Published:
Feb 26, 2025
Updated:
February 26, 2025
What is Double Materiality?
Double materiality, comprised of financial and impact materiality, is an emerging framework backed by the European Commission that broadens the responsibilities of companies to provide more transparent information to a larger group of stakeholders. In 2019, the Commission published in the Official Journal of the European Union the following statement: “Without sufficient, reliable and comparable sustainability-related information from investee companies, the financial sector cannot efficiently direct capital to investments that drive solutions to the sustainability crises we face and cannot effectively identify and manage the risks to investments that will arise from those crises.1” The commission argued that while improvements had been made in prior years, there were still gaps in sustainability reporting that needed to be addressed.
Double materiality is now being implemented to address these concerns throughout much of Europe via the EU’s Corporate Sustainability Reporting Directive’s requirement to report under the European Sustainability Reporting Standards (ESRS) which began the phase-in process during 2024. Although double materiality and the ESRS framework originated in the EU, large US-based companies may also be affected by the framework’s implementation.
The first dimension of double materiality is referred to as financial materiality, or an “outside-in” view of a company. That is, financial materiality asks how sustainability risks present outside of the company will affect the financial health of the entity. The second dimension of double materiality is impact materiality, or an “inside-out” perspective. In other words, impact materiality asks how the operations of a firm affect outside stakeholders such as local communities, the environment, governments, and society at large.
How is Double Materiality Calculated?
During the first half of 2024, the European Reporting Advisory Group (EFRAG) published ESRS Implementation Guidance that outlines the general framework for implementing double materiality2. While the actual assessment of materiality considers numerous variables and considerations, the double materiality assessment process (DMA) can be summarized into four basic steps:
- Gain an Understanding of Business Activities and Relevant Stakeholders.
- Identify Impacts, Risks, and Opportunities (IROs).
- Determine the Materiality of IROs.
- Document and Report Material IROs.
Gain an Understanding of Business Activities and Relevant Stakeholders
The goal of the first step is for the reporting company to gain an overview of how business activities affect its value chain, including suppliers, customers, other business relationships, and community members to name a few. While business activities and stakeholders will vary between industries, Deloitte named several possible sources to involve in the consideration, such as: the reporting entity’s regulatory environment, media publications about the entity and its industry, scientific findings relating to sustainability, and any other external materials related to the entity. In addition, business plans, strategies, financial statements, and other investor-aimed information should be consulted3.
Identify Impacts, Risks, and Opportunities (IROs)
The second step to be completed during the DMA is to identify IROs based on the findings in step one. IROs include both positive and negative impacts that the company could have on the environment and stakeholders, risks that may affect the firm’s economic performance, reputation, or legal standing, and opportunities that have material effects on the firm. This list may be extensive and should include both actual and potential IROs. In addition, the double materiality framework encourages businesses to engage with stakeholders during this process. IROs could relate to things such as greenhouse gas emissions, waste management, product safety, resource depletion, labor practices, and biodiversity loss, to name a few.
Determine the Materiality of IROs
Possibly the most challenging step, companies must then perform a materiality analysis for each IRO identified. Due to the possibility of a broad variety of IROs identified, it is likely that businesses will engage in various forms of input when determining materiality, including stakeholder’s input, qualitative data, and ongoing internal due diligence4.
With regard to impact materiality, ESRS 1 states that positive and negative IROs should be evaluated according to their scale and scope. Negative impacts are evaluated on the additional criteria of remediability. Potential impacts must also be judged according to their likelihood. Companies are expected to utilize this multi-dimensional approach coupled with professional judgment to score each impact and determine whether it is material. Financial materiality, while still complicated, is considered in a more concise fashion. Current guidance requires companies to consider both the magnitude and likelihood for all financial risks and opportunities. Unlike impact materiality, financial materiality uses quantitative and qualitative factors for each financial risk or opportunity being assessed. Only IROs deemed to be material under these criteria are further assessed4.
Document and Report Material IROs
Finally, the findings and judgments made up to this point are consolidated and reported under the supervision of management. ESRS 1 dictates two components that make up the final disclosures that summarize the previous steps taken. The first part of the disclosures should outline the process of identifying and assessing material IROs, while the second details the outcome of the DMA. The second component also goes beyond listing material IROs but also includes how the material IROs interact with the entity’s business model and forward-facing strategy4.
Final Considerations
It’s no secret that the double materiality framework is in its infancy. ESRS guidance, while thorough, is not yet comprehensive. In the early years of reporting, affected businesses will need to actively engage with stakeholders and regulatory bodies to foster transparency, setting a foundation for more credible and comprehensive reporting that addresses both financial and societal concerns. With regard to double materiality assessments, PwC outlined pitfalls that the firm expects many businesses to fall into, with accompanying remedies. While the overall message from PwC is that updated reporting standards should not be underestimated for their complexities, some specific items companies should consider are the need for extensive documentation, the use of several assessment tools, and an equal consideration of both impact and financial materiality5.
As companies increasingly face regulatory requirements to address both financial and impact materiality, the double materiality framework marks a shift toward a more holistic approach in corporate reporting. By embracing this evolving framework, organizations can not only meet compliance demands but also strengthen transparency and accountability in ways that align with global sustainability goals.
Sources:
1. European Commission Double Materiality 2019
2. EFRAG Guide on Materiality Assessment
3. Deloitte on Calculating Double Materiality
Footnotes
Feb 26, 2025