Navigating ESRS materiality: What are impacts, risks and opportunities?

A focal point of the CSRD (and, consequently of the ESRS) is that on disclosing so-called impacts, risks, and opportunities of sustainability topics. 

As businesses prepare to meet these stringent reporting requirements, it’s fundamental to understand and articulate the key concepts and pillars of ESRS materiality assessments.

Materiality refers to the criteria used to prioritize and include information regarded as “important” in the final report (which, in the case of the CSRD, has to be compliant with the disclosure requirements laid out in that regulation and in the ESRS). 

This article gives you a closer look at the IROs (Impacts, Risks, and Opportunities), why they are critical for businesses, and how they relate with the disclosure requirements laid out by the ESRS. Let’s dive in!

What are Impacts, Risks, and Opportunities in the context of the ESRS?

Under the ESRS, companies must report material sustainability-related information, focusing on the financial risks and opportunities of climate, social and governance risks, as well as, the (actual and potential) impacts of a company’s products and operations on the environment and society. 

The concept of “financial materiality” of ESG factors is central for various sustainability reporting frameworks, such as the IFRS (as “sustainability risks and opportunities”), and SEC disclosures (in the context of “climate risks”). Financial materiality usually includes not just current but also potential future financial effects of sustainability-related risks and opportunities, affecting the company in the short, medium, or long term. 

Financial materiality is especially important in the context of disclosures that are destined to investors, because it has implications for the financial viability of a company.  Climate change, biodiversity loss, ecosystem degradation, and geo-political risks can seriously affect business operations, productivity, and markets.

The ESRS (European Sustainability Reporting Standards), breaks down financial materiality into “risks” and “opportunities”. 

Risks are uncertainties related to environmental, social, or governance factors that could negatively impact the company’s business and sustainability strategies. Managing these risks involves identifying, measuring, preventing, and reducing them to avoid negative outcomes.

In the context of a materiality assessment, ESG risks have to be assessed with respect to their likelihood, and to their potential magnitude. Companies must think about the identification, measurement, prevention and mitigation of sustainability-related financial risks. 

Opportunities: These are chances related to environmental, social, or governance factors that, if they happen, could positively affect the company’s business and sustainability strategies. Opportunities can help a company reach its goals and create value, influencing its decision-making in sustainability. 

Adding “impact” into the mix

In addition to the financial materiality perspective, the ESRS mandates that companies look into the topics that are material from an impact perspective. This approach - called double materiality - entails that impacts are regarded as equally important as financial risks and opportunities. 

Broadly speaking, impacts are the effects a company has or could have on the economy, environment, and people (including human rights). These effects show whether a company’s activities are generally beneficial or harmful to sustainable development. Impacts can vary—they can be current or potential, positive or negative, short-term or long-term, and they might happen on purpose, or by accident. According to the ESRS 4 (still in Draft form at the date of publication of this article), negative impacts must be assessed in their “severity”, meaning according to the scale, scope and irremediable character of the impact, as well as according to their likelihood.

Reporting on “impacts” in addition to risks and opportunities greatly broadens the scope of ESRS disclosure, and consequently, the burden on companies. 

Assessing the materiality of IROs

According to the ESRS 4 certain impacts, risks and opportunities can apply (or be material) to: 

All companies, independently of the sector: Some impacts, risks, and opportunities are relevant to every type of business, no matter what industry they are in. Because of this, all companies must report these details (these are called sector-agnostic disclosures).

Companies in specific sectors: Other impacts, risks, and opportunities are mainly relevant to businesses in certain industries. Only companies in those industries need to report these details (these are called sector-specific disclosures).

Some companies, based on entity-level circumstances: Whether certain impacts, opportunities and risks are important enough to report can also depend on the specific situation of each entity. Companies need to evaluate their unique circumstances to decide what to disclose.

It’s important to note that the ESRS follow a “comply or explain” approach. Usually, if a disclosure requirement is set by the ESRS as applying for a specific sector or to all sectors, it is assumed to be material (meaning it likely impacts or presents risks or opportunities for the company), and thus the company should fully report on it as the ESRS specifies.

However, this assumption can be challenged. If a company finds that a particular disclosure isn't as relevant due to its specific circumstances, and if it can provide good evidence for this, it can decide not to report it fully. This way, the company can avoid filling sustainability reports with unnecessary information. Each requirement from the ESRS needs to be individually assessed by the company to see if it needs full disclosure or not - and it is identified as “not material”, it must be clearly labeled as such, with, in many cases, supporting evidence for this choice. 

Policies, actions, and targets 

Not only should companies under the scope of the ESRS assess their material impacts, risks and opportunities, but in some cases they should also complement this information with the policies and actions developed to address and prevent risks and impacts, as well as with broader targets that are related to the impacts themselves. 

In conclusion

In summary, complying with the CSRD and ESRS disclosure requirements involves carefully evaluating how its operations impact various sustainability factors and how these factors, in turn, impact its financial health. 

Reporting and materiality assessments under these new requirements are crucial for making the company’s activities transparent, both to investors who are interested in the financial stability and ethical operations of the company, but also for other stakeholders, such as employees, customers, and communities affected by the company’s operations. However, they can also be cumbersome and complicated, especially to the complex nature of the “double materiality” perspective chosen by European regulators in the context of sustainability disclosures. 

At Briink, we use advanced AI models to simplify the gathering and verification of ESG and ESRS KPIs buried in reports and other documents. If you are currently burdened with these disclosures, we can help you with your project while also preparing you for future reporting requirements. You can start populating your first ESRS report with AI generated insights for free on our platform.