Last Friday, EFRAG finalized its first three ESRS Implementation Guidance documents. The guidance addresses the materiality assessment (IG 1), value chain (IG 2) and ESRS datapoints (IG 3).
For the uninitiated, EFRAG (the European Financial Reporting Advisory Group) is the technical adviser to the European Commission that developed the draft European Sustainability Reporting Standards issued under the CSRD. Its mission is to serve the European public interest in both financial and sustainability reporting by developing and promoting European views in the field of corporate reporting.
In this post, we discuss IG 1, EFRAG's materiality assessment implementation guidance. The guidance contains an illustrative materiality assessment process for undertakings. It also discusses impact and financial materiality, providing examples and indicating how these two concepts relate to each other. In addition, IG 1 contains FAQs on the double materiality assessment to provide practical implementation guidance on disclosing material impacts, risks and opportunities (IROs). EFRAG previously had published IG 1 in draft form for public feedback (see our earlier post).
The EFRAG guidance is non-authoritative. It is intended to support the implementation activities of preparers and others using or analyzing ESRS reports. The guidance does not amend or modify the ESRS.
Thirteen key points from the guidance
IG 1 characterizes the following as its key points:
1. Sustainability statements prepared pursuant to the CSRD must include relevant and faithful information about all IROs across ESG matters determined to be impact and/or financially material. A materiality assessment is to be completed to determine material information on sustainability IROs. This involves determining material matters and material information to be reported. A materiality assessment based on objective criteria is pivotal to sustainability reporting. The undertaking must use judgment when applying the criteria, and the related explanations are expected to provide transparency from the undertaking to the users of the sustainability statement.
2. The materiality assessment is to consider the undertaking's entire value chain. In other words, it is to include the undertaking's upstream and downstream value chain, in addition to its own operations.
3. Once an undertaking has identified an IRO related to a sustainability matter as material, it must first refer to the related ESRS Disclosure Requirements to identify the relevant information to be considered. If the IRO is not covered or is insufficiently covered by the ESRS, the undertaking must provide entity-specific disclosure on the matter. Relevance is the criterion to identify the information to be disclosed and is based on the significance of the information in relation to the matter it depicts or its decision-usefulness.
4. The disclosure requirements in ESRS 2, which addresses cross-cutting general disclosures, are to be reported irrespective of the outcome of the materiality assessment. For policies, actions and targets, information must either be disclosed according to the Disclosure Requirements or the undertaking must state that it does not have policies, actions or targets related to the material sustainability matter.
Metrics disclosure is subject to the materiality assessment. The information defined in the relevant Disclosure Requirements are to be included when the undertaking has assessed the metrics to be material. If that is not the case, the metrics are to be omitted.
Following a structured materiality assessment, the omission of a metric indicates to users that the metric is not material. Omissions are useful sustainability-related information since they support the general coherence of the sustainability statement and therefore the fair coverage of sustainability matters. An omission is required to be explicitly indicated if the datapoints are derived from other EU legislation (these datapoints are indicated in ESRS 2, Appendix B). Otherwise, the omission can be implicit.
5. The ESRS do not mandate a specific process or sequence of steps to follow when performing a materiality assessment. These are left to the undertaking's judgment. The process that is used should reflect the undertaking's facts and circumstances.
6. As an illustration, a materiality assessment that includes the following steps would meet the requirements of the ESRS:
- Understanding of the context;
- Identification of actual and potential IROs related to sustainability matters;
- Assessment and determination of the material IROs related to sustainability matters; and
- Reporting.
7. Engagement with affected stakeholders informs the materiality assessment process. It also is consistent with the practice suggested by the international instruments referenced in the CSRD (the UN Guiding Principles on Business and Human Rights, OECD Guidelines for Multinational Enterprises and OECD Due Diligence Guidance for Responsible Business Conduct).
Stakeholder engagement entails seeking input and feedback to understand concerns and evidence regarding actual and potential impacts of the undertaking on people and the environment. It also helps to substantiate the importance of sustainability matters from the perspective of affected stakeholder groups.
The ESRS do not mandate specific behavior on stakeholder engagement and do not preempt stakeholder engagement under the EU's Corporate Sustainability Due Diligence Directive, which is awaiting signature and will take effect starting in 2027 for the largest companies.
8. The materiality of impacts for reporting purposes is to be assessed based on severity and likelihood. This includes setting appropriate quantitative and/or qualitative thresholds for reporting purposes. Severity is based on the scale, scope and irremediable character of negative impacts and the scale and scope of positive impacts.
9. An undertaking's material risks and opportunities generally derive either from impacts or from dependencies and other risk factors. The materiality of risks and opportunities is to be assessed based on appropriate quantitative and/or qualitative thresholds related to anticipated financial effects on performance, financial position, cash flows and access to finance, including cost of capital.
10. The due diligence process (in accordance with the recognized international due diligence instruments referenced in the CSRD, which are noted above) can help an undertaking to identify and assess its actual and potential negative impacts and to assess their materiality for reporting purposes based on the criteria of severity and likelihood.
11. An assessment under the Global Reporting Initiative Universal Standards is a good basis for the assessment of impacts under the ESRS.
12. Application of the ESRS is expected to align with the identification of sustainability-related information on risks and opportunities under the ISSB Standards since financial materiality scope under the ISSB standards and the ESRS is aligned.
13. Following completion of the materiality assessment process, an undertaking must disclose:
- The process to identify and assess its material IROs (ESRS 2 IRO-1);
- The interaction of its material IROs with its strategy and business model (ESRS 2 SBM-3); and
- The Disclosure Requirements under the ESRS covered by its sustainability statement (ESRS 2 IRO-2).
How is the final guidance different?
Since it's more in the weeds than most readers will want to go, we haven't summarized the changes from the draft guidance in this post. The changes, which were relatively modest, are discussed in detail in EFRAGs' Feedback Statement.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.