Introduction
Determining financial materiality thresholds is a key step in compliance with the Corporate Sustainability Reporting Directive (CSRD), particularly within the Double Materiality Assessment (DMA). Financial materiality focuses on identifying sustainability risks and opportunities that may significantly impact an organisation’s financial performance over the short, medium, or long term.
While the CSRD and European Sustainability Reporting Standards (ESRS) do not prescribe specific thresholds, organisations are required to define their own based on a combination of likelihood and potential magnitude of financial effects. This article provides practical guidance, including the importance of engaging with the board and C-suite members, to help ensure your organisation sets appropriate thresholds.
What Does the CSRD Say About Financial Materiality Thresholds?
The ESRS 1 guidance indicates that thresholds should be based on:
Likelihood of occurrence: How likely the risk or opportunity is to materialise.
Magnitude of financial effects: The potential scale of the financial impact (on revenue, costs, assets, or equity).
These thresholds can take the form of:
Absolute monetary thresholds, such as fixed amounts.
Relative monetary thresholds, such as a percentage of revenues, profits, total assets, or equity.
Organisations should also consider:
Time Horizon: Sustainability reporting requires a longer-term view than traditional financial statements. Risks that develop gradually (e.g., climate-related costs) must be included.
Qualitative Considerations: Reputational risks or dependencies on natural and social resources may be material, even if their financial effects cannot yet be quantified.
Stakeholder Perspectives: Materiality assessments should reflect the expectations of stakeholders, including shareholders, investors, and lenders.
The Importance of Collaboration with Leadership
Defining materiality thresholds is not just a technical exercise—it requires input from senior leadership, particularly those responsible for risk, compliance, and overall business strategy.
Here’s how this collaboration typically works:
Risk and Compliance Team Engagement: The risk and compliance teams analyse risks and opportunities, estimate their likelihood and potential financial impact, and propose thresholds.
C-Suite and Board Involvement: Thresholds must be reviewed and signed off by the executive management and/or board of directors. These leaders are best positioned to determine what level of risk is acceptable for the business based on strategic priorities and industry dynamics.
This communication ensures thresholds are not only aligned with financial realities but also integrated into the broader business strategy. It also fosters accountability and ensures materiality decisions reflect both operational insights and long-term business goals.
Is 5% of Net Revenue a Reasonable Financial Threshold?
A 5% financial threshold can be reasonable, depending on your organisation’s risk profile, industry, and sustainability priorities. Based on our experience:
Companies typically use thresholds ranging between 3% and 10% of net revenue, profit, or other financial metrics.
Organisations in high-risk industries (e.g., energy, chemicals) may adopt stricter thresholds closer to 3% to account for significant sustainability risks.
Those in industries with lower exposure may set thresholds at the higher end of the range.
The appropriateness of a 5% threshold should be validated through internal collaboration and by benchmarking against peer companies in your sector.
Best Practices for Setting Financial Materiality Thresholds
Collaborate Across Teams: Involve finance, risk, compliance, and sustainability teams to develop a comprehensive view of potential risks and opportunities.
Engage Leadership: Seek input from the C-suite and the board of directors to ensure thresholds align with the organisation’s strategic risk appetite.
Benchmark Against Peers: Compare your thresholds with similar organisations in your industry to remain aligned with best practices.
Consider Long-Term Impacts: Ensure thresholds account for cumulative risks over the short, medium, and long term.
Integrate Qualitative and Quantitative Approaches: Balance quantitative thresholds (e.g., percentage of revenue) with qualitative assessments of reputational risks or stakeholder concerns.
Conclusion
Setting financial thresholds for CSRD materiality is a collaborative process that requires input from multiple stakeholders, including risk and compliance teams, the C-suite, and the board.
Defining these thresholds thoughtfully not only ensures compliance with CSRD requirements but also integrates sustainability risks and opportunities into broader business decision-making.
If you need further assistance or would like to benchmark against peers, please contact the KEY ESG team via the in-platform chat function or email us at support@keyesg.com. We’re here to help!