The CSRD directive introduces new European standards for ESG (Environmental, Social, and Governance) reporting. These upcoming sustainability-focused standards, the ESRS (European Sustainability Reporting Standards), will require many European Union companies to adopt "double materiality assessment" practices. This is a central concept in the CSRD, leading to new prerequisites for CSR (Corporate Social Responsibility) strategies.
What is the CSRD Directive?
The CSRD (Corporate Sustainability Reporting Directive), which the European Commission, the European Parliament, and the European Council agreed upon in 2022, introduces new requirements for non-financial reporting. The directive aims to combat greenwashing by promoting increased transparency regarding corporate CSR efforts and commitments to sustainability.
Building on the foundation of the NFRD (Non-Financial Reporting Directive), which has required companies to include non-financial reports in their annual management reports since 2014, the CSRD complements and addresses the shortcomings of the NFRD. This enhancement is designed to make environmental performance and social responsibility declarations more reliable, measurable, and more easily comparable.
The CSRD has expanded the obligation of non-financial reporting to a broader range of companies. Here is a summary of the businesses affected by this requirement:
| Net turnover total exceeding | Balance sheet total exceeding | Average number of employees exceeding |
Large companies (listed or not) | €50 million | €25 million | 250 |
Listed SMEs (excluding micro-enterprises) | €900,000 | €450,000 | 10 |
The CSRD will also apply to non-European companies if they have a subsidiary or branch operating within the European Union and exceeding €150 million in annual net turnover.
A progressive timeline for implementation has been established, with the initial reporting due in 2025 for large companies already subject to the NFRD, followed by a phased extension of the obligation until it applies to non-European companies in 2029.
What are the ESRS (European Sustainability Reporting Standards)?
ESRS, or European Sustainability Reporting Standards, make up a set of 12 standards outlined by the CSRD directive, which companies will utilize for sustainability data reporting. These standards are developed by EFRAG (European Financial Reporting Advisory Group) and aim to standardize non-financial disclosures by companies, enabling the measurement of the environmental and social impact of an organization's activities, as well as the financial impact of sustainability matters on the business. The 12 ESRS can be categorized into four main types of indicators:
2 cross-cutting standards dedicated to general requirements and disclosures
5 environmental standards: climate change, pollution, water and marine resources, biodiversity and ecosystems, resources and circular economy.
4 social standards cover the company's workforce, workers in the value chain, affected communities, customers and end-users.
1 standard for corporate governance (business conduct).
With the end of the co-legislators scrutiny period on October 21st 2023, the ESRS are now integrated into the European legal framework.
Understanding the principle of materiality in CSR
While the initial focus was on the requirement for accuracy in non-financial reporting, the introduction of the materiality criterion strengthens the fight against greenwashing by promoting a culture of relevance. To achieve the Sustainable Development Goals (SDGs) of the 2030 agenda, it is essential to be able to measure and monitor the impact of environmental and societal risks on a company's activities, and vice versa. Materiality enhances non-financial reporting by expanding the scope of analysis, comprehending a company's performance in all its dimensions, identifying issues comprehensively, and prioritizing them based on their relevance. Introduced within a CSR approach, materiality reveals the correlation between non-financial and financial performance. Through materiality analysis, reporting on sustainability issues becomes a driver for value creation.
Principle of Double Materiality
Double materiality is grounded in the same principles as single materiality: identifying significant issues that can influence investor decisions. However, it consists of two distinct types of materiality, corresponding to internal and external perspectives on the sustainability of a company's activities:
Financial Materiality (Outside-In): This examines how environmental and social issues impact a company's economic performance. It identifies how deteriorating social and environmental conditions might affect the company’s activities and what economic opportunities these conditions might present for the sector.
Impact Materiality (Inside-Out): This evaluates the impact of the company's activities on the environment and society. It involves identifying relevant issues to include in sustainability reports, such as greenhouse gas emissions, human rights, resource management, diversity and inclusion, and business ethics.
These two aspects are closely linked to the concept of IRO (Impacts, Risks, and Opportunities), which is central to assessing a company's sustainability. Impacts are primarily covered by impact materiality, while risks and opportunities are addressed in financial materiality.
Double materiality assessment, a prerequisite for CSRD
A central concept in the European Sustainability Reporting Standards (ESRS) developed for the implementation of the CSRD directive, double materiality places sustainability information and financial information on an equal footing.
By promoting double materiality, the European approach distinguishes itself from the American approach, which is solely based on the analysis of financial materiality. The standards proposal published in 2023 by the European Commission confirms this approach, as all ESRS are subject to double materiality assessment. EFRAG offers a methodology that allows companies to assess the materiality of an issue. Financial materiality analysis is based on three criteria: the significance of the issue (whether it represents a harmful impact or an opportunity), its importance, and its likelihood of occurrence.
Impact materiality analysis, on the other hand, evaluates the quality of the impact, whether it is potential or realized, its severity (importance, scope, remediation), and the probability of its occurrence.
The role of IROs in double materiality assessment
IROs (Impacts, Risks, and Opportunities) are a fundamental element of the double materiality analysis required by the CSRD. This approach provides companies with a comprehensive perspective on their sustainable performance, considering both their effects on the environment and society (impact materiality) and the influence of ESG issues on their financial results (financial materiality).
In this context, IROs are categorized as follows:
Impacts: These can be positive (such as creating local jobs) or negative (such as greenhouse gas emissions).
Risks: These are potential threats to the company, like supply chain disruptions due to climate change.
Opportunities: These represent possibilities for growth and innovation, such as developing eco-designed products.
This approach allows companies to:
Map their complex interactions with the socio-environmental ecosystem
Anticipate and mitigate future risks
Identify and exploit new avenues for sustainable development
Improve their adaptability to ESG challenges
The ultimate goal is to transform non-financial reporting into a genuine strategic management tool, going beyond mere regulatory compliance.
A concrete example of double materiality assessment
Let's consider the case of an automobile manufacturer concerning climate change to illustrate double materiality.
Impact materiality & financial materiality for an automobile manufacturer
Impact materiality | The automobile industry has a substantial environmental impact, particularly through the production of vehicles with internal combustion engines. These vehicles emit greenhouse gases, contributing to climate change. However, automobile manufacturers are also involved in the development and production of electric vehicles, which produce zero tailpipe emissions. |
Financial materiality | Climate change also holds financial significance for automobile manufacturers. The success of these companies hinges on their ability to produce and sell vehicles compliant with increasingly stringent emissions regulations. If the cost of renewable energy decreases or if climate change regulations become more rigorous, automobile manufacturers investing in electric vehicles could reap financial benefits. Conversely, if climate change worsens, leading to more extreme weather events such as floods, hurricanes, or wildfires, automobile manufacturers may face substantial financial costs, including damage to production facilities or disruptions in their supply chain. |
Specific disclosure examples
Impact materiality disclosure:
Greenhouse gas emissions and emission reduction strategies.
Water consumption and conservation initiatives.
Waste generation and waste reduction efforts.
Financial materiality disclosure:
Risks and opportunities related to climate change.
Investments in renewable energy and climate change mitigation technologies.
Climate change-related litigation risks.
By disclosing this information, automobile manufacturers can help their stakeholders understand how climate change impacts their businesses and how they are managing those impacts. This information can also help investors to make informed investment decisions.
Conclusion
Double materiality assessment is now an integral part of European environmental regulations and must be carried out by companies affected by the CSRD. While its inclusion in the sustainability report is not mandatory, it represents a significant opportunity for companies to accelerate their environmental and sustainable transition.
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