust data collection, and ongoing stakeholder engagement. With EFRAG’s guidance, companies can better navigate the complexities of double materiality and ensure that their sustainability reporting is both compliant and meaningful.

By aligning with EFRAG’s best practices, businesses can turn regulatory compliance into a strategic advantage, driving long-term value creation while enhancing their sustainability footprint. Now is the time to act, as CSRD deadlines loom—and those who take a proactive approach to double materiality will be better positioned to thrive in the sustainable economy of tomorrow.