The implementation of the Corporate Sustainability Reporting Directive will introduce new challenges in business reporting, not least the tricky concept of double materiality, writes Mike O’Halloran
In 2024, a new era of corporate reporting has kicked off. The Corporate Sustainability Reporting Directive (CSRD) began to apply to some of the largest entities in Ireland for financial periods commencing on or after 1 January 2024.
The cohort of entities applying the CSRD will increase significantly in the years ahead as the numbers in scope rise in 2025, 2026 and 2028.
Under the European Green Deal, the European Commission aims to transform the EU into a modern, resource-efficient and competitive economy with no net emissions of greenhouse gases by 2050, economic growth decoupled from resource use and no person or place left behind.
In seeking to achieve this goal as part of the deal, the CSRD will not be without its implementation challenges. One of the challenges that preparers will have to navigate is double materiality.
The CSRD requires the assessment of the materiality of impacts, risks and opportunities relating to sustainability matters via a double materiality assessment. This will be new to most preparers of sustainability statements and those providing assurance on the information.
Double materiality is a unique concept of reporting under the European Sustainability Reporting Standards (ESRS).
It is the most notable difference between these standards and the International Sustainability Standards Board’s standards (IFRS S1 and IFRS S2), which will be adopted in other jurisdictions outside Europe. This will most likely include the UK where the Department for Business and Trade has indicated that it may be endorsed in 2024 as part of its Sustainability Disclosure Standards.
Materiality – two perspectives
As the name might suggest, a double materiality assessment is performed from two perspectives – financial and impact. The result forms the basis for what should be disclosed in a sustainability statement.
The use of two perspectives differs significantly from the “traditional” materiality assessments accountants will be familiar with. This is because a double materiality assessment focuses not just on matters that are financially relevant, but also on those that impact stakeholders, both internal and external, and the environment.
Without a double materiality assessment, an entity could simply focus on sustainability matters that are financially relevant to itself and ignore what is important to the wider society it affects.
A double materiality assessment involves consideration of the entity’s direct and indirect impact. This means that it covers the entity’s own operations as well as its upstream (e.g. suppliers and pre-production activities) and downstream (e.g. post-production activities and end customers) value chain, when considering its material impacts, risks and opportunities.
The output from a double materiality assessment identifies impacts, risks and opportunities related to sustainability matters that are considered to be material for the entity, its stakeholders and the environment, and therefore must be reported on in its sustainability statement.
Financial materiality
For a sustainability matter to be material from a financial perspective, it must trigger (or must reasonably be expected to trigger) material financial effects on the undertaking. In assessing this, an entity must consider whether sustainability matters generate risks or opportunities that materially influence its development, financial position, financial performance, cash flows, access to finance or cost of capital over the short-, medium- or long-term. The materiality of risks and opportunities should be assessed based on a combination of the likelihood of occurrence and the magnitude of financial effects.
Impact materiality
Impact materiality looks at how an entity may have an impact on its stakeholders from an environmental, social and governance (ESG) point of view. For a matter to be material from an impact perspective, it must generate (or have the potential to generate) positive or negative impacts on people or the environment. The relevant person affected is the stakeholder and impact materiality is viewed through the eyes of the stakeholder to identify sustainability impacts.
When an entity is considering impact materiality, then, it must consider actual or potential impacts, positive and negative impacts and impacts covering the short-, medium- or long-term. The assessment of the severity of its impacts, and therefore whether they are material, is based on three factors:
• Scale – how grave or beneficial the impact is;
• Scope – how widespread the impact is; and
• Irremediability – whether or not the impact can be mitigated or resolved.
Furthermore, if an entity is addressing potential impacts, it is required to consider the likelihood that the issue will occur.
Engagement with stakeholders is a key consideration when reviewing impact materiality and it will help to inform the entity about its material sustainability impacts, risks and opportunities.
The ESRS do not set out how an entity should engage with its stakeholders and the engagement process should be determined by the reporting entity.
Some of the stakeholder categories an entity may consider as part of its materiality assessment include employees, suppliers, customers, consumers, end users, regulators, local communities and nature.
Double materiality sets the reporting boundary
When an entity determines that impacts, risks and opportunities related to a sustainability matter are material because of a double materiality assessment, then it is required to disclose information required by the disclosure requirements related to that sustainability matter in the corresponding topical and sector-specific ESRS.
In addition, it is required to disclose any additional entity-specific information when an ESRS does not sufficiently cover this matter.
As a result, a double materiality assessment sets the entity’s sustainability reporting boundary. If a matter is material from a financial perspective, an impact perspective or both, then it must be disclosed in a sustainability statement.
The challenges
There are several challenges that entities performing a double materiality assessment may struggle with, particularly in the initial years of implementation. These include:
Understanding and applying the concept
While preparers will already be familiar with materiality, double materiality introduces some new parameters they will need time to become comfortable with. The ESRS do not specify a process to follow when carrying out a double materiality assessment. The reason for this is that no one process would meet the requirements of all the entities reporting under the standards. Therefore, an entity that performs a materiality assessment must design and apply a process tailored to its circumstances, while remaining within the requirements set out in ESRS 1. While such an approach allows entities to tailor their processes accordingly, the lack of a rules-based system may prove difficult for some entities to adapt to, particularly in the earlier years as practices and precedent are being established. In the absence of a strict rules-based approach, entities will need supplementary material to guide their methodologies. Currently the European Financial Reporting Advisory Group is drafting implementation guidelines to assist with this.
The assurance requirement
A key requirement of the CSRD is external assurance on an entity’s sustainability statement. This will initially require limited assurance before being upgraded to reasonable assurance at some point in the future. While assurance will help to ensure that the integrity and reliability of sustainability information reported on will be enhanced, it will also bring with it a level of complexity whereby the judgements made by preparers will be assessed by assurance providers. This may introduce differing opinions on what should be deemed as material from an impact or financial perspective.
All eyes on the first reporters
The number of reporters in the first wave of CSRD adopters in Ireland will be low in number but high in terms of market capitalisation.
All eyes will be on the sustainability statements prepared by these entities in early 2025 as users, preparers and other interested parties will be keen to see how they have approached double materiality.
Despite the low number of reporters for 2024 year-ends, many entities will be indirectly impacted as they will be part of the supply chain of reporters. They will therefore be providing information to entities preparing their sustainability statement.
Furthermore, many entities that will be subject to the requirements of the CSRD in future years will be keen to learn from the challenges encountered by the first adopters.
Despite the onerous requirements of the new suite of standards and in particular double materiality, it is important for entities and their stakeholders to remember the reasons for their introduction and the underlying cause they seek to remedy.
The EU’s goals under the European Green Deal are ambitious, but they need the full support and backing of businesses to be successful.
Mike O’Halloran is Technical Manager in the Advocacy and Voice Department of Chartered Accountants Ireland
Double materiality: brewery example
Consider an entity operating a brewery in Ireland. In carrying out a double materiality assessment it may, among other things, consider the following matters to be material, from one or both perspectives:
- Energy (financial perspective) – due to the energy intensiveness of the production process and the financial risk of increased energy prices;
- Pollution of water (impact perspective) – due to the large amount of water discharged during the production process and the impact that this may have on water quality locally;
- Water consumption (financial perspective) – due to the cost involved and the availability of sufficiently clean water;
- Land-use change as a direct impact driver of biodiversity loss (impact perspective) – due to the large amount of malt, barley and other crops used in the production process;
- Sustainability matters under the heading of “own workforce” including health and safety of employees (impact perspective) – due to the large workforce an entity has employed in its factory;
- Resource inflows and outflows (impact and financial perspectives) – given the amount and cost of packaging and storage materials used, particularly in an entity’s downstream activities;
- Personal safety of consumers and end users (impact and financial perspectives) – given the health implications of a breach of food safety regulations on consumers as well as the financial implications that it would bring; and
- Responsible marketing practices (impact perspective) – given the addictive and age-restricted nature of the product being produced by the brewery.
This example is for illustrative purposes only and is not intended to be a complete list, nor a list of the matters that are mandatorily material for a similar entity. Individual judgment must be applied in each instance.
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