CSRD: The challenges of dual materiality

The CSRD delegated act published on July 31, 2023 introduces the concept of double materiality. Often described as a major step towards greater transparency on the real impact of companies, the application of double materiality to European companies with more than 250 employees is a necessary prerequisite for aligning companies with the objectives of the Paris Agreement. In the spotlight recently, Impact France tells you all about the introduction of this key concept for corporate behavioral transition.

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Dual materiality: combining financial materiality and impact materiality

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The CSRD (Corporate Sustainability Reporting Directive), adopted in November 2022 by the European Union, will gradually require over 50,000 companies to publish sustainability reporting. Introduced in the CSRD's delegated act (adopted on July 31, 2023), double materiality analysis is at the heart of this new ESG reporting exercise.

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Double materiality corresponds to the conjunction of two types of materiality:

• Financial materiality (also known as simple materiality): the impact of the economic, social and natural environment on a company's performance.
• Impact materiality : the impact of the company's activities on its economic, social and natural environment.

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👉An indicator (e.g. pollution) is said to be "material" when the company's activities have an impact on it and/or when this indicator has an impact on the company's performance.

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The company's assessment of materiality: a key issue and a subject of controversy

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Provided for in the CSRD's delegated act, this self-assessment implies that the company will only communicate an indicator if it considers that it may have an impact on its performance and/or if its activity may have an impact on this indicator.

According to the Commission: this measure should reduce the burden on businesses and ensure that standards are applied in a proportionate manner.

According to Eurosif, this analysis will enable companies toomit entire sections of their sustainability information.

According to the NGO Finance Watch, the Financial Services Sustainability Reporting Regulation (more commonly known by its acronym SFDR) obliges financial institutions to capture information on the greenhouse gas emissions of the companies in which they invest, and this reporting could be constrained if some of these companies omit indicators (e.g. "air pollution").

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➡️ To mitigate these risks, the European Commission has specified that :

• If a company concludes that climate change is not material, it will need to provide a detailed explanation of the conclusions of its materiality assessment.
• If a company concludes that a data point derived from SFDR is not material, it must explicitly state this.

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Advocates of rigorous reporting regret that this "detailed explanation" does not apply equally to biodiversity, since, as many specialists, including Jean-Marc Jancovici, explain, there is " no human activity that does not depend on biodiversity and harm it ": biodiversity is therefore "material" by nature.

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ISSB standards: two major differences from CSRD's ESRS standards

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For several years now, Europe, through the NFRD (Non-Financial Reporting Directive, forerunner of the CSRD) and then the CSRD, has been accelerating the standardization of sustainability information. Having chosen to develop its own standards in the same way as the United States, the European Union must now face up to international competition. The main competitor is the ISSB (International Sustainability Standards Board), the armed wing of the IFRS Foundation, created in 2021 with the aim of developing a set of international reference standards for the publication of information on the risks and opportunities associated with corporate sustainability. 

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➡️ The ISSB approach is said to be "less ambitious" for two main reasons:

• The two standards (IFRS 1 and IFRS 2) published by the ISSB relate solely to climatic data; 
• Only financial materiality is taken into account, unlike ESRSs based on double materiality (financial and impact).

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Criticism and misconceptions about the European approach: analysis and decoding

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The financial materiality of a piece of information is clearly sanctioned by the markets, whereas the non-economic aspect of dual materiality (or impact materiality) does not lead to immediate sanction: the two materialities would therefore be incomparable.

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Although less "powerful", impact materiality is essential because :

• Although it does not "strongly" drive financial market flows, a company's impact on its social or natural environment is of interest to investors, and therefore entails financial risks . The more ambitious the reporting framework, the more the impact will drive investor choices.
• It will provide companies with information on the transformations they need to make to ensure the sustainability of their business model, while meeting the expectations of their stakeholders.

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Double materiality simply produces a list of information that can be used to enlighten stakeholders, as it is impossible to provide precise information on impacts, particularly on biodiversity.

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Although the evaluation methodology has not yet stabilized, this in no way detracts from the relevance of double materiality in guiding strategic choices. There are two main challenges:

• Taking stakeholders into account: a key element of future materiality analysis, the stakeholders to be identified are, on the one hand, those on whom the company's activities have an impact, and, on the other, the users of sustainability reports (investors, partners, trade unions, NGOs, etc.).
• Assessing the severity of the impact : this relates to 3 fields: the scale, scope and irremediable nature of the impact in question.

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An extra-accounting standard cannot lead a company to reduce its emissions.

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The CSRD, complemented by other legislation adopted and/or in the process of being adopted by the European Union on corporate sustainability, will ultimately lead companies to align themselves with the Paris Agreement. and this for two main reasons:

• It is mandatory, as companies are obliged to carry out a materiality assessment certified by an auditor (in France, the H3C will make a technical proposal).
• On the specific subject of ESRS climate standards (which are close to IFRS standards), the constraint is even stronger, since if a company concludes that climate change is not material, it will have to provide a detailed explanation of the conclusions of its materiality analysis.

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As Efrag Chairman Patrick de Cambourg explained, "transparency doesn't dictate behavior, but it obviously influences it".

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In a nutshell 

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Although the impact materiality methodology is far from stabilized, the relevance of double materiality is far from being an illusion, for at least three reasons:

• While impact materiality does not provide an exhaustive accounting of impacts, it is capable, despite its imperfections, of guiding corporate transformations; 
• The existence of a framework obliging companies to examine their environment (economic, social and natural) and to question their stakeholders is a first step, and impact assessment methodologies will gradually improve, particularly through practice; 

• While materiality of impact has much less influence on financial flows, it still drives the choice of many investors, as the market becomes increasingly attentive to ESG data.

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The following table provides a simplified overview of the advantages and disadvantages of the two standards frameworks: