CSRD - Double Materiality Assessment

The ESRSs provide a list of sector-agnostic sustainability matters that organizations should consider in their materiality assessment.

Organizations will also be required to identify entity-specific sustainability matters that are not explicitly mentioned in the ESRS. An example is a company's tax policy, which can have a significant impact on society, and can also be a risk and opportunity considering regulations on tax transparency and measures against tax avoidance. In a later stage organizations will also have to consider sector-specific sustainability matters based on the sector-specific ESRS that are still in development.

Organizations need to consider their sectors of activities, geographical areas of operation, as well as steps in the value chain when identifying potentially relevant sustainability matters. Previous materiality assessments, internal documentation (e.g. impact and risk assessments), external documentation (e.g. sector reports, benchmarks and ESG ratings), and insights from stakeholder engagement can be used as sources of input.

By working with internal specialists (e.g. from sustainability and risk teams) and using internal resources (e.g. strategy documents) organizations can avoid being overwhelmed with a huge list of topics and can create an actionable short list of topics to be considered in the next steps of the assessment.

In the process of determining whether the sustainability matters as identified in the previous step are indeed material (and should therefore be disclosed in the sustainability statements), the next step is to define them - as required by the ESRS - in terms of the impacts the organization has  and the risks and opportunities they present.

This can be a challenging exercise. Impacts related to any sustainability matter on people and the environment can be positive or negative, actual, or potential, and interconnected with the impacts from other topics. Impacts, risks, and opportunities can occur in the short, medium or long term and pertain to (future) events and activities across the value chain.

In our experience it is crucial to tap into all the relevant units of an organization in order to make these assessments as rich as possible and also to avoid double work. And since these assessments need to cover their entire value chain, organizations need to consult stakeholders and topic experts, for example when it comes to biodiversity-related impacts and human rights of workers in the supply chain.

Once sustainability matters have been described in terms of impacts, risks and opportunities (step 3), the next step is to quantify those impacts (step 4) and risks and opportunities (step 5). This requires answering questions such as How much damage does a certain activity cause? How many people are affected by it? What is the cost of undoing the negative impact of an activity?

The level of detail involved in this step is on the one hand needed to apply the parameters defined in the ESRS. It also facilitates future disclosures. A granular assessment helps to later determine which disclosure requirements and data points are material. Moreover, organizations need to disclose how they manage the impacts, risks and opportunities connected to each topic. Going into detail here will clarify potential strategic implications.

Input for these quantitative assessments can be obtained from (again) engaging with stakeholders and experts, both internally and externally, through interviews, surveys, and workshops. In addition to this bottom-up approach, a holistic, top-down review of the outcomes is advised to address a critical challenge organizations face when assessing impacts: How to compare impacts that are completely different in nature? Does it make sense for example that biodiversity scores higher on impact materiality than corruption?

The next step is to assess the effect of sustainability risks and opportunities on the enterprise value of a company, in other words to assess the financial effects that have not yet been incorporated into the financial statements. The CSRD asks organizations to look at financial effects from two perspectives: to what extent can you continue to use your current resources and to what extent can you maintain your existing relationships?

Again, this is a challenging exercise. It requires an understanding of what is happening in the value chain, as well as insight into sustainability developments that can affect business processes. Will polluting activities be taxed more heavily? Will customers ask for other (more sustainable) products and services? What are the financial consequences of reputational risks as a result of possible human rights violations?

The assessment of risks and opportunities requires input from a range of experts. Sustainability teams can help identify events that might trigger a risk or opportunity, e.g. new regulations, increased public scrutiny or changing stakeholder expectations regarding a certain topic. Risk experts can support and ensure alignment with the broader enterprise risk management approach. Financial experts can help to assess the magnitude of the financial effect, e.g. increase in R&D expenses, loss of revenue or increase in operational costs. We suggest bringing experts together in a workshop so they can challenge each other on the relative score of each topic and how that fits in the bigger picture.

Once all impacts, risks and opportunities have been assessed, an organization can create separate ranked lists (high to low materiality score) for negative impacts, positive impacts, risks and opportunities. By applying a threshold or cut-off point these lists can be split in material (top) and not material (bottom) impacts, risks and opportunities. 

Here, the challenge is in setting the thresholds, since the ESRS provide limited guidance on this. An organization should include all significant impacts, risks and opportunities, but if too many are included the sustainability statements and strategy no longer focus on those topics that matter most. A dialogue with senior management and the experts involved is needed to develop a holistic view of the most material matters.

For the sustainability statements, but also for internal discussions, the outcomes of the assessment now need to be visualized. A materiality matrix is an option, but not a requirement under CSRD. The advantage is that a matrix provides an easy-to-read, consolidated overview. The downside is that some information is lost, given that assumptions are needed to consolidate and plot positive and negative impacts and risks and opportunities in a single dot in the matrix. Some organizations therefore decide to show the results in a table which includes more detail. 

For each sustainability matter that has been identified as material, the CSRD requires that companies disclose exactly what measures they are putting in place to manage their environmental and societal impacts. As a result, companies have to disclose not only the metrics and targets they have set for each sustainability measure, but also the policies and action plans they will execute to achieve their goals. In short: 

• What do they want to achieve?
• How do they expect to do this?

In addition, the CSRD requires companies to make disclosures about how they account for sustainability matters in their strategic planning processes. This includes coverage of how material impacts, risks, and opportunities arise from and require adaptation of the business model, market position and value chain (today and in the future).

In sum, these requirements lead to an increasing need to expressly consider sustainability impacts and to take a longer-term perspective when developing corporate strategy. The disclosure of action plans also requires companies to formulate credibly how they will ensure sustainability matters are addressed in the organization and which parts of the organization need to be involved.