Authors: Translated by Eva Kleemann (DFGE), Source Text here.
Publication: Juli 2023
Background
In January 2023, the European Union’s Corporate Sustainability Reporting Directive (CSRD) came into effect. From 2024 onwards, companies in the EU are required to provide detailed non-financial information in their management reports regarding environmental, social, and governance aspects. The European Sustainability Reporting Standards (ESRS) serve as the guiding framework for reporting. Fact Sheet 1 provides an initial overview of the background and scope of the directive, as well as the requirements of the ESRS. One of the significant changes introduced by the CSRD is the concept of Double Materiality.
This fact sheet explains what this concept means and the challenges it poses for companies.
Materiality in Sustainability Reporting
Similar to financial reporting, sustainability reports should focus on providing meaningful information that is relevant and assessable to the target audience. This focus is referred to as „materiality.“
Given the multitude of aspects encompassed by environmental, social, and governance areas, companies face the challenge of narrowing down their reporting to the topics that are material to them.
The Double Materiality Principle
Various concepts of materiality have been discussed and developed in sustainability reporting in recent years. In these discussions, topics were often prioritized based on the intensity of their impact on the environment, society, and the economy, as well as the expectations and interests of stakeholders.
The principle of double materiality represents a shift in reporting practice, as it guides companies to consider the materiality of sustainability aspects from two perspectives: Inside-Out perspective (Impact Materiality) and Outside-In perspective (Financial Materiality).
- The Inside-Out perspective helps companies identify the actual and potential positive and negative impacts of their business activities on various sustainability topics.
- The Outside-In perspective (financial materiality) examines the opportunities and risks of sustainability topics for a company’s financial position and the future viability of its business model.
When defining which topics are material for a company, both perspectives are taken into account when conducting a materiality analysis according to the Double Materiality Principle: a topic is considered material if it either creates risks and opportunities for business success (Outside-In perspective) or if it is significant based on the impact of business activities on the environment and people (Inside-Out perspective). Thus, a topic is also subject to reporting obligations if it is classified as material from the perspective of either of the two perspectives.
If a topic meets these criteria, the company must report on it in accordance with the specific ESRS standard for that topic. This includes disclosing information about the strategy and governance related to the topic, details of implemented measures, as well as targets and key performance indicators.
Industry example for the application of Double Materiality
To illustrate the practical application of double materiality, let’s consider an oil and gas company as an example. The core activity of the company is the extraction and sale of fossil fuels, which have significant environmental impacts and contribute to climate change.
From a financial materiality perspective (Outside-In), the topic of climate change, for example, can impact the company’s ability to generate short-, medium-, and long-term revenues and profitability. Regulatory requirements to reduce carbon emissions can create financial risks for the company, such as fines or increased production costs.
On the other hand, from an impact materiality perspective (Inside-Out), the sustainability impacts of the company can cover a wide range of topics. The company’s activities can have negative effects on the environment and society, such as greenhouse gas emissions, biodiversity loss, and the displacement of local communities in extraction areas.
How to identify potentially material topics
To determine which topics are material for a company in line with the concept of Double Materiality, the company must conduct a materiality analysis according to the CSRD requirements. This process requires adequate preparation, allocation of necessary resources, and involvement of senior management.
At the beginning of the analysis, companies should consider which sustainability aspects are potentially material, i.e., which topics should be further evaluated within the materiality analysis. To ensure coverage of all potentially material topics in the list, a comparison with relevant standards and frameworks is advisable. Within the context of CSRD reporting obligations, the thematic ESRS standards serve as the basis for evaluation. These standards provide a starting point for compiling the list of potentially material topics. In addition, industry-specific standards, sustainability ratings, and sector materiality profiles can be used to assess which topics are typically material for a company in a specific industry.
When selecting topics, the value chain should also be considered. Negative and positive impacts, as well as risks and opportunities, can arise not only from direct business activities but also from the supply chain or product use phase. For example, hotspots can be identified through relevant studies. Companies should reinforce these findings through independent risk and impact analyses.
How to evaluate and prioritize topics
Subsequently, by analyzing the environment, the prioritization of the previously identified topics can be determined in accordance with the principle of double materiality. A materiality analysis should always include the perspectives of a company’s stakeholders.
Representants from the fields of science, media, trade unions, associations, civil society, authorities, as well as consulting firms, investors, and the company’s lawyers are considered experts. Stakeholders to consult may include suppliers, business partners, customers, employees, employee representatives, shareholders, residents, or other affected groups.
To integrate expert and stakeholder perspectives, derivations can be made from public statements, online surveys, or interviews, for example.
After prioritizing the material topics for the company, a materiality threshold for reporting needs to be established. All topics exceeding this threshold should be highlighted and addressed in the report in accordance with the ESRS standards.
Transparency regarding the methodology is also required under the CSRD. Companies must report on how the materiality analysis based on the double materiality concept was conducted.
It is important to emphasize that the materiality analysis based on double materiality is an ongoing process and should be regularly updated and reviewed to ensure that the reporting remains relevant and meaningful.
Benefits of Materiality Analysis
Conducting a materiality analysis for prioritizing sustainability reporting fulfills a central requirement of the CSRD. In addition, identifying material topics offers further benefits for companies:
- The materiality analysis allows companies to identify strategically relevant sustainability topics and focus their sustainability management efforts on them. This enables companies to allocate their resources more effectively and improve their sustainability performance more targetedly.
- The materiality analysis sheds light on the needs and expectations of stakeholders. By identifying the material topics that are important to their stakeholders, companies can better meet their expectations, strengthen stakeholder trust and loyalty. A materiality analysis can serve as the basis or part of an ongoing stakeholder dialogue.
- The materiality analysis also enables companies to identify and evaluate risks related to sustainability topics. Companies can take measures to minimize or avoid these risks, thereby reducing potential harm to the company and the environment
Final recommendations
Conducting a double materiality analysis is not trivial. Many companies need to first understand and assess the two perspectives of double materiality for their own business.
Often, the complexity of a materiality analysis is underestimated, resulting in insufficient time and resources allocated to it. Another challenge is considering the materiality of topics throughout the entire value chain. To obtain robust results through the materiality analysis, various data sources need to be consulted, and stakeholder perspectives need to be sought.
However, the effort is worthwhile not only to meet reporting requirements but also to gain important insights into significant impacts, risks, and opportunities. These insights can contribute to the development of sustainability strategies and serve as a starting point for stakeholder dialogues.
DFGE is happy to support you in this process.
Further information
Contact
DFGE – Institute for Energy, Ecology and Economy
Phone +49 (8192) 99733 – 20
Web www.dfge.de
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