EFRAG's implementation guidance for the materiality assessment as of December 2023

January 13, 2024
Sustainability in Business
In the November meeting of the EFRAG working group on Sustainability Reporting, the group provided an update on the guidance for materiality assessment. This document incorporates comments from previous rounds of revisions, and it is expected to be publicly released once all comments are incorporated and it receives approval.

In the November meeting of the EFRAG working group on Sustainability Reporting, the group provided an update on the guidance for materiality assessment. This document incorporates comments from previous rounds of revisions, and it is expected to be publicly released once all comments are incorporated and it receives approval.

EFRAG drafted the European Sustainability Reporting Standards (ESRS) which was adopted by the European Commission as a delegated regulation on July 31, 2023. The organization works closely with EU regulators on the technical requirements for sustainability reporting under the Corporate Sustainability Reporting Directive (CSRD). As outlined in the adopted delegated regulation, a “materiality assessment” is a required activity for organizations to determine the scope of “sustainability matters” that should be reported under the CSRD. It is therefore, a crucial starting point of sustainability initiatives. It is "the process by which the undertaking determines material information on sustainability impacts, risks and opportunities."

What information should be reported? The draft Implementation guidance for the materiality assessment builds on previous work by Global Reporting Initiative who helped construct the concept of “double materiality” for sustainability and develop the stakeholder process for materiality assessment. It also incorporates the standards issued by the ISSB, which integrated the work of TCFD on climate-related financial disclosures. Indeed it is mentioned in the implementation guidance that "(t)he performance of a materiality assessment based on objective criteria is pivotal to sustainability reporting which shall include relevant and faithful information about all impacts, risks and opportunities (IROs) across environmental, social and governance matters determined to be material from the impact materiality perspective or the financial materiality perspective or both." To determine and appropriately report the information considered material, the criterion of "relevance", which is based on the significance of the information and its decision-usefulness, should be applied. The disclosure requirements of the ESRS outlines the reporting requirements of the sustainability matters considered material. The guidance further emphasizes that "(t)he assessment considers the undertaking’s entire value chain, i.e., it includes the undertaking’s upstream and downstream value chain, in addition to its own operations." This information will be further outlined in the Value Chain Implementation Guidance.

What if a sustainability matter is determined to be "not material"? Even if some matters are considered to be non-material after a careful assessment, it is considered to be useful sustainability-related information since it supports the "general coherence of the sustainability statement." The disclosure of such matters can be omitted, and the determination of whether to report such matters should be explicit if the information is derived from other EU legislation. Otherwise they are considered implicit. Omitting datapoints derived from other EU legislation (according to ESRS 2 Appendix B) requires stating explicitly that they are not material. When a reporting entity omits a datapoint because it is not material, it has to include an explicit statement that such datapoint is “not material." In its reporting, it must include a table of all the datapoints in ESRS 2 Appendix B, specifying where they can be found in the statement and for those that are omitted as not material, reporting that the respective datapoint is not material. ESRS 2 Disclosure Requirements which address crosscutting matters should be reported in all cases. These cross-cutting requirements include the process to identify and assess its material impacts risks and opportunities (ESRS 2 IRO1), the interaction of impacts, risks and opportunities with its strategy and business model (ESRS 2 SBM3), and the Disclosure Requirements under the ESRS covered by its sustainability statement (ESRS 2 IRO2).

Is there a prescribed process for the materiality assessment? The ESRS do not explicit mandate a specific process when conducting the materiality assessment because it believes that this should be left to the judgment of the individual reporting entities. It suggests that a process that could satisfy the ESRS requirements may include steps of understanding the context, identifying actual and potential impacts, risks and opportunities, determining the materiality of each identified matter, and finally reporting. The determination of impacts, risks and opportunities may start with the identification of impacts and the determination of whether such impacts lead to risks and opportunities. Other risks and opportunities that are not sourced from impacts then should be added to the evaluation. The reporting entity is required to set objective criteria, including thresholds, for the materiality assessment. The CSDDD which is currently under definition in the EU legislation process may provide additional clarity on the requirements of the due diligence process. The guidance highlights the importance of engaging with a broad range of stakeholders in the materiality due diligence process, as it helps to "substantiate the importance of the sustainability matters from the perspectives of the affected stakeholder groups" but it does not prescribe specific requirements in stakeholder engagements and leaves that to other regulations with a focus on the due diligence process.

How to implement the concept of "double materiality"? The draft guidance acknowledges that "(m)aterial risks and opportunities generally derive from impacts and dependencies" and thus a practical approach to determining materiality is to start with the identification of impacts. Risks and opportunities associated with such impacts should then be assessed if such impacts lead to risks and opportunities, and they includes "risks and opportunities that derive from dependencies on resources, when there are also impacts on that resource". If there are risks and opportunities not sourced from impacts, then they should be identified beyond the identification of impacts. This may include "risks and opportunities that derive from dependencies on resources, when there are no impacts on that resource". It is acknowledged that impact materiality and financial materiality are two different but highly inter-related concepts. The reporting entity is expected to exercise judgement when determining whether the two processes should be separate or integrated with common steps while it is encouraged to maximize "procedural synergies" between the two for efficiency and to avoid gaps. ESRS 1 AR 16 is a index list of sustainability matters that should be referenced as a starting point to identify material sustainability matters.

How is "interoperability" with GRI and ISSB considered in ESRS implementation? The guidance considers "(a)n assessment performed under the GRI Universal Standards constitutes a good basis for the assessment of impacts under the ESRS." The process outlined in the GRI standards can help the reporting entity to identify and assess its "actual" and "potential", "positive" and "negative" impacts. It can also help to support materiality assessment based on "severity" and "likelihood". With regard to the ISSB standards, the guidance acknowledges the "the equivalence of the scope of financial materiality in ISSB standards and the ESRS", such that a reporting entity that "applies the ESRS is expected to be able to comply with the identification of the sustainability related information on risks and opportunities under IFRS Sustainability Disclosure Standards(also known as ISBB Standards)".

The draft implementation guidance is now in Open Consultation until February 2, 2024. Link to feedback survey. Additional draft modifications will be reflected in future articles.

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