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 under the CSRD will therefore be required to perform a double materiality analysis. Simply put, this analysis requires a company 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 dual materiality and the CSRD, in this article we answer the key questions surrounding this topic.
This article is a brief summary of the in-depth handbook developed by Empact for Sdu. For more information, visit Jes!Knowledge.
What exactly is double materiality?
The concept of double materiality is an essential component within CSRD. Double materiality sounds very difficult, but it is simpler than you think. Indeed, material here means relevant. So an ESG theme is material to an organization when it is relevant to that organization and its stakeholders. Then, to determine whether a theme is relevant, it is analyzed from two perspectives (which is why it is called “dual materiality”): from an impact perspective and from a financial perspective. Is a theme relevant from one or both perspectives? Then it passes the double materiality test and must be reported on.
Impact materiality
A topic or theme is impact material when it has a (large) positive or negative impact on people and the environment. Think of suppliers in the supply chain who violate human rights or customers who use the products to reduce their carbon footprint.
Financial materiality
An issue 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. Think of 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 CSRD because it gives direction to the entire sustainability analysis and, ultimately, so does reporting on it. By starting with a thorough analysis of what is and is not important to an organization, it ensures that as the analysis continues, the organization actually focuses on the issues that have the most impact on the organization itself, its stakeholders and the planet.
The analysis also provides greater 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, active management can be done to avoid these risks and increase the company value.
How do you arrive at a good materiality perspective for a company?
The CSRD itself does not provide any specific requirements with respect to conducting a dual materiality test. The idea behind this is that each organization is unique. However, the European Financial Reporting Advisory Group (EFRAG) does impose conditions on the analysis, such as the condition that all topics potentially relevant to an organization must be analyzed. EFRAG has published a draft “implementation guidance for materiality assessment” that provides in-depth insight into both the principles and practical application of the concept of materiality. This original guidance includes four steps, but we have formulated eight steps to give the overall process a more solid structure:
- Identification ESG themes. A double materiality analysis starts by making a longlist of all possible ESG themes, risks and opportunities. A good start are the themes, data points and sector-specific topics as described in the ESRS.
- Assessing ESG themes. Next, all themes identified in Step 1 are thoroughly evaluated from both a financial and impact perspective. For this, the process of due diligence is applied and all themes are assessed based on both qualitative and quantitative criteria. Consider the scale and scope of certain problems, as well as what is in an organization’s power to do something about them.
- Prioritization of themes. After conducting the analysis from step 2, all results are aggregated to reveal any overlaps and connections. Then these themes are arranged and visualized in, for example, a graph with impact materiality on one axis and financial materiality on the other.
- Review analysis. Next, it is crucial to have the results validated by peers and external experts and stakeholders. This ensures a more holistic approach and organization-wide support for the process.
- Approval analysis. After validation by internal and external stakeholders, the process of obtaining approval from the Executive Board and possibly the Board of Directors, Supervisory Board and/or Supervisory Board begins. This is logically important because strategic goals and changes can only be determined at the c-level.
- Validation. After Board approval, the materiality analysis should be reviewed by an auditor. This also provides opportunities to gather feedback and areas for improvement.
- Manage overview of material perspective. Develop a plan for managing material perspective so that it can be reviewed each year.
- Report material themes. The last step is to report on the materiality analysis. Primarily on how the double materiality test took place, but of course also on the results (according to ESRS 2: SBM-3 and IRO-2).
Example double materiality analysis by Philips
Philips is one of these companies that has already applied a double materiality test. In their Annual Report 2022, they have applied the double materiality test to their company. It is interesting to study this report because it provides insight into how to implement the double materiality test in practice. Below is a summary of their roadmap.
Identifying ESG themes and prioritization
Philips must identify which Environment, Social and Governance topics have the greatest impact on the Company itself and are most important to stakeholders in the Company’s value chain. One of the ways Philips identifies these topics is through a multi-stakeholder process. The stakeholders with whom Philips engages in dialogue include customers, suppliers, investors, employees, peer organizations, social partners, regulators, NGOs and academics.
In addition to stakeholder dialogue, 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 identify ESG topics. The topics were then prioritized by sending a survey to a large and diverse group of stakeholders and combining the outcome with input from the application.
Materiality Assessment
After Philips has identified which ESG themes have the most impact on the environment, a materiality assessment is linked to it. The materiality matrix shows how Philips’ activities are ranked in terms of 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 shows the activities with low materiality, the light blue area the activities with medium materiality and the dark blue area the activities with high materiality. It is important to note here that this is a relative weighting of activities.
Financial materiality test
Subsequently, Philips chose to also perform a financial materiality test. As this test is not yet a requirement, Philips has chosen to subject only the above medium and high materiality activities to this test. The result of this double materiality test is shown below.
Philips’ conclusion is that the double materiality test did not result in significant changes to the identified material issues.
Want to learn more about double materiality within the CSRD or need help conducting a materiality analysis for your company? If so, don’t hesitate to get in touch. Impact we make together!