This is part one in a series of posts to come. In this and future posts, I want to highlight some of the major aspects of the European Sustainability Reporting Standards (ESRS). I will start with how the ESRS deal with materiality, which is fundamental to all sustainability reporting.
What are the ESRS?
The ESRS are required reporting standards for companies that are subject to the Corporate Sustainability Reporting Directive (CSRD), which came into force on January 5, 2023. This new EU law requires certain companies to disclose the impact of their activities (i.e., impact materiality) on the environment and people along with their risks and opportunities (i.e., financial materiality) arising from social and environmental issues. In broad terms, companies required to comply are:
- Large, EU market listed companies, banks, and insurance companies already subject to the Non-Financial Reporting Directive (NFRD)
- Other EU market listed companies
- Listed European Small to Medium Enterprises
- Large private European companies
- Non-European companies with significant business in the EU
It goes without saying that if you think the CSRD applies to your company, you should seek legal counsel.
The ESRS were adopted by the European Commission and officially published on December 22, 2023. You can view explanatory videos and download the standards here.
What is the focus of these standards?
Reporting the most significant (material) sustainability issues for a company is the heart of sustainability reporting. For ESRS, double materiality is the key to these standards. Impact materiality and financial materiality are the two components that companies must assess to determine what to report.
What is impact materiality?
A material impact is described 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. Impacts include those connected with the undertaking’s own operations and upstream and downstream value chain, including through its products and services, as well as through its business relationships. Business relationships include those in the undertaking’s upstream and downstream value chain and are not limited to direct contractual relationships.
In this context, impacts on people or the environment include impacts in relation to environmental, social and governance matters.”
ESRS 1, General Requirement 3.4
The ESRS describe a three-step process needed to assess impact materiality and what needs to be reported.
- Step One – The company should understand its context in terms of its activities, its business relationships, and its stakeholders.
- A value chain map, which describes a company in relation to its upstream connections (its supply chain), its activities (its own business), and its downstream connections (its customers), is a useful tool to understand its context.
- Step Two – The company needs to identify actual and potential impacts (both negative and positive) with help from stakeholders and experts.
- The company may also use scientific and analytical research covering impacts on sustainability matters.
- Step Three – The company assesses the materiality of the company’s actual and potential impacts identified in step two.
- In determining what is material, the company shall adopt thresholds to determine which of the impacts will be included in its sustainability statement.
A company’s impact on its own workforce is an example of a social impact. If this is material, then the company would use ESRS S1 Own Workforce to report how it affects its own workforce and any actions to prevent, mitigate or remediate those impacts.
This is the first half of double materiality. I will cover financial materiality in my next notable post.