Transparency and Relevance: How to Succeed in Materiality Assessment According to the ESRS



published on 10 november 2023 | reading time approx. 3 minutes


With the start of application of the Corporate Sustainability Reporting Directive (CSRD) on January 1, 2024, companies within its scope are required to disclose information about environmental, social, and governance (ESG) aspects using the new European Sustainability Reporting Standards (ESRS). The ESRS mandate the performance of a double materiality assessment as the starting point for reporting. But what exactly does “double materiality” entail? When should one commence the materiality assessment? And what specific steps are necessary to efficiently and purposefully identify the material topics for your company? These and other questions related to materiality assessment will be addressed in the following article. 
  • Objective of the materiality assessment

  • Who has to carry out a materiality assessment?

  • Double materiality in the sense of the ESRS

  • What is particularly important to note?

  • Best Practice approach to identifying the material matters

  • Outlook and conclusion


    Objective of the materiality assessment 

    Impacts, Risks, and Opportunities (IROs) – These three terms, commonly abbreviated as IROs, constitute a central element of the European Sustainability Reporting Standards (ESRS) adopted by the EU Commission on July 31, 2023. Specifically, they refer to the company-specific sustainability-related impacts, risks, and opportunities that are to be identified at the outset of the reporting process through a double materiality assessment. Given the numerous disclosure requirements and data points defined in the ESRS, the goal of the materiality assessment is to restrict the sustainability report to the information that is material for the individual company and, therefore, relevant to the report's users. The ESRS explicitly state that companies should only disclose information on topics that have been assessed as material. Materiality assessment thus serves as the crucial starting point for reporting according to ESRS. 

    Who has to carry out a materiality assessment? 

    With the start of application of the Corporate Sustainability Reporting Directive (CSRD) and, thus, the ESRS, the performance of a double materiality assessment becomes mandatory for the companies affected. The timing of the commencement of reporting obligations is staggered and depends on the size and capital market orientation of a company: 

    • Financial years beginning on or after January 1, 2024: Large companies that are already subject to the Non-Financial Reporting Directive (NFRD)   
  • Financial years beginning on or after January 1, 2025: all other large companies that are not covered by the NFRD   
  • Financial years beginning on or after January 01, 2026: capital market-oriented SMEs (option of voluntary deferral until 2028)

Accordingly, an estimated 15,000 companies across Germany will gradually fall within the scope of the CSRD. In order to fulfill the extensive requirements resulting from the numerous qualitative and quantitative data points of the ESRS, efficient and robust reporting processes must be established in good time. To do this, the company must first understand its key issues – after all, only then can gaps in existing reporting processes be identified, responsibilities defined, IT systems configured, and synergies recognized in a truly targeted manner. To ensure that there is sufficient time to define, implement, refine, and document the processes, it is therefore advisable to start identifying the key issues as early as possible. 

Double materiality in the sense of the ESRS

With the obligation to apply the ESRS, the principle of double materiality has been introduced into the practice of sustainability reporting. According to ESRS, a sustainability aspect is material if it fulfills the criteria for impact materiality or financial materiality or both. The impact perspective aims to determine what negative and positive impacts a company has or could have on people or the environment in the short, medium and long term through its own business activities, its upstream and downstream value chain, its products and services or its business relationships (inside-out). In contrast, the financial impact perspective is used to consider the sustainability-related risks and opportunities that (could) affect the company's financial position, financial performance, cash flows, access to finance or cost of capital in the short, medium or long term (outside-in).   

What is particularly important to note? 

Before starting the assessment process, it is essential to develop a precise understanding of the ESRS-specific features and terminology in connection with the materiality assessment. For example, the ESRS explicitly distinguish between material sustainability matters and material impacts, risks and opportunities (IROs): A sustainability matter is material if the associated IROs have been assessed as material. Conversely, this means that it is not the sustainability-related topics (e.g., climate change, resource use, health and safety, etc.) that have to be assessed and then assigned to the corresponding sustainability matters, as has often been the case in other frameworks to date, but rather company-specific IROs (e.g., risks to the health of employees in the laboratory due to contact with hazardous substances). 

Furthermore, users should be aware of the relationship between impact and financial materiality from the outset: By their very nature, the two dimensions should by no means be considered in isolation but are sometimes subject to complex interactions. The ESRS therefore explicitly emphasize that the identification of impacts (impact materiality) should be the starting point of the materiality assessment, as these, along with dependencies on natural and social resources (e.g., natural gas, water, qualified employees, etc.), are often the cause of the emergence of risks or opportunities (financial materiality). If, for example, a company's activities have a negative impact on local communities such as indigenous peoples (impact materiality), this could lead to NGOs becoming aware of this and publicly criticizing the company's practices. This could be accompanied by reputational damage and possible fines and therefore poses a risk to the company's financial situation (financial materiality). If, for example, a company is increasingly dependent on water due to its business model (dependency), the quality, price and availability of this resource could affect production and thus the financial situation and entail corresponding risks and opportunities (financial materiality).   

Best practice approach to identifying the material matters 

Step 1: Defining the scope 
Before starting the actual materiality assessment, a systematic analysis of the company context is recommended. This includes, for example, mapping the company's activities, products and/or services and locations as well as the upstream and downstream value chain. In addition, relevant legal and regulatory framework conditions (e.g., sector-specific regulations), media reports or benchmarking can also be included in the analysis. Furthermore, the scope and type of involvement of the technical experts and stakeholders is defined in more detail in this step, corresponding representatives of the stakeholder groups are identified and assigned to the individual subject areas. 

Step 2: Compiling the longlist 
The ESRS provide a table as a basis for the compilation of the longlist of potentially material matters, in which the ten topics covered by the ESRS are in turn broken down into sub-topics and sub-sub-topics. In addition – and this is particularly relevant in view of the postponement of the publication of sector-specific standards by a further two years – companies must expand the longlist with individually identified industry and/or company-specific topics. The results from the company analysis (step 1) can be helpful here, for example. 

Step 3: Identification of impacts, risks and opportunities 
Based on the longlist, company-specific short-, medium- and long-term impacts, risks and opportunities for the individual topic areas are identified by the previously defined and trained experts. Sources for IROs can be, for example, previous materiality assessments, internal risk management or feedback from stakeholder dialog formats. It is important to note that IROs can occur not only in the company's own operations, but along the entire value chain. The ESRS also differentiate between negative and positive as well as actual and potential impacts and between risks and opportunities. This classification should be made directly by the experts during the identification process in order to prevent misunderstandings later on. The (sub-/sub-sub-)topics to which no IROs could be assigned can be removed from the list of potentially material topics. At best, the resulting shortlist is validated by a broader stakeholder group to ensure quality.  

Step 4: Materiality assessment 
The materiality assessment is based on the assessment criteria defined by the ESRS for the specific IROs. For example, actual negative impacts are assessed based on the criteria of scale (how grave?), scope (how widespread?) and irreversibility (to what extent can they be remedied?), while the likelihood of occurrence is an additional factor for potential negative impacts. In order to increase objectivity and thus create a uniform understanding among the assessors, the characteristics of the scales used should be defined as precisely as possible in advance. On the basis of the scales, threshold values are defined for the individual criteria, which are used later to derive the specific IROs identified as material. As a further quality assurance measure, it is advisable to have those elements that are close to the materiality threshold assessed and validated by experts.  

Step 5: Compilation of material matters 
In the final step, the IROs identified as material are reflected back to the associated (sub-/sub-sub-)topics and their assessments are aggregated accordingly. The presentation of the material topics and IROs, as well as the level of granularity to be selected, is not prescribed by the ESRS and is therefore left to the company itself. However, the complex evaluation system, including the IRO classification on which the material topics are based, argues against the usual presentation of the topics in the form of a matrix, which inevitably involves a high loss of information, and more in favor of a tabular listing and classification. The material topics prepared in terms of content and graphics should then be finally validated together with the management.  


Outlook and conclusion

The comparatively high implementation costs associated with carrying out an ESRS-compliant materiality assessment should not be underestimated and currently presents many companies with major challenges. Companies are often unaware of the complexity and urgency as well as the resources required for the assessment and therefore start the necessary preparations too late. Even if the reporting obligation for those large companies that have not yet had to publish a non-financial report still seems a long way off with the first application in the 2025 financial year, it is worth taking a close look at the upcoming reporting obligations and thus the materiality assessment in accordance with ESRS now. First of all, a uniform awareness of the great importance of the materiality assessment for the subsequent reporting process should be created among all those involved and the company management. It is then advisable to define who is responsible and to clarify key issues such as the internal and external sources that can be used, the planned time required and the available human and financial resources in advance. If these steps are tackled in good time, there is sufficient time during the process to react appropriately to unforeseen difficulties such as a lack of willingness to cooperate on the part of stakeholders, unclear scale definitions or different levels of detail in the identified IROs and to steer the process in the right direction again and again. On the other hand, the results of the materiality assessment can be used to carry out a detailed gap analysis at an early stage and to develop strategies, measures and targets for the respective topics based on this – as envisaged by the ESRS. Despite the high demands and additional resources required, the materiality assessment should therefore also be seen as an opportunity that can help companies to further develop their own sustainability strategy and thus ensure long-term success. 

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