The materiality analysis

Date

13/08/2024

The materiality analysis is the centrepiece of sustainability reporting. It is a process for assessing which potential sustainability topics (from the areas of environment, social affairs and governance) are the most important for a company. As a result of the materiality analysis, these core topics determine which and how many aspects the company explains in the sustainability report.

They can also serve as a starting point for a sustainability strategy or the prioritisation of measures. The materiality analysis is therefore also referred to as the foundation of the sustainability strategy and reporting.

Companies that have already prepared sustainability reports - whether voluntarily or due to a reporting obligation - have also determined the topics for their sustainability reports on the basis of materiality analyses. How such an analysis is carried out is usually defined in the reporting standards. The sustainability reporting standards usually also specify how the topics are to be selected.

The CSRD and affected companies

The CSRD, an EU directive that must be transposed into national law by the EU member states, requires large companies to prepare a sustainability report from 2024-2028 - depending on which of the following criteria they fulfil

Financial year from 1 January 2024 for companies already subject to the previous sustainability legislation, the NFRD (reporting in 2025 on the data from 2024)
Financial year from 1 January 2025 for large companies that are not currently subject to the NFRD (reporting in 2026 on the data from 2025) According to the German Commercial Code, large companies are those that fulfil at least two of the following three criteria

Total assets > 25 million euros
Net sales > 50 million euros
Annual average number of employees > 250
Financial year from 1 January 2026 for listed SMEs as well as smaller and non-complex credit institutions and captive insurance companies (reporting in 2027 on the data from 2026)

Double materiality: two perspectives in the assessment

The CSRD requires these companies to publish an annual sustainability report in accordance with the European Sustainability Reporting Standards (ESRS). These standards were developed specifically for this purpose and specify how a materiality analysis should be carried out. The ESRS follow the principle of "double materiality" (sometimes also referred to as "dual materiality"). This means that two perspectives should be taken into account in the process for determining the most important sustainability issues:

Inside-out: On the one hand, consideration should be given to how the various sustainability issues impact the environment or society. These interactions are referred to as (positive or negative) impacts.

Outside-in: On the other hand, consideration should be given to how environmental or social changes affect the financial performance of the company. These interactions are referred to as (sustainability-related) risks or opportunities.

Materiality analysis is only the first step

For companies that are required to report in accordance with the CSRD, the materiality analysis is the first step in terms of content. The materiality analysis process is set out in the ESRS, in particular ESRS 1. As only rough principles for the materiality analysis are mentioned there, the EU Commission has published further supporting documents, such as the Implementation Guidance 1 Materiality Assessment and a compilation of Q&As. However, these documents also only provide guidance on what needs to be considered in the materiality analysis. There is no precise step-by-step description. Therefore, each company must to a certain extent determine for itself what the exact procedure should look like. The design of the materiality analysis should be adapted to the context of the company and take appropriate account of the business model, the size of the company and the stakeholders involved.

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Materiality analysis in the ESRS

In addition to the principle of dual materiality described above, the ESRSs stipulate that the company should identify the most important impacts, opportunities and risks associated with the business model in its materiality analysis - the abbreviation IROs for impacts, risks and opportunities is often used in this context.

According to the ESRS, the materiality analysis should roughly comprise three steps:

Understanding the context: recording the company's business activities and relationships as well as affected stakeholders.
Determining the impacts: Identifying actual and potential, positive and negative impacts by involving stakeholders, experts and scientific studies.
Assessment of materiality: Defining thresholds to determine which IROs should be considered material.

Assessment of the material characteristics

Both positive and negative impacts must be identified. Companies should assess their actual negative impacts using the following criteria:

Extent: how severe are the negative impacts or how beneficial are the positive impacts for people and the environment?
Scope: How widespread are the negative or positive impacts? In the case of environmental impacts, the extent can be understood as the extent of the environmental damage or a geographical radius. In the case of human impacts, the extent can be understood as the number of people negatively affected
Reversibility: Whether and to what extent can the negative effects be remedied? In other words, can the previous state of the environment or the people affected be restored?

Each of the three characteristics can lead to an IRO being assessed as significant. In the case of positive impacts, criterion (c) does not apply. In the case of only probable impacts, in contrast to actual impacts, companies should also assess their probability and include it in the assessment.

Involvement of stakeholders

In the assessment, the company should use "appropriate quantitative and qualitative" thresholds to distinguish material issues from immaterial ones. The ESRS also emphasise the importance of involving stakeholders in the materiality analysis process. The ESRS do not specify exactly how this should be done.

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