Material impacts are not most often financially material

Material impacts are not most often financially material – a response to EFRAG

🙉 In December 2023, EFRAG opened the floor for public feedback on its draft double materiality assessment guidance, a crucial tool for companies navigating disclosure obligations under the CSRD. Our hearing response, titled “Getting Financial Materiality Right,” delves into key considerations for a more robust and aligned approach. Here are our main points and the full response can be found is attached.

❕ Financial Materiality Alignment:
We believe that the guidance should more clearly stress the need for aligning with financial materiality in financial reporting to ensure that sustainability-related disclosures follow the very same materiality principles and thresholds that guide financial reporting.

💶 Financial Effect vs. Financial Materiality:
Our response challenges specifically the assumption in the draft guidance that “material impacts most often trigger material risks and opportunities.” We believe this is inaccurate, that the evidence is weak, and that applying this dictum companies risk misrepresenting to investors the financial effects of sustainability-related risks and opportunities.

💶 Financial materiality thresholds:
We argue for consistency in financial materiality thresholds across companies risks and opportunities, and that when applying a financial threshold of 5-10% of net operating profit (a typical audit risk threshold), many material sustainability-related impacts do not cause financially material effects. In addition to using 5-10% of net operating profit as a disclosure threshold for magnitude of financial effect, companies can consider their monetary threshold for disclosing operational risk.

✳ Integration with ERM Systems:
We recommend using companies’ enterprise-wide risk management models for assessing financial materiality but underline the importance of distinguishing between the thresholds for seeking mitigation and public disclosure.

⌛ Time Horizons and Nature of Financial Effect:
We call for greater clarity on how companies shall disclose financial materiality across time horizons and the nature of financial effects (e.g., cash flow, balance sheet, P/L).

✅ Conclusion:
We believe that CSRD is an important piece of legislation in fostering greater transparency on companies’ sustainability-related impacts, risks and opportunities, however the guidance that comes along need to guide companies to apply principles of financial materiality that are consistent with financial reporting.