Double materiality

Greenscope
july 2023
14 min read

Introduction

Since the adoption of the CSRD (Corporate Sustainable Reporting Directive) in November 2022, double materiality analysis has been at the heart of reflections aimed at defining a suitable sustainability reporting strategy. This principle was officially used in the European NFRD regulation in June 2019. Although the concept of double materiality is not new, the CSRD helps to clarify and strengthen it.

According to the latest draft delegated act (draft revised standards) issued by the European Commission on June 9, all cross-sector ESRS standards (with the exception of ESRS 2) will be subject to double materiality analysis. Thus this concept appears to be the keystone of the new directive.

What are we talking about?

The principle of double materiality distinguishes two types of related and interdependent materiality. Entities will have to report on both their financial materiality (simple materiality) and their impact materiality:

  • Financial materiality: according to the "outside-in" logic, this refers to the positive impacts (opportunities) and negative impacts (risks) generated by the economic, social and natural environment on the company.

Here is the exact definition given by the European Commission (ESRS 1, General principles, page 13 paragraph 53):

"Financial materiality in the context of sustainability reporting is a characteristic of a sustainability matter or information in relation to the undertaking. For the purposes of preparing sustainability reporting, a sustainability matter is material from a financial perspective if it triggers or may trigger significant financial effects on undertakings, i.e., it generates or may generate significant 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 it is not captured or not yet fully captured by financial reporting at the reporting date."

  • Impact materiality: according to the "inside-out" logic, this refers to the negative or positive impacts of the company on its economic, social and natural environment.

Here is the exact definition given by the European Commission (ESRS 1, General principles, page 13 paragraph 49):

"Impact materiality is a characteristic of a sustainability matter or information in relation to an undertaking. A sustainability matter is material from an impact perspective if it is connected to actual or potential significant impacts by the undertaking on people or the environment over the short-, medium- or long-term. This includes impacts directly caused or contributed to by the undertaking in its own operations, products or services and impacts which are otherwise directly linked to the undertaking’s upstream and downstream value chain, and not limited to contractual relationships."

What role can double materiality play in sustainability reporting?

According to Appendix A of ESRS 1 ("Definition of terms"), double materiality is used to determine whether or not information on a sustainability issue should be included in the sustainability report. A sustainability issue is considered to meet the criteria of double materiality if it is material from an impact point of view, a financial point of view, or both.

In general, the starting point is assumed to be the assessment of the materiality of the impact, since a lasting impact is likely to translate into financial effects in the short, medium or long term.

It is also important to note that, due to the interdependence between impacts on people and the environment, risks and opportunities, a single policy may apply to several important issues, including more than one ESRS. The company should declare the information required once in the relevant ESRS while providing the information required by other applicable ESRSs, with a clear explanation of the disclosures covered and appropriate references.

How do you double-check materiality?

ESRS 1 (Appendix B page 30) contains a guide on how to carry out this double-materiality analysis:

1.           Mapping of all the company's key stakeholders. The relevant stakeholders must be consulted for each standard. The ESRS define stakeholders as "individuals, groups and institutions on whom the company's activities may have an impact, or who themselves have an impact or may influence the company's activities". Two types of stakeholder are thus identified: those on whom the company's activities have an impact (individuals or groups whose interests are or could be affected) and those who use sustainability reports, such as investors, business partners or trade unions.

2.           Identify areas of impact. Actual as well as potential areas of impact should be identified, taking into account the list of sustainability issues provided by the ESRS (ESRS 1 General Requirements p.34-37). The company can then draw on scientific and analytical research into the impact of sustainability issues, and must engage with its stakeholders and relevant experts.

3.           Measuring the severity of the impact : this should be assessed in terms of scale, deferral, irremediability and potential inevitability. The level of detail in the policy description should also correspond to the severity of the impacts identified and the importance of the risks and opportunities: the company should not provide the content of all related policy documents (such as codes of conduct, which can be found on the company's website). Instead, the company should prioritize and summarize relevant content

4.           Identification of a threshold for impact reporting: impacts that exceed the specified severity level must be reported specifically.

5.            Measuring financial consequences: these are divided into risks and opportunities.

6.            Identification of a threshold for information on financial consequences : if the financial consequences exceed the specified severity level, they must be the subject of a specific report.

Restitution

Dual materiality analysis can be presented in the form of a double materiality matrix. With financial materiality on the x-axis and impact materiality on the y-axis, this representation provides a quick overview of all risks and opportunities. However, matrices alone are not enough, so they need to be accompanied by explanatory texts.

Sanofi's example of double materiality analysis

"In 2022, we carried out a double materiality analysis to better understand Sanofi's impact on the external environment and its ESG risks and opportunities, and to prepare for the forthcoming CSRD regulation in the European Union. The results of this assessment will help guide Sanofi's CSR strategy in the future. Below are the main results of the dialogue with internal and external stakeholders.

The following phases were completed:

Phase 1: Selection of relevant stakeholder groups and 16 material topics for review.

Phase 2: Interviews with internal and external stakeholders. The 16 material topics were grouped into batches, and each stakeholder was assigned to a batch, associated with their area of expertise. Stakeholders were invited to give their views on the impacts, risks and opportunities for Sanofi with regard to the topics in their assigned group. The results of the interviews were aggregated for all interviewees and summarized in fact sheets, one for each topic.

Phase 3: Survey of selected members of Sanofi management to prioritize the 16 most important topics. The fact sheets were used as pre-reading, to ensure that management had all relevant information. Survey participants ranked the five most important and three least important topics as regards:

  • ‍ Sanofi's impact on society from an economic, environmental and human point of view (i.e. the materiality of the impact), and
  • The company's impact on Sanofi's commercial value (i.e. financial materiality).
After consolidating the survey results, the following double matrix was obtained:

The results of this analysis will help us prepare for the new European Directive on Corporate Sustainability Reporting (CSRD) and help guide our CSR strategy."

Greenscope
july 2023 
14 min read