Double materiality: why and how to apply the concept?

In the CSRD (Corporate Sustainability Reporting Directive) the concept of double materiality plays a very important role. Becoming familiar with this concept will help you and your company to determine which sustainability topics are material and therefore require appropriate disclosures in your sustainability reporting. Applying this concept properly will not only help you in the process of becoming CSRD-compliant and focusing on the right topics,  but,  it also will provide you with valuable input in determining your company’s strategy on ensuring the company is future-proof!

In this article we will guide you through this concept by using the draft European Sustainability Reporting Standards (ESRS) as published by EFRAG.

What is double materiality?

Double materiality is a concept which provides criteria for determination of whether a sustainability topic or information has to be included in the undertaking’s sustainability report.

Double materiality is the combination of impact materiality and financial materiality. Therefore, a sustainability topic or information meets the criteria of double materiality if it is material from the impact perspective or from the financial perspective or from both of these two perspectives. Both perspective are equally important.

Let’s have a closer look at the two perspectives.

Impact materiality – looking “inside out”

A sustainability topic or a piece of information is material from an impact perspective if the undertaking is connected to actual or potential significant impacts on people or the environment and is related to the sustainability topic over the short, medium or long term. This includes impacts directly caused or contributed to by the undertaking and impacts which are otherwise directly linked to the undertaking’s upstream and downstream value chain. The impact can be either positive or negative.

Financial materiality – looking “outside in”

A sustainability topic is material from a financial perspective if it triggers financial effects on undertakings, i.e. generates risks or opportunities that influence, or are likely to influence, the future cash flows and therefore the enterprise value of the undertaking in the short, medium or long term but are not captured by financial reporting at the reporting date.

How to apply double materiality

First step: Understanding how your business creates value

Start by asking how value is defined by customers, investors, employees, suppliers and other stakeholders of your undertaking. Defining the value creation model of your company starts with identifying stakeholders, understanding how they are relevant to the organization’s purpose and strategy and understanding their needs and expectations.

Second, you need to gain insight in the input needed to conduct your business, the added value of your company and the output provided by your company. Many companies use the International Integrated Reporting Framework to create a value creation model: InternationalIntegratedReportingFramework.pdf

To get a complete overview of value creation model of your business you need to involve the value chain of your company as well.

Second step: Define the sustainability topics for which you need to determine if it is material for your company.

Your second step will be to collect data on potentially material topics.

 You need to identify sustainability topics and structure them before performing the materiality assessment. The basis for the identification and categorization of sustainability topics is provided by your value creation model.

In addition you collect this data by consulting the UN Sustainable Development Goals (UN SDG), the OECD Guidelines for Multinational Enterprises and other guidelines on corporate responsibility. Also take a look at the best practices within your industry and peer group.

Throughout this process you need to involve your stakeholders and users and their information needs as the basis for the process of deciding on the materiality of the topic.

Third step: Assessing materiality of the sustainability topics

From the list of sustainability topics you have made in the previous step, you have to determine the impacts, risks and opportunities.

Impact materiality:

When determining the impact materiality of sustainability topics you need to evaluate the scale, scope and, in case of a negative impact, the remediability of the sustainability topic. These parameters can be determined for example by using the following scales:

You also need to take into account the likelihood of the impact to get the final assessment of the impact materiality.

Financial materiality:

The financial materiality is determined by using the variables “magnitude” and “likelihood”.

Magnitude is the size of the (potential) financial risks and opportunities. Likelihood is the assessment of the chance that the risk or opportunity will actually occur.

Fourth step: which topics from the initial list are actually material?

As soon as one of the topics from your initial list is qualified as material from either impact materiality perspective, financial materiality perspective or maybe both, you will need to include this as a “material topic” in your sustainability report.

Fifth step: Embed strategic implications in your organization to create a sustainable business.

Finally you need to embed the material topics in your organization’s strategy and activities. This will help you further develop policies and procedures and implement these in your organization. Not only will this help you to measure and report on the key performance indicators related to your material topics, but it will also help you to make your organization sustainable!

Want to know more about ESRS, CSRD or CSRD-reporting? The specialists of Crowe Peak are here to help. Please contact us.