What is double materiality? Here's what you need to know.

The upcoming European Sustainability Reporting Standards (ESRS), brought in by the CSRD, will officially require ‘double materiality’ assessment and reporting practices from thousands of EU companies. But what is double materiality, how is it defined by the ESRS and how should it be approached?  

Where did the concept of ‘materiality’ originate? 

Stemming from a core accounting concept, business materiality originally had a single, clear focus: to address the needs and interests of investors. More recently, business leaders have started taking a broader view of materiality, applying the same principles to help guide high-level strategy and decision-making while considering the needs of not only investors, but all company stakeholders. 

As this wider approach to materiality took hold, companies also began considering certain non-financial factors as potentially material to the performance of their business. This was officially cemented in 2006, when the Global Reporting Initiative published guidelines on conducting materiality assessments in sustainability reporting. 

What is double materiality?

Double materiality takes the concept of materiality in sustainability reporting one step further. According to double materiality, companies must report both on how their business is impacted by sustainability issues (“outside-in”) and how their activities impact society and the environment (“inside-out”). 

In other words, businesses must consider two perspectives:

1. What is material to them
2. What is material to society or the planet

While considering their own interests, companies are also encouraged to examine how their actions affect the very resources and people they rely upon to function, thereby helping them gain a more complete picture of the organisation, its activities and its role in the wider context.    

Double materiality emerged due to growing pressures from governments, investors and the general public to better address the role companies play in environmental and social matters. As investors have begun to comply with investment policies containing rules surrounding sustainability, the demand for more detailed disclosures on environmental impact has increased, fuelling the need for more rigorous reporting guidelines. 

Which standards and guidelines incorporate double materiality? 

The European Commission was the first official body to publish a definition of double materiality in their 2019 guidelines on non-financial reporting. Meanwhile, the International Sustainability Standards Board has been working on a global guide for sustainability reporting which will incorporate double-materiality. 

Many popular sustainability reporting guidelines, such as the GRI or the SASB, that started off only looking at the “outside-in” approach have now begun to move towards double materiality by incorporating the “inside-out” perspective into their frameworks. Some companies seeking to incorporate double materiality into their sustainability reporting choose to follow two frameworks (such as TCFD and SASB) to cover both perspectives. 

Most notably, the European Sustainability Reporting Standards (ESRS), brought in by the CSRD and coming into effect in 2024, will be the first to introduce mandatory double materiality sustainability reporting for nearly 50,000 companies operating in the EU. 

What does the ESRS say about double materiality? 

Double materiality is a central part of the European Sustainability Reporting Standards (ESRS). 

The ESRS breaks double materiality into two categories:

1. Impact materiality (the “inside-out” perspective)
2. Financial materiality (the “outside-in” perspective)

These are defined as follows:

“A sustainability matter is material from an impact perspective when it pertains to the undertaking’s material actual or potential, positive or negative impacts on people or the environment over the short-, medium- or long term. A material sustainability matter from an impact perspective includes impacts caused or contributed to by the undertaking and impacts which are directly linked to the undertaking’s own operations, its products, and services through its business relationships. Business relationships include the undertaking’s upstream and downstream value chain and are not limited to direct contractual relationships.”

(ESRS 1 General principles​​, p. 11)

“A sustainability matter is material from a financial perspective if it triggers or may trigger material financial effects on the undertaking’s development, including cash flows, financial position and financial performance, in the short-, medium- or long-term. This is the case, in particular, when it generates or may generate risks or opportunities that significantly influence or are likely to significantly influence its future cash flows. Future cash flows, together with other critical factors such as business model, strategy, access to finance and cost of capital, are likely to influence the financial position and financial performance of the undertaking in the short-, medium- or long-term.”

(ESRS 1 General principles​​, p. 12)

Notably, while many frameworks started with the “outside-in” (or financial materiality) approach and have more recently incorporated the “inside-out” (or impact materiality) perspective, the ESRS specify that impact materiality must be the starting point for double-materiality assessments, and that impact matters must be reported upon regardless of whether they are (or will become) financially material for the company. It also acknowledges that “impact materiality and financial materiality assessments are interrelated and the interdependencies between the two dimensions shall be considered” (ESRS 1 General principles​​, p. 11). 

How should companies following the ESRS conduct a double materiality assessment? 

ESRS 1 General Requirements contain detailed guidelines on how a double-materiality assessment should be conducted, including a step-by-step guide (see p.30, Appendix B: Application Requirements). 

As a general overview, these can be broken down as follows: 

1. Map out all key business stakeholders. Affected stakeholders should be consulted as part of the materiality assessment process. According to the ESRS, nature can be considered a ‘silent shareholder’.
2. Determine the areas of impact. Actual and potential areas of impact should be identified by considering the list of sustainability matters provided by the ESRS (ESRS 1 General Requirements p.34-37), and by consulting affected stakeholders and experts. 
3. Assess the severity of the impact. This takes into account its scale, its scope and how irremediable it is. 
4. Determine a threshold for reporting on impact. Impacts that are above the determined level of severity must be reported on in line with the specific guidelines for its related topic.
5. Assess the financial materiality of all the above areas of impact. These are separated into risks and opportunities. 
6. Determine a threshold for reporting on financial materiality. This is based on the likelihood and scale of the financial impact. Those above the determined level of severity must be reported on in line with the specific guidelines for its related topic.

The EFRAG has specified that certain topics, such as those detailed in ESRS 2 General Disclosures, ESRS E1 Climate Change and specific disclosures within ESRS S1 Own Workforce, are mandatory for all companies to report upon. Outside of these, companies are expected to report on all topics they deem material in line with their double materiality assessment. For any topics that were not deemed material, a brief explanation must be provided. 

Preparing for double materiality 

Whether or not your business is in scope of the CSRD, now is the time to start preparing for ESG double materiality. Across the board, the same underlying trends are emerging: the need for transparent, reliable and detailed reporting practices. By engaging stakeholders, establishing unified processes and improving access to relevant data, companies can begin to lay solid foundations for the future.