Materiality assessment in ESG reporting standards needs further guidance, say EU regulators

EU financial regulators and the ECB have submitted their opinions on the first set of sustainability reporting standards, which are due to be adopted in June.

The European supervisory authorities have urged the European Commission to provide more clarity on how companies should report their materiality assessments part of the first set of requirements under the European Sustainability Reporting Standards framework, following their release last November.

Under EU proposed rules, companies will be required to carry out a materiality assessment, aimed at determining which sustainability issues are most critical to their business model.

In their opinions, the EU bodies – the European Banking Authority, the European Insurance and Occupational Pensions Authority and the European Securities and Markets Authority – agree consistency of this materiality assessment should be improved so that the process is aligned across the different sets of standards.

The regulators have also asked the commission for further guidance on how materiality thresholds should be set once the sustainability topics have been ranked according to their severity.

According to the European Central Bank, these thresholds would facilitate implementation and significantly improve the quality of reporting, both by avoiding the risk of over-reporting by companies concerned about the reputational risk of being found as disclosing insufficient information, and by “limiting the risk of opportunistically restrictive interpretations of materiality”.

The EBA and Eiopa both also noted that more clarity is required on the definition of “value chain” for financial services companies so that relevant sustainability impacts may be reported in a proportionate manner that reflects different levels of risk.

The current set of ESRS consists of two “cross-cutting” standards addressing general requirements and disclosures in sustainability reporting, and 10 additional “topical” standards.

The latter covers five environmental factors (climate change, pollution, marine resources, biodiversity, and circular economy) and four social factors (internal workforce, workers in the value chain, communities, and customers), with business conduct features as the only governance topic.

Meanwhile, the European Financial Reporting Advisory Group, the body tasked with creating the standards, is in the process of designing a second, sector-specific set of draft ESRS, which will also focus on small and medium-sized companies.

The EU proposes a “double materiality” principle, under which companies will have to disclose the effects of sustainability factors on their business, as well as the impact of business activities on the environment and society.

This is in contrast with other reporting initiatives such as the International Sustainability Standards Board that focus primarily on financial materiality.

The standards underpin the EU Corporate Sustainability Reporting Directive, which will oblige nearly 50,000 companies with operations in Europe to gradually report on sustainability factors from 2024. They are set to be adopted as delegated acts by June 30 2023.

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