EU Corporate Sustainability Reporting Directive draft materiality assessment guidance published – key points from the guidance

On December 22, EFRAG published draft guidance concerning the materiality assessment required by the European Sustainability Reporting Standards issued under the CSRD. Draft EFRAG IG 1 explains the ESRS approach to materiality, illustrates how the materiality assessment is to be performed, explains how undertakings can take account of other frameworks and standards and includes FAQs on impact and financial materiality, the materiality assessment process, stakeholder engagement, aggregation/disaggregation and reporting.

The objective of the implementation guidance is to support the implementation activities of preparers and others using or analyzing ESRS reports. The guidance is non-authoritative. It accompanies but does not form part of the ESRS. 

For the uninitiated, EFRAG (the European Financial Reporting Advisory Group) 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.

Thirteen key points from the draft guidance

Draft IG 1 characterizes the following as its key points:

1. An ESRS sustainability statement must include relevant and faithful information about all Impacts, risks and opportunities (IROs) across environmental, social and governance matters that are material from an impact and/or financial materiality perspective. The materiality assessment is the process by which an undertaking determines material information concerning sustainability IROs. This is achieved by determining the material matters and information to be reported. The performance of a materiality assessment based on objective criteria is pivotal to sustainability reporting. The undertaking is to use its judgment when applying the criteria and the related explanations are expected to provide transparency to users of the sustainability statement. 
2. The materiality assessment considers the undertaking’s entire upstream and downstream value chain, in addition to its own operations.
3. Once the undertaking has identified that an IRO related to a sustainability matter is material, it first must 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 used to determine 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 address cross-cutting general disclosures – are to be reported irrespective of the outcome of the materiality assessment. For policies, actions and targets, information must be disclosed according to the Disclosure Requirements, or the undertaking must state that it does not have policies, actions and/or targets related to the material sustainability matter. Metrics are subject to a materiality assessment; the information defined in the relevant Disclosure Requirements must be included when the undertaking has assessed them to be material. Metrics otherwise are to be omitted. The omission of metrics after having followed a structured materiality assessment indicates to users that a metric is not material. Omissions are considered useful sustainability-related information, supporting the general coherence of the sustainability statement and therefore the fair coverage of sustainability matters. The omission of datapoints derived from other EU legislation is required to be explicit (ESRS 2, Appendix B lists these datapoints). In other cases, their omission is implicit. 
5. The ESRS do not mandate a specific process or sequence of steps to be followed when performing the materiality assessment. The process and sequence are left to the undertaking’s judgment. The process used should reflect the undertaking’s facts and circumstances. 
6. Draft IG 1 indicates as an example that a materiality assessment meeting the requirements of the ESRS could include the following steps: (a) understanding the context; (b) identification of actual and potential IROs related to sustainability matters; (c) assessment and determination of the material IROs related to sustainability matters; and (d) reporting.
7. Engagement with affected stakeholders informs the materiality assessment process and is consistent with practice suggested by the international due diligence 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). Engagement with affected stakeholders entails seeking input and feedback to understand concerns and evidence regarding the undertaking’s actual and potential impacts on people and the environment. It also helps to substantiate the importance of the sustainability matters from the perspectives of the affected stakeholder groups. The ESRS do not mandate specific behavior concerning stakeholder engagement. They also do not preempt the EU’s Corporate Sustainability Due Diligence Directive (on which political agreement was reached in December).
8. Impact materiality for reporting purposes is to be assessed based on severity and likelihood. This includes setting appropriate quantitative and/or qualitative thresholds for reporting. 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. Undertakings are to assess the materiality of risks and opportunities 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 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. An undertaking that applies the ESRS is expected to be able to comply with the identification of sustainability-related information on risks and opportunities under the IFRS sustainability disclosure standards (i.e., the International Sustainability Standards Board standards) due to alignment of the scope of financial materiality between the ISSB standards and the ESRS.
13. Following completion of the materiality assessment process, an undertaking must disclose (a) the process to identify and assess its material IROs, (b) the interaction of its material IROs with its strategy and business model and (c) the Disclosure Requirements under the ESRS covered by its sustainability statement.

An earlier draft of EFRAG’s materiality assessment guidance was published in August. That draft is discussed in our post here. 

Next steps

Draft IG 1 is currently open for public comment. Stakeholders can provide feedback until February 2, 2024. EFRAG previously indicated it intends to finalize its materiality assessment guidance during the first quarter of 2024 (see our earlier post).   

Value chain guidance

On December 22, EFRAG also published draft value chain implementation guidance, Draft EFRAG IG 2. Draft IG 2 will be discussed in our next post.

Additional Ropes & Gray posts on the ESRS 

For additional posts discussing the ESRS – including the topics discussed in this post – see our Summer of CSRD series, which can be linked to here. 

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