5 steps of Double Materiality Assessment

We will finally see some reporting with the performance and disclosure of a double materiality analysis in this year’s reports, as the European CSRD/ESRS legislation will be adopted in 2023.

Our previous article outlined the concept of double materiality and 3 points for successful analytical assessment.

This article outlines the specific analysis and assessment process, and the working points. Please note that this process is based on the assumption that companies apply the CSRD/ESRS.

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※On 31th of May, 2024, EFRAG has published its final version of ESRS Implementation Guidance Double materiality assessment documents. This guidance is supplementary to the ESRS outlined in Directive 2013/34/EU but isn’t part of it. ESRS prevails over any contradictions. It’s issued under EFRAG’s responsibility, which assumes no liability for the content or outcomes of following this advice. Users should use their judgment when applying ESRS and not replace professional services.

Double materiality assessment process

The previous article mentioned that future organisational activities would require management strategies and medium to long-term plans based on this double materiality analysis.  

GRI 2021, which applies to reports issued on or after 1 January 2023, requires impact materiality in ‘GRI 3: Material Topics 2021’. Specifically, it requires that ‘actual and potential negative impacts on the environment and people are identified and negative impacts are identified by their scope, scale and irremediable character’.

The European Sustainability Reporting Standards (ESRS), which will apply to material activities from 1 January 2024, require double materiality.  

Although the GRI and ESRS differ in scope and approach to materiality, both emphasise stakeholder engagement, which is an essential part of the process of identifying materiality (Learn more about “Mapping of ESRS and GRI”).

Against the background of these regulatory and guidelines developments, it is recommended that double materiality assessments be conducted as early as possible, especially in global companies. 

But deciding which approach to assess and implement can be a challenge. Here are outlines of the five steps with key points.

Step 1: Understand value chain impacts and relevant stakeholders

1-1. Value chain and stakeholder selection

Analyse the overall value chain impacts and relevant stakeholders, and understand a holistic of stakeholders. Limited stakeholder engagement will result in gaps. On the other hand, extensive stakeholder engagement can be time consuming and costly. 

Step 2: Identify sustainability topics through stakeholder engagement

2-1. Principles for stakeholder engagement

To drive materiality assessments, it is important to set stakeholder engagement principles. This principles include: the channels of stakeholder engagement, the level of participation in each channel, at what stage of the assessment specific stakeholder groups should be engaged, how the results of stakeholder engagement will be verified, the identification of material topics, the governance of the process, decisions on how to visualise the results, and the purpose of conducting the materiality analysis assessment. 

The ESRS provides two main groups of stakeholders.

1) Affected stakeholders:
Individuals or groups whose interests are affected or could be affected – positively or negatively – by the undertaking’s activities and its direct and indirect business relationships across its value chain – Employees, Suppliers, Consumers etc.

2) Users of sustainability statements:
Primary users of general-purpose financial reporting (existing and potential investors, lenders and other creditors, including asset managers, credit institutions, insurance undertakings), as well as other users, including the undertaking’s business partners, trade unions and social partners, civil society and non-governmental organisations, governments, analysts and academics.

Engagement with affected stakeholders is positioned as central to the company’s ongoing due diligence process and materiality assessment. This includes the process of identifying and assessing actual and potential negative impacts, which is reported as the materiality assessment process.

2-2. Granularity of material topics

Achieving the right balance of granularity is important in avoiding topics becoming too general (e.g. environment) or too detailed (e.g. CO2 emissions). Defining each topic from both a financial and impact perspective is important to create a common understanding of each topic among stakeholders.

2-3. Fair scoring and processes

A robust scoring methodology should be implemented to minimise organisational subjectivity. Qualitative interview results can also support the interpretation of quantitative results. Therefore, it is also effective to conduct stakeholder dialogues with external experts and other stakeholders.

As the CSRD requires limited assurance within three years of implementation and reasonable assurance within six years, it is particularly important for companies applying the CSRD to minimise subjectivity and identify balanced topics in this scoring. 

Step 3: Identification and assessment of key topics

3-1. Assessing impacts materiality

We research and analyse relevant external materiality, such as ESG rating agencies, international guidelines, industry materiality reviews and broader societal issues, as well as the key issues identified through stakeholder engagement in Step 2. 

We then examine internal materiality factors, such as the mid-term management strategies and business plans.

Furthermore, as mentioned earlier, GRI 2021 explains that the way this impact materiality is identified in GRI 2021 is by the scale, scope and irremediable character of the materiality to identify the severity. Assuming that the GRI and the ESRS are interoperable, “GRI3: Material Topics 2021”, it is useful to carry out an analytical assessment.

3-2. Assessing financial materiality

What is the financial impact of the company’s risks? What is the likelihood of their occurrence? A feature of the double materiality analysis is the extent of the financial impact on issues that would appear in the results of the external materiality assessment in 3-1, for example, climate change or forced labour by suppliers. 

The financial impact is potentially significant and is analysed in terms of increased purchasing costs and loss of reputation and operational revenue throughout the supply chain if the business is forced to turn around.

3-3. Time horizon and geographic perspective 

The CSRD requires companies to assess their financial impacts in the short, medium and long term, as the financial impacts of climate change and other factors can increase yearly (short, medium and long-term plans are provided).

Global companies are also required to measure their impacts from a multifaceted perspective (global and local), which shows how they consider their impact on the sustainability of the business (engagement with geographically diverse stakeholders).

Step 4: Integration into strategy and reporting

4-1. C-suite involvement

The C-suite should be involved in the materiality assessment process. The C-suite needs to be aware of the results of the process and understand which issues are material from both a financial and impact perspective. They also need to be actively involved in the validation phase. 

The fact that CSRD assurance is now mandatory means that it is no longer sufficient to disclose material topics; as required by ESRS 1(3-3. Double materiality), “The undertaking shall explain how it applies criteria set under sections 3.4 and 3.5 in this [draft] Standard, using appropriate thresholds.”

Also as required GRI 2021 (GRI 3-1 Process to determine material topics), the entire identification process will need to be documented (how the evidence and information were generated, the thresholds applied, how it was identified, who identified it and why in terms of finance and impact, or both). The involvement of the C-suite is crucial.

4-2. Cross-organisational integration and practice

As the financial effects of organisational impact become clearer, the involvement of multiple departments can bring clear benefits to the business as a whole, including the ability to steer business decisions. 

4-3. Clarify objectives

The objectives of a materiality assessment are very different between a compliance-driven approach and a strategic approach to assessing risks and opportunities and developing or reshaping a company’s ESG strategy, and should be defined in advance.  

Step 5: Continuous materiality assessment

Both external and internal materiality changes significantly. It needs to be determined whether the potential sustainability issues already identified have reached the materiality threshold or whether new external issues arise and new potential sustainability issues are identified. It is recommended that materiality continues once an identification assessment has been carried out and should be reviewed regularly.

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If the sustainability issues in these steps are material from either an impact perspective, a financial perspective, or both, then the criteria for double materiality are met. Conducting a double materiality assessment provides insight into the risks and opportunities that arise from what is material to the organisation.

A better understanding of materiality and its relevance to management and business strategy can help create long-term corporate value.

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