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If you have been following ESG regulations, you might have heard about double materiality. This idea is becoming part of regulatory requirements like the Corporate Sustainability Reporting Directive (CSRD). The European Union (EU) is leading efforts to create regulations and policies to safeguard the environment and address climate change.
The CSRD reporting standards are anticipated to be officially approved and adopted later this year. That's why we want to provide you with a step-by-step guide on the Double Materiality Assessment based on the European Sustainability Reporting Standards (ESRS).
This guide will help you meet the requirements of CSRD.
Materiality refers to information that is of real importance or has significant consequences. The double materiality concept has two parts:
It assesses the impact of climate change on a company's financial health and outlook, and the impact of a company's operations on stakeholders and the environment.
Investors, consumers, and regulators are increasingly demanding that companies disclose information about their environmental impacts. Key components of regulatory frameworks are the Scope 1, Scope 2, and Scope 3 emissions reporting requirements. These require companies to report, based on defensible data, their direct emissions, emissions from the purchase and use of energy, and supply chain emissions.
The CSRD standards go beyond GHG emissions and call for information on a company's impact on water and marine resources, biodiversity, and ecosystems. The rules also mandate independent auditing of company reports. Therefore, companies need to acquire inte lligence, data, and ESG software to support their compliance efforts.
Double materiality encourages companies to recognize and openly communicate the impact of their operations on climate change and the environment. It's about understanding both how a company is affected by these issues and how the company, in turn, affects them. By conducting double materiality assessments and integrating the findings into their reporting and strategies, companies can demonstrate their dedication to sustainability and establish themselves as frontrunners in responsible business practices.
According to the ESRS, companies have to do a double materiality assessment by considering both impact materiality and financial materiality. They need to identify and assess the impacts, risks, and opportunities in their value chain to determine their materiality, focusing on areas where they are deemed likely to arise based on the nature of their activities, business relationships, geographies, or other risk factors concerned. The sustainability matter is considered material for the undertaking when it meets the criteria defined for impact materiality or financial materiality or both.
The ESRS also mentions sustainability due diligence. It's a process that companies go through to understand, prevent, reduce, and take responsibility for any harmful effects they might have on the environment and people connected to their business.
This includes negative impacts that come from the company itself, as well as those linked to its operations, products, or services through its business relationships. This process is described in international agreements like the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises.
The sustainability due diligence process allows for action to be prioritized based on the severity and likelihood of the impacts. It is this aspect of the sustainability due diligence process that informs the assessment of material impacts. The identification of material (environmental and social) impacts also supports the identification of material sustainability risks and opportunities (financial impacts), which are often a product of such (environmental and social) impacts.
Here is a structured approach for the Double Materiality assessment. There are four steps in the materiality assessment, as outlined in page 28 of ESRS 1:
1. Understanding of the context in relation to its impacts including its activities, business relationships, sustainability context and stakeholders.
2. Identification of actual and potential impacts (both negative and positive), through engaging with relevant stakeholders and experts. In this step, the undertaking may rely on scientific and analytical research on impacts on sustainability matters.
3. Assessment of the materiality of its actual and potential impacts.
4. Determination of the material matters.
These steps are designed to help an undertaking identify which sustainability matters are most significant to its operations and stakeholders, so that it can prioritize reporting on those issues.
It's crucial to analyze the impacts and relevant stakeholders across the company's value chain to create a holistic understanding. Limited stakeholder engagement can create gaps, while extensive engagement can be costly and lengthy.
Striking the right balance in the granularity of material topics is important to avoid being too generalized or detailed. Defining each topic from a financial and impact lens helps establish a common understanding for stakeholders.
You might be wondering now:
So here is some more detail on that:
Value chain impacts refer to the effects on the environment, society, and governance that happen throughout the entire process of creating and delivering a product or service. These impacts can occur at any stage of the value chain, starting from the extraction of raw materials and continuing until the product or service reaches the end of its life and needs to be disposed of.
The value chain includes all the activities, resources, and relationships that a company relies on to bring its products or services from the initial idea to the final delivery, consumption, and disposal.
The ESRS defines two main stakeholder groups: "Affected stakeholders" and "Users of sustainability statements." Affected stakeholders are those individuals or groups that are or may be affected in a positive or negative way by a company's activities, including those across its value chain. Users of sustainability statements include investors, lenders, trade unions, and NGOs, among others. Engaging with stakeholders is crucial for companies to gain valuable feedback and insights into the risks and opportunities identified in the materiality assessment.
The sustainability matters to be included in the materiality assessment are listed in Appendix B of the [Draft] ESRS 1 General requirements. The list is categorized by topics, sub-topics, and sub-sub-topics to support the materiality assessment.
The impacts on the state of species and ecosystems should also be considered, such as species population size, species global extinction risk, land degradation, desertification, soil sealing, and impacts and dependencies on ecosystem services.
Additionally, resource inflows including resource use, resource outflows related to products and services, and waste should be considered. Working conditions such as secure employment, working time, adequate wages, and social dialogue should also be included.
In the second step of the materiality assessment process, organizations should discuss the list of topics with internal and external stakeholders, ensuring a strong foundation for the assessment. Setting clear guiding principles for stakeholder engagement is crucial and includes decisions on the channel, level and nature of participation, stage in the assessment, testing of results, list of material topics, governance, and results visualization.
This step aims to identify actual and potential impacts, both negative and positive, by engaging with relevant stakeholders and experts. Organizations must gather information on the sustainability matters most important to stakeholders and determine which matters are most significant to their operations. Undertakings may rely on scientific and analytical research to help identify these issues and should engage with a wide range of stakeholders, including those directly or indirectly affected by the operations, as well as those with expertise in relevant sustainability matters.
To ensure a robust and objective assessment, a strong scoring methodology must be in place. Qualitative interview results can support the interpretation of quantitative findings, while maintaining the traceability of assumptions, which is key for external assurance readiness under the CSRD. The CSRD also requires organizations to assess the financial impact of sustainability matters for short, medium, and long-term periods, making transparency about the time horizon used essential.
The third step in the materiality assessment is to assess the materiality of the actual and potential impacts identified in the previous step. Materiality refers to the significance of an impact, which is determined by its size, nature, and potential effect on stakeholders.
The undertaking should consider both quantitative and qualitative factors when assessing materiality, such as the magnitude of the impact, its likelihood of occurring, and its duration. The undertaking should also consider whether the impact is reversible or irreversible, and whether it affects a large number of stakeholders or only a few. By assessing materiality, the undertaking can prioritize which sustainability matters to report on in its sustainability statements.
The fourth and final step in the materiality assessment is to determine the material matters. This involves identifying which sustainability matters are most significant to the undertaking's operations and stakeholders, based on the results of the previous three steps.
The undertaking should consider both positive and negative impacts, as well as short-, medium-, and long-term time horizons. The material matters should be those that are most likely to have a significant impact on the undertaking's ability to create value over time, or that are most important to stakeholders. By determining the material matters, the undertaking can focus its reporting efforts on those issues that are most relevant and meaningful to its stakeholders.
In conclusion, the Double Materiality Assessment is an essential process for companies to understand and report their impacts on the environment and stakeholders, as well as the financial implications of these impacts. By conducting a thorough assessment, companies can prioritize their sustainability efforts, comply with regulatory requirements, and demonstrate their commitment to sustainable business practices. Effective stakeholder engagement and robust methodologies are key to ensuring a comprehensive and transparent assessment.
Daato is a comprehensive ESG software solution that can help you streamline your sustainability reporting process and conduct an effective Double Materiality Assessment. With Daato, you can:
Daato's features make it an all-inclusive solution, offering API integrations with relevant business software, custom reporting options, and efficient stakeholder management. By using Daato, you can navigate the complexities of the Double Materiality Assessment and meet your sustainability reporting requirements effectively and efficiently.