What is Double Materiality?
The EU Commission adopted the European Sustainability Reporting Standards (ESRS) for all companies under the Corporate Sustainability Reporting Directive (CSRD). The Double materiality assessment (DMA) is an integral step to understand a company's reporting requirements under ESRS. It goes beyond traditional financial materiality by considering both the impact of a company’s activities on the environment and society (impact materiality) and the impact of sustainability issues on the company’s financial performance and position (financial materiality). This dual perspective ensures that companies not only account for financial risks but also take into account their broader responsibility towards the planet and people.
Why is Double Materiality Essential for CSRD?
Double materiality is essential for CSRD compliance because it provides a holistic view of a company’s sustainability performance. By assessing both how a company's activities affect the world and how environmental, social, and governance (ESG) issues impact the company, organizations can:
Enhance Transparency: Offering stakeholders, including investors, customers, and regulators, a clearer picture of the company’s sustainability risks and opportunities.
Improve Decision-Making: Identifying material ESG issues enables companies to make informed decisions that align with their long-term business strategy and sustainability goals.
Meet Regulatory Requirements: Double materiality assessment is a mandatory part of CSRD compliance, ensuring that companies meet EU standards and avoid penalties.
Build Trust and Reputation: Demonstrating commitment to both financial performance and positive societal impact helps build trust and enhances the company's reputation among stakeholders.
How to Perform a Double Materiality Assessment
To complete the Double materiality assessment, inputs from stakeholder engagement, internal processes, and analysis, using both quantitative and qualitative data, should be leveraged. The outcome of this would be a comprehensive understanding of the organisation’s sustainability impacts, risks, and opportunities.
Step 1: Identifying Impacts, Risks, and Opportunities (IROs)
IROs refer to the positive and negative impacts your organisation has on the environment, as well as the financial risks and opportunities they present to the organisation. Assessing IROs requires considering all activities, products or services, and locations, extending to the organisation's own operations as well as upstream and downstream value chains.
The value chain covers the entire lifecycle of the organisation's products and services, focusing on both upstream and downstream business relationships, and the financial, geographical, and regulatory environments in which the organisation operates. The upstream value chain includes suppliers and resource providers that contribute inputs to production, while the downstream value chain includes distribution, customer use, and recycling or disposal.
Use the ESRS sustainability matters list: Follow the structure of the ESRS sustainability matters list on the KEY ESG platform to identify IROs for each applicable matter
Consider business-specific matters: Identify additional IROs specific to the organisation. The KEY ESG platform allows users to add IROs to additional sustainability matters outside the ESRS matters list using the ‘Add topic’ button.
Include topics identified during stakeholder engagement or due diligence. This may include decision-useful information required by stakeholders
Incorporate information from other EU legislations and widely recognised sustainability reporting standards and frameworks, such as SASB or GRI Standards
Example: An Oil & Gas company identifies a significant IRO related to land use and community relocation due to extraction plans. While the community hasn’t protested yet, there’s a risk that future resistance could disrupt production, incurring substantial financial costs. The company identifies this IRO to fall under ‘S3.1.4 Land-related impacts’ within ‘S3 Affected communities.’
Step 2: Evaluating impact materiality
Assess if the identified IROs have a positive or negative impact on people and/or the environment, including impacts from the organisation's own operations and, upstream and downstream value chain.
Determine the source: Identify if the impact is a direct result of the organisation's operations or stems from the value chain. For potential impacts, specify the anticipated timeframe.
Assess impact severity and likelihood: Consider the following criteria to assess severity and likelihood of the impact, on a ranking of 1 to 5
Scale: Evaluate the severity of the impact on society or the environment. Consider if it affects essential aspects of life, such as access to education, clean water, or sustainable livelihoods. A rank of 1 indicates minimal impact, while 5 indicates a high impact.
Scope: Determine the extent of the impact by evaluating the number of individuals or communities affected, or the geographic scale of the environmental impact. A rank of 1 represents a small number of people affected or a limited environmental impact, while 5 indicates a large number of people affected and a significant environmental impact.
Irremediable Character (for negative impacts): Evaluate whether the impact can be reversed or mitigated. Consider the feasibility of compensating affected parties, restoring resources, or rehabilitating the environment. A rank of 1 indicates it is easy to counteract the negative impact, while 5 indicates it is very difficult to mitigate.
Likelihood (for potential impacts): Determine the probability of occurrence, considering factors that may influence the likelihood of the impact happening. A rank of 1 represents a very low probability of occurrence, while 5 indicates a high probability.
Example: The Oil & Gas company identifies that this impact is resulting directly from its operations and assesses the negative impact’s severity by evaluating the scale (3) as significant disruption to community livelihoods and cultural practices, the scope (4) as affecting over 1,000 displaced individuals, and the irremediable character (3) as a potential irreversible loss of cultural heritage.
Step 3: Evaluating financial materiality
Assess if the identified IROs present financial risks or opportunities to the organisation, including effects on cash flow, financial position, performance, cost of capital, and funding access. Financial materiality is determined based on what is relevant to primary users of financial reports, particularly if omitting or misrepresenting this information could impact their resource allocation decisions. Typically, organisations evaluate financial risks and opportunities from impacts identified in Step 2 and may also consider additional risks arising from dependencies on natural or human resources.
Determine the source: Identify if the impact is a direct result of the organisation's own operations or stems from the value chain. For potential impacts, specify the anticipated timeframe.
Consider the following criteria to assess financial risks and opportunities, on a scale of 1 to 5:
Size: Evaluate the potential financial magnitude of each impact. This may involve absolute monetary thresholds or relative thresholds, such as a percentage of revenues, costs, total assets, or net equity. A rank of 1 indicates a minor financial effect, while 5 indicates a major financial effect.
Likelihood (for potential impacts): Determine the probability that the impact will materialise. A rank of 1 represents a very low probability of occurrence, while 5 indicates a high probability.
Example: The Oil & Gas company faces potential financial risks, including costly delays, legal fees, or project abandonment due to possible opposition from the displaced community. The size (5) of the financial risk is rated high, as project abandonment would incur significant financial losses. Given the current state of relations and ongoing compensation efforts, the likelihood (3) is assessed as moderate, with a mid-term timeframe for potential escalation.
Step 4: Evaluating overall materiality
Combine the insights from Step 2 (Impact Materiality) and Step 3 (Financial Materiality) to determine which sustainability matters are material. A matter can be material from an impact perspective, a financial perspective, or both.
Establish a threshold: A sustainability matter may be considered material if any IRO meets or exceeds a certain score. Define an appropriate threshold for the organisation to decide what is significant enough to be reported. Wherever possible, base the materiality assessment on objective, supportable evidence, and use informed judgement if objective data is unavailable.
Example: With significant effect from both impact materiality and financial materiality perspectives, the Oil & Gas company concludes that land-related impacts is a material sustainability matter requiring detailed reporting and ongoing management.
Step 5: Viewing the materiality matrix
Sustainability matters identified as material will be imported to the materiality matrix including the average IRO scores identified for that sustainability matter.
Note: Based on the organisation's existing materiality assessments or other available inputs, the organisation can first identify a sustainability matter as material and then determine the relevant IROs associated with that matter.
Practical Tips for Effective Double Materiality Assessment
Involve Cross-Functional Teams: Include representatives from different departments (e.g., finance, operations, HR, legal) to gain diverse perspectives and insights.
Leverage Technology: Use data analytics tools to collect and analyze data more efficiently, ensuring accuracy and consistency in your assessment.
Keep it Dynamic: Materiality assessments are not one-time activities. Regularly review and update them to reflect changes in business operations, regulatory requirements, or stakeholder expectations.
Benchmark Best Practices: Learn from industry leaders and apply best practices that have proven successful in similar contexts.
Other examples of Double Materiality in Action
A manufacturing company might find that its water usage (impact materiality) is a significant concern for local communities, while stricter water regulation presents a financial risk (financial materiality).
A technology firm could identify data privacy as a critical material issue because it impacts consumer trust (impact materiality) and could lead to substantial fines if not managed correctly (financial materiality).
Conclusion
Double materiality is at the heart of CSRD reporting, driving companies to adopt a comprehensive view of their ESG impacts and risks. By following the steps outlined in this guide and leveraging practical tips, companies can effectively perform a double materiality assessment, ensuring compliance with CSRD and fostering sustainable business practices.
If you need more information or assistance with your CSRD reporting, reach out to the KEY ESG team via our in-app chat function or email us at support@keyesg.com.