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The European Union’s Corporate Sustainability Reporting Directive (CSRD) is a highly impactful regulation that will transform how your company reports sustainability information. By design, the CSRD in part aims to raise sustainability reporting standards to the same level as corporate financial reporting by mandating disclosures of certain environmental, social and governance topics. Even if your company has reported nonfinancial data in the past, you will likely need to expand the nature and extent of your disclosures.
To comply with the CSRD, your company will need to identify its material sustainability impacts, risks and opportunities. The required approach for doing that is a “double materiality” assessment, which broadens the concept of materiality from a sole focus on financial materiality to one that includes a view of your impact on stakeholders and society. Impact and financial materiality are not mutually exclusive. Material risks and opportunities are generally derived from the impacts and dependencies on natural, human and social resources. In addition, for most material impacts, a material risk and/or opportunity may emerge over time. This assessment requires viewing materiality from two perspectives.
- Financial materiality: This “outside in” view focuses on how sustainability matters may pose either a prospective material risk or opportunity that could affect a company’s financial performance and position over the short, medium and long term. Sustainability matters are considered material for primary users of a company’s financial reports if omitting or misstating the information could influence the users’ decisions.
- Impact materiality: This “inside out” view focuses on the actual or potential short, medium and long-term impacts on people or the environment that are directly linked to a company’s operations and its value chain. These impacts can be both positive and negative.
This two-pronged perspective adds a level of complexity to materiality assessments. The European Sustainability Reporting Standards (ESRS), which detail the reporting requirements for companies in scope of the CSRD, require that companies independently assess if a sustainability matter (a topic, sub-topic or sub-sub-topic) is material from a financial or impact perspective or both. A sustainability matter needs to be material from only one of the two perspectives to require disclosure. To make those determinations, companies will likely need a greater understanding of sustainability matters in their value chain to measure and assess financial and impact materiality. These steps are likely new for many companies.
Common materiality assessment mistakes and how to overcome them
For now, there isn’t consensus on practices and implementation guidance recently proposed by EFRAG may describe some flexibility in how to approach materiality assessments. In this environment, it is important for companies to avoid common pitfalls when designing and performing their materiality assessment. This will establish the critical foundation for the CSRD reports.
To assist, we have outlined some common pitfalls we have observed as companies conduct a materiality assessment. We list these pitfalls and key insights so that you can avoid making similar mistakes and be well prepared for any questions that may arise from senior management, audit committees, or during the assurance process.
What your company should do now to prepare for the CSRD’s disclosure requirements
The ESRS guidelines outline a wide range of requirements and should not be underestimated in terms of their complexities. It’s imperative that companies start to prepare for their reporting obligations now by gaining an understanding of those requirements (including which sustainability matters are material), the processes needed to obtain the data from across your value chain and the development of a reporting system.
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