The “Summer of CSRD” series – ten key points from EFRAG’s recent materiality assessment guidance

The EU’s Corporate Sustainability Reporting Directive will have broad impact. Approximately 50,000 undertakings are expected to have a reporting obligation. The recently finalized European Sustainability Reporting Standards specify the information required to be reported under CSRD.

As we recently posted, this summer’s ESG must-read is ESRS 1, which contains the general requirements applicable to CSRD reporting. The objective of ESRS 1 is to provide an understanding of the architecture of the ESRS, the drafting conventions and fundamental concepts used and the general requirements for preparing and presenting sustainability information in accordance with CSRD.

Understanding ESRS 1 is therefore critical to preparing for CSRD reporting. It will drive not only disclosure, but also the underlying processes and controls. As a threshold matter, understanding ESRS 1 also is important for developing the project plan for CSRD readiness.

Each post thus far in this “Summer of CSRD” series discusses selected aspects of ESRS 1, in a bite-sized read, in more or less the order presented in ESRS 1.

In the last post, we discussed mandatory and materiality-based disclosures and other related provisions of ESRS 1.

In this post, we are ESRS-adjacent. On August 18, EFRAG published draft materiality assessment implementation guidance. The draft guidance was prepared by the EFRAG Secretariat for discussion at a public meeting of the EFRAG Sustainability Reporting Board and is part of an early stage of the development of a potential EFRAG position. The implementation guidance is non-authoritative. It accompanies, but does not form part of, the ESRS.

For the uninitiated, the European Financial Reporting Advisory Group (EFRAG) is the technical adviser to the European Commission which developed the draft ESRS. 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.

Ten key points from the EFRAG draft guidance are noted below. Many of these points also are noted in prior posts in this series:

• The performance of an objective materiality assessment is pivotal to sustainability reporting, which must include relevant and faithful information about all impacts, risks and opportunities (IROs) across environmental, social and governance matters determined to be material from an impact and/or financial materiality perspective.
• The materiality assessment is not limited to the undertaking’s own operations. It also includes its upstream and downstream value chain.
• Once an IRO has been identified as material, (1) the undertaking must refer to the requirements in the related ESRS to identify the relevant information to be considered for disclosure on the matter or (2) when the IRO is not covered or insufficiently covered by the ESRS, the undertaking must design a relevant entity-specific disclosure. Relevance is based on the significance of the information in relation to the matter it depicts or its decision-usefulness.
• The determination of the information to be reported depends on whether the information relates to (1) policies, actions and targets or (2) metrics. For policies, actions and targets, information is to be disclosed according to the ESRS Disclosure Requirements, or the undertaking must state that it does not have policies, actions and/or targets. Metrics may be omitted when they are assessed as not material based on the materiality assessment. Omitting datapoints derived from EU legislation based on materiality requires stating explicitly that they are not material. ESRS 2 Disclosure Requirements, which address cross-cutting matters, are to be reported on in all cases, irrespective of the outcome of the materiality assessment.
• The materiality assessment process must be designed to identify all material IROs, as well as to exclude those that are not material. A materiality assessment that would meet the requirements of the ESRS could include the following steps: (1) understanding the context and definition of the stakeholder engagement strategy; (2) identification of the list of potentially material sustainability matters and IROs; and (3) determination of the final list of material matters based on an assessment of the materiality of the IROs.
• Following the materiality assessment, the undertaking must disclose (1) the process to identify and assess its material IROs, (2) the interaction of IROs with its strategy and business model and (3) the Disclosure Requirements in the ESRS covered by its sustainability statement.
• Stakeholder engagement entails seeking input and feedback to understand the concerns and evidence of actual and potential impacts of the undertaking on people and the environment. It helps to substantiate the importance of the sustainability matters from the perspectives of the affected stakeholder groups.
• To assess the materiality of the undertaking’s impacts, appropriate quantitative and/or qualitative thresholds based on severity for actual negative impacts, and severity and likelihood for potential negative impacts, are to be used. Severity is based on the scale, scope and irremediable character of negative impacts and the scale and scope of positive impacts.
• Material risks and opportunities for the undertaking generally derive either from impacts or from dependencies. To assess their materiality, appropriate quantitative and/or qualitative thresholds based upon anticipated financial effects in terms of performance, financial situation, cash flows, access to finance and cost of capital are to be used.
• An assessment performed under the Global Reporting Initiative standards constitutes a good basis for the assessment of impacts under the ESRS. Reflecting the equivalence of the scope of financial materiality in the International Sustainability Standards Board standards and the ESRS, an undertaking that applies ESRS is expected to be able to comply with the identification of the risks and opportunities to be disclosed under International Financial Reporting Standards. The due diligence process, as defined in the international instruments, can help an undertaking to (1) identify and assess its potential and actual negative impacts and (2) assess materiality for reporting purposes based on severity and likelihood.

Next up: Disaggregated reporting.

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