Within the new Corporate Sustainability Reporting Directive (CSRD), the concept of double materiality plays an important role. Companies that will soon have to report on their ESG performance based on the CSRD will therefore be required to carry out a double materiality analysis. Simply put, a company must use this analysis to demonstrate which topics and themes are and are not relevant to report on. Because we at Empact regularly receive questions about the concept of double materiality and the CSRD, we answer the most important questions surrounding this topic in this article.
What exactly is double materiality?
The concept of double materiality is an essential element within the CSRD. Double materiality sounds very difficult, but it is easier than you think. Material here means relevant. An ESG theme is therefore material for an organization if it is relevant to that organization and its stakeholders. In order to subsequently determine whether a theme is relevant, it is analysed from two perspectives (which is why it is called ‘double materiality’): from an impact perspective and from a financial perspective. Is a theme relevant from one or both perspectives? It then passes the double materiality test and must be reported on.
A subject or theme is impact material when it has a (major) positive or negative impact on people and the environment. Consider suppliers in the supply chain who violate human rights or customers who use the products to reduce their ecological footprint.
A topic or theme is material from a financial perspective when it has or could have a (major) positive or negative impact on the company’s financial performance, such as costs, revenues and access to capital markets. Consider cost reductions due to better energy performance, better valuation by ESG investors or cost increases to pay better wages in the supply chain.
Why is double materiality important within the CSRD?
Double materiality is so important within the CSRD because it provides direction to the entire sustainability analysis and therefor the CSRD reporting itself. By starting with a thorough analysis of what is and is not important for an organization, it is ensured that in the remainder of the analysis the organization actually focuses on the matters that have the most impact on the organization itself, its stakeholders and the planet.
The analysis also ensures more transparency and better decision-making in the future. For example, a thorough analysis of the value chain provides guidance for strategic choices in terms of supplier selection. And when the financial risks are properly identified, you can actively manage to avoid these risks and increase business value.
How do you conduct a materiality assessment for a company?
The CSRD itself does not provide specific regulations regarding the performance of a double materiality analysis. The idea behind this is that every organization is unique. The European Financial Reporting Advisory Group (EFRAG) does impose conditions on the analysis, such as the condition that all potentially relevant themes for an organization must be analysed. The EFRAG has published a draft ‘implementation guidance for materiality assessment’ that provides in-depth insight into both the foundations and the practical application of the concept of materiality. This original guideline includes four steps, but we have formulated eight steps to give the overall process a more solid structure:
- Identification of ESG themes. A double materiality assessment starts with making a longlist with all possible themes, risks and opportunities in the field of ESG. A good start are the themes, data points and sector-specific topics as described in the ESRS.
- Assessment of ESG themes. All themes identified in step 1 are then thoroughly evaluated, both from a financial and impact perspective. For this purpose, the due diligence process is applied and all themes are assessed based on both qualitative and quantitative criteria. Consider the scale and scope of certain problems, but also what is within the power of an organization to do something about them.
- Prioritization of themes. After performing the analysis in step 2, all results are merged to reveal any overlaps and connections. These themes are then arranged and visualized in, for example, a graph with impact materiality on one axis and financial materiality on the other.
- Review analysis. It is then crucial to have the results validated by colleagues, external experts and stakeholders. This ensures a more holistic approach and organization-wide support for the process. A external stakeholder validation of the materiality is also mandatory for CSRD compliance.
- Approval of analysis. After validation by internal and external stakeholders, the process begins to obtain approval from the Management Board and possibly the Board of Directors, Supervisory Board and/or the Supervisory Board. This is logically important because strategic goals and changes can only be determined at C-level.
- Validation. After approval by the Board, the materiality analysis must be checked by an accountant. This also offers opportunities to collect feedback and points for improvement.
- Manage overview of material perspective. Develop a plan for managing material perspectives so that it can be reviewed annually.
- Reporting material themes. As a final step, the materiality analysis must be reported. Firstly about how the double materiality test took place, but of course also about the outcomes (according to ESRS 2: SBM-3 and IRO-2).
Example of double materiality analysis by Philips
Philips is one of these companies that has already carried out a double materiality test. In their Annual Report 2022, they applied the double materiality test to their company. It is interesting to study this report because it provides insight into how the double materiality test can be carried out in practice. Below is a summary of their step-by-step plan.
Identifying ESG themes and prioritization
Philips must determine which Environmental, Social and Governance topics have the greatest impact on the company itself and are most important to stakeholders in the company’s value chain. Philips identifies these topics, among other things, through a multi-stakeholder process. The stakeholders with whom Philips has a dialogue include customers, suppliers, investors, employees, peer organizations, social partners, regulators, NGOs and academics.
In addition to the dialogue with stakeholders, Philips uses various other sources (such as GRI standards and the media) and has collected a lot of information (through an AI-based application) to determine ESG topics. The priority of the topics was then determined by sending a survey to a large and diverse group of stakeholders and combining the outcome with input from the application.
After Philips has determined which ESG themes have the most impact on the environment, a materiality assessment is linked to this. The materiality matrix shows how Philips’ activities are classified by materiality. On the y-axis the impact on stakeholders, on the x-axis the impact on the company itself. The white area of the matrix contains the activities with low materiality, the light blue area the activities with average materiality and the dark blue area the activities with high materiality. It is important to note that this is a relative weighting of the activities.
Financial materiality assessment
Philips subsequently opted to also carry out a financial materiality assessment. Since this test is not yet mandatory, Philips has chosen to subject only the above activities with medium and high materiality to this test. The result of this double materiality assessment shown below.
Philips’ conclusion is that the double materiality test has not led to significant changes in the identified material topics.
Would you like to know more about double materiality within the CSRD or do you need help carrying out a materiality assessment for your company? Please do not hesitate to contact us. We make an impact together!