Public Consultation: Materiality Assessment Implementation, and Value Chain Implementation Guidance

Public Consultation

Materiality Assessment Implementation Guidance Value Chain Implementation Guidance

Collective feedback by

Contributors:

Climate & Company: Max Tetteroo | max@climcom.org Raphael Tietmeyer | raphael@climcom.org

Climate Focus: Erin Matson | e.matson@climatefocus.com Georg Hahn | g.hahn@climatefocus.com

For any questions, please contact Max Tetteroo (max@climcom.org)

About This document sets out our joint feedback to the public consultations on EFRAG’s Materiality Assessment Implementation Guidance (MAIG) and Value Chain Implementation Guidance (VCIG). The document has been drafted collaboratively by Climate & Company and Climate Focus.

This work was financed by the Gordon and Betty Moore Foundation and is part of the project "Sustainable Finance Instruments for Sustainable Land Use"

Feedback to the Materiality Assessment Implementation Guidance Chapter 2 – The ESRS approach to materiality 2.1: Implementing the concept of double materiality •

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In Paragraph 35, a brief explanation of dynamic materiality and its forward-looking perspective would enhance clarity and understanding.

• Regarding Paragraph 37, while the examples provided are insightful, they predominantly focus on company actions. It's essential to include an example illustrating how something can evolve into a material risk or opportunity over time due to external changes, unrelated to a company's decisions. For instance, envision a manufacturing company heavily invested in traditional production methods. A sudden and substantial shift in government policies favouring sustainable practices and imposing carbon taxes could pose a transition risk. As policies promoting eco-friendly manufacturing gain traction, the company may face financial challenges and market uncertainties, impacting its long-term sustainability. More precisely, the emergence of the EUDR highlights how changes in legislation can transform environmental concerns into financially material issues for companies. Mandates requiring supply chains to be deforestationfree could lead to legal penalties, regulatory restrictions, market access limitations, reputational harm, and supply chain disruptions. Similarly, consider a factory located in a region prone to extreme weather events. Over time, the increased frequency and intensity of climate-related events, such as hurricanes or floods, could transform the factory from a potential asset into a significant physical risk. The changing climate conditions may lead to disruptions in production, property damage, increased insurance costs, and supply chain vulnerabilities, highlighting the importance of assessing physical risks associated with climate change impacts.

Alternatively, consolidating both definitions and examples into “FAQ 9: How to consider time horizon in the double materiality analysis?” could streamline understanding and provide comprehensive guidance.

Chapter 3 – How is the materiality assessment performed?

3.2: Step B: Identification of the actual and potential IROs related to sustainability matters

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Currently, the text, paragraph 72 states: “The undertaking should use the list of the sustainability matters in ESRS 1 paragraph AR16 to support this process and to ensure completeness. It is equally important for the undertaking to consider entity-specific sustainability matters not covered in that list, if any. Currently, until the sector standards are issued, sector sustainability matters shall be identified and assessed as entity-specific matters.”

Firstly, we recommend editing the paragraph as follows: “The undertaking should use the list of the sustainability matters in ESRS 1 paragraph AR16 to support this process and to ensure completeness. It is equally important for the undertaking to consider entity-specific and sector sustainability matters not covered in that list, if any. Currently, until the sector standards are issued, sector sustainability matters shall be identified and assessed as entity-specific matters.”

We think that the current version of the paragraph is unclear regarding the meaning of the word “until” and could leave room to interpret it like: It is equally important to consider entity-specific sustainability matters, (good!)

Sector standards are part of that until they are issued, (good!)

Potential interpretation to avoid: “so when they are, they don't fall under the entity-specific anymore, and are therefore no longer of equal importance” Secondly, there's a risk that users may interpret references to 'entity-specific matters' in isolation from paragraph 72, potentially overlooking sector standards. This discrepancy could occur frequently within key passages and illustrations throughout this guidance. To prevent this misunderstanding, we recommend addressing this issue either within the 'Summary in 13 Key Points' or in the Introduction section. This could be achieved by adding a paragraph following the Acronyms section (paragraph 22) or incorporating a textbox similar to the Annexes found in the delegated act.

Thirdly, it's crucial to integrate this clarification into the visual elements throughout the document.

Visual representations hold significant impact and are often shared across slides and social media platforms worldwide. Presently, "Figure 3: Example of a Materiality Assessment Process" and Figure 1c could potentially be viewed independently from the note in paragraph 72, leading to the oversight of sector standards as part of entity-specific sustainability matters. To mitigate this risk, we strongly recommend including a reference such as "For sector-specific standards, see paragraph 72" in both Figure 3 and 1c, ensuring alignment between textual and graphical representations.

Chapter 4 – How to leverage other sources?

We strongly recommend considering the incorporation of the LEAP approach into this document for the following reasons: 1. The LEAP approach can serve as a valuable tool for the materiality assessment, particularly when conducted from a double materiality perspective, aiding in the identification of potential material sustainability matters and IROs. Given the option provided by the TNFD to choose between a single or double materiality approach, it's crucial to emphasise that only the double materiality approach renders the LEAP assessment applicable. This connection can be established by linking the LEAP to the ESRS' 'Impact Materiality' definition (see ANNEX II, p. 17).

2. The LEAP approach is already integrated into ESRS E2 to E5, encompassing 80% of the environmental standards. Therefore, its inclusion in the materiality assessment

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implementation guidance is warranted. For instance, ESRS E2 Pollution (p.110) explicitly mentions the utilisation of the LEAP approach when conducting a materiality assessment on environmental subtopics.

3. Incorporating the LEAP approach promotes interoperability, aligning with the efforts of businesses and business associations, which advocated for aligning ESRS E4 with TNFD during the 2022 public consultation. Additionally, EFRAG has entered into a formal agreement with TNFD, working towards enhanced interoperability through the ESRS-TNFD interoperability mapping. Considering that GRI and ISSB are already referenced in the guidance, the inclusion of TNFD's LEAP would further advance interoperability efforts, representing a missed opportunity if omitted from the MAIG. 4. We propose incorporating the LEAP approach in Chapter 4 – How to Leverage Other Sources. Alternatively, adding the following text and image to paragraph 37 would be beneficial: "To illustrate how impacts and dependencies contribute to risks and opportunities, organisations can consider the Locate and Evaluate stages of LEAP as prerequisites for identifying risks and opportunities during the Assess stage. LEAP, developed by the Taskforce for Nature-related Financial Disclosures, is referenced in ESRS E2, ESRS E3, ESRS E4, and ESRS E5 of the framework."

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Chapter 5.3 – FAQs on the materiality assessment process We fully support the sentiments expressed in FAQ 8, paragraph 164. Recognising that sector-specific and/or entity-specific sustainability matters may serve as a more intuitive starting point for certain undertakings, we advocate for clarity regarding the utilisation of all these factors as potential starting points. It's essential to emphasise that while these factors can individually inform the process, none should be considered in isolation from the others.

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Feedback to the Value Chain Implementation Guidance (VCIG) We appreciate that EFRAG is providing specific guidance on how undertakings should disclose value chain information under the ESRS. This shows the importance of considering value chains for gaining a comprehensive understanding of an undertaking’s sustainability impacts. Furthermore, the guidance ensures that undertakings report meaningful information on material impacts, risks, and opportunities in their upstream and downstream value chains.

We think that the latest version of the VCIG is clearer and more comprehensive than previous versions, especially regarding the definition of value chains, what exactly is included in an undertaking’s value chain, and how different parts of the value chain should be treated. At the same time, we think that further clarification is needed for some aspects, especially related to certain definitions, value chain mapping, considering value chains in the materiality assessment, inclusion of value chain information in metrics, and use of secondary data.

Chapter 2: Navigating value chain under CSRD and ESRS •

Chapter 2 of the VCIG should clarify whether a site, asset, plant, etc. is always counted as part of the undertaking’s “own operations” if the undertaking has operational control over that specific site, etc. For example, ESRS E4 para. 16 states in part: “a list of material sites in its own operations, including sites under its operational control...” The formulation is unclear about whether the phrase “including sites under its operational control” after “own operations” serves as a definition (i.e.

“Own operations always includes sites under operational control.”) or a clarification that is specific to this Disclosure Requirement (DR) (i.e. “For the purposes of DR SBM 3, when considering biodiversity specifically, one should consider sites under operational control as part of one’s own operations.”).

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Para. 52: The reference to ESRS 1 para. 67 in the last column of the second row of the table is incorrect. ESRS 1 para. 67 refers to how undertakings should report information related to associates and joint ventures if these are part of the reporting entity’s value chain. The correct reference to be included here is ESRS E1 para. 46 which states that for associates, “the undertaking shall include the GHG emissions in accordance with the extent of the undertaking’s operational control over them.”

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Para. 52: The formulation “There are no specific indications … on how to measure impacts connected with the undertaking through its associates/investments” is unclear. We suggest that the VCIG clarifies whether the reporting undertaking needs to consider these relationships in their materiality assessment and report them if found to present material IROs.

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Para. 53: The title of this decision tree should make it more explicit that this decision tree is only relevant for the E standards (if this is the case).

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Para. 53: It is not sufficient that the answer for the final scenario (“No, they are not actors in the value chain such as suppliers or customers”) is presented as only relevant for E1. For all E standards, and indeed for the entire ESRS, if an associate, joint venture, etc. is not part of the value chain, then the

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undertaking should treat disclosure for these as it would treat disclosure for any other business relationship. ESRS 1 para. 43 clearly states that a sustainability matter can be determined to be material for disclosure based on all types of business relationships, not just relationships via the upstream and downstream VC. Hence, the answer in the decision tree for this scenario should be: “Include as “business relationships” via investment, shareholding positions, etc. for the purposes of the materiality assessment and subsequent disclosure.”

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Para. 58: “The transitional requirements are optional, i.e., the undertaking can decide whether it wants to use them or not and they apply whether the VC actor is an SME or not.” This sentence is somewhat unclear due to the use of “requirements” (rather than “provisions”) and due to it being a run-on sentence. We suggest making more explicit in this section that undertakings should feel free to report as much as they can related to the VC, if the data is, in fact, available. We suggest the following change: “The transitional provisions apply regardless of whether the VC actor(s) are SME(s). The transitional provisions are optional, i.e. undertakings can decide whether to take advantage of the additional time to prepare for disclosure. If undertakings have access to the needed VC data within the initial three years of sustainability reporting, they can decide to forgo the transitional provisions and begin reporting VC information earlier.”

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Para. 66(b): The VCIG should clarify whether this provision is meant to be a stopgap or placeholder until sector-specific standards are published. The VCIG also needs to clarify whether frameworks such as IFRS and GRI should no longer be used after the first three annual sustainability statements.

If that is the case, the VCIG needs to give a clear reasoning for it. Furthermore, the VCIG needs to identify the basis for this in the ESRS.

Chapter 3: FAQ 1 •

Para. 74(c): The example does not identify biodiversity loss itself as a source of risk to the reporting undertaking. Instead, the example only points to “the request by local authorities to restore damaged habitats” as the source of “more variable production of key natural inputs and higher production costs.” This is incomplete and could therefore be misleading; the loss of habitat and biodiversity in and of itself could negatively impact the reporting undertaking in the same way, for example by reducing supply of natural inputs whose production depends on ecosystem services such as pollination. The example should therefore be re-written to equally emphasise the risks to the reporting undertaking from biodiversity loss.

Chapter 3: FAQ 2 •

Para. 77: This paragraph is misleading, as it could be interpreted to say that material IROs via equity investments should only be disclosed in the context of Category 15 of GHG emissions under ESRS E1. We suggest to re-write this sentence as: “As described in paragraph 49, the only specific investment-related disclosure requirement in the topical ESRS relates to Category 15 of GHG emissions where significant under ESRS E1. However, other material IROs related to equity investments should always be disclosed where relevant to other disclosure requirements, or as entity-specific disclosures.”

Chapter 3: FAQ 3

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Para. 79: The statement that undertakings “should focus on the parts of their VCs where material impacts are most likely to occur” to identify material IROs should reference guidance that undertakings can use to identify the relevant parts of their VCs. We suggest adding language to FAQ 3 where appropriate that says: “To understand where material impacts are most likely to occur in its VC, the undertaking can consider both sector-specific guidance such as IFRS and GRI and the sectorspecific ESRS, and the list of sustainability matters in ESRS 1 Appendix A AR 16.” This language could be added to para. 83 or 86 or as its own paragraph and should be referenced in para. 79. The VCIG should make clear that undertakings should refer to relevant sector-agnostic and sector-specific guidance.

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Para. 92: The examples of commodities, components, and products here are useful, but it would be more useful to describe the impacts that are associated with these things. But this should also be done carefully – e.g. “commodities or components whose production may be associated with severe systemic impacts, such as deforestation from palm oil production…” … “impacts that are a result of the use of its products such as … adverse health outcomes from the use of cigarettes”.

Chapter 3: FAQ 4 •

Para. 97 (c) (i) could include “(including indirect suppliers)” after “suppliers” to make it more explicit.

Chapter 3: FAQ 5 •

Para. 118: The meaning of the following statement is unclear: “These do not necessarily result in the need to collect VC data from actors in the VC solely for the purpose of reporting. The undertaking is expected to leverage on information that is collected for business purposes, e.g., E4-1 par 13, E4 2 IRO 1 par 17(a), E4-4 par 32(c).” The VCIG needs to clarify in which situations collecting data from VC actors is actually required to disclose against the ESRS mentioned here.

Chapter 3: FAQ 6 •

Para. 119: When this paragraph is read in conjunction with para. 122, it becomes clear that para.

119’s answer of “Mostly not” is misleading. Para. 122 specifies that the inclusion of VC information in metrics should be based on the outcome of the materiality assessment if it is determined to be necessary from an entity-specific perspective. Examples a-c in para. 122 illustrate that a large number of undertakings could fall into the described, or similar, situations. Therefore, many undertakings may find it “necessary” to include VC information in their metrics, even if the ESRS does not “mandate” this inclusion beyond a few DRs. We suggest removing “Mostly not” in para.

119, and emphasise that “the inclusion of VC information in metrics is largely related to the outcomes of the materiality assessment, as described in para. 122.”

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Para. 120: The VCIG should be clearer what the use of life cycle assessments means for disclosure of information on land-use change within the VC. The guidance does not specify what companies need to report if they “may also disclose their land-use based on a Life Cycle Assessment” per ESRS E4-5 para. 36. A detailed example of what this type of disclosure could look like would be useful, e.g., if a

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Life Cycle Assessment for a food product is conducted and reveals the presence of deforestation in the production of one of the commodities used as an input.

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Para. 122(a): This example should be more concrete. We suggest the following: “impact data of suppliers should be included in the reported metrics, when the undertaking depends in its upstream VC or supply chain from activities that have a high impact on the environment, for example, production of feed stuff in tropical forest areas with high biodiversity.”

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Para. 124: The paragraph does not specify so-called available best reporting practices even though the guidance points to ESRS 1 para. 131(b) where IFRS and GRI Sector Standards are mentioned. We suggest adding more specificity here by mentioning concrete examples relevant for different ESRS, e.g., TNFD for environmental ESRS.

Chapter 3: FAQ 7 •

Para. 128: The statement “This may be particularly relevant for incidents of child or forced labour in the VC” should include more examples (especially regarding environmental issues) of severe impacts where suppliers might want to omit relevant information.

Chapter 3: FAQ 8 •

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Para. 134: We suggest referencing local verification schemes at the end of the paragraph by including the following edits: “If more details are known, such as the specific location of farming and manufacturing processes, more specific data may be available. To obtain locally specific data, undertakings should also make use of local verification schemes. Local actors, especially affected communities, frequently have extensive knowledge of an undertaking’s material environmental and social impacts in the respective location. The reporting entity should give value to this source of information when assessing the material impacts of its VC. The local providers or certifiers of information should be compensated adequately and fairly for their time and services.”

We recommend that these local verification schemes, especially for VC-related environmental and social impacts, are further defined as part of the set of ESRS standards, especially in the context of guidance for auditors.

Para. 139: The paragraph should specify why primary data on an undertaking’s environmental footprint is deemed unreliable and what data undertakings should use instead.

Chapter 3: FAQ 9 •

FAQ 9 does not seem to specify/explicitly consider principles for high-quality secondary data such as SMART principles mentioned in TNFD’s VC guidance (= reported data/information should be specific, measurable, ambitious, realistic, and time-bound). We suggest including a list of quality criteria for secondary data.

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Para. 147: The meaning of the following statement is unclear: “Disclosing quantitative measures of indirect impacts does not produce relevant information about the undertaking’s impact in all circumstances.” The VCIG needs to clarify in which situations quantitative measures of indirect impacts produce relevant information. The guidance should include more detail on this.

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