At NORD advise, we have extensive experience with double materiality analyses from both the company and auditor perspectives. Our double materiality projects cover a wide range, from preparing the entire draft and documentation package to acting as advisors and quality reviewers for companies’ own processes. Additionally, we conduct pre-assurance/compliance reviews of companies’ double materiality analyses, developed a compliance checklist used by 30 audit firms, and educate the sustainability auditors in Denmark on the auditor’s role in the double materiality analysis.
From a compliance perspective, we observe a number of recurring challenges that can individually lead to a modified auditor’s opinion (qualification).
Many of these issues are centered around the fact that the auditor must issue a limited assurance statement about the process of identifying and assessing the topics to be included in the sustainability report, but not about the actual results.
The following five challenges are described below:
- Documentation of the process for the double materiality analysis is not sufficient
- The understanding phase is not thoroughly completed (and documented) before the company begins the identification phase
- The defined sustainability topics in AR16 are not used correctly during the identification phase
- Complete or partial lack of documentation for ratings of IROs and the materiality threshold
- Lack of argumentation and description of IROs (impacts, risks, and opportunities) creates challenges in reporting the results
1. Documentation of the process for the double materiality analysis is not sufficient
When companies conduct their double materiality analysis, there are numerous requirements for the process, criteria, and other elements that must be met. However, it is largely up to the company itself to design an appropriate process that ensures these requirements are fulfilled and that relevant matters are identified and assessed.
At NORD advise, we often see that while the results may appear appropriate, the process is not properly documented.
It is essential that companies not only conduct a thorough process but also formalise and document it sufficiently. The documentation of the double materiality analysis must include a memorandum that completely and accurately describes the process, methods, established criteria, thresholds, assumptions, estimates, and more.
If the process for the company’s double materiality analysis is not properly documented, the auditor is technically unable to assess whether:
- A process has been designed in accordance with the requirements,
- The designed process has been followed, and
- The description of the process, which must be included in the final sustainability report, aligns with what was actually done.
2. The understanding phase is not thoroughly completed (and documented) before the company begins the identification phase
At NORD advise, we often see companies beginning the identification phase – where relevant sustainability topics are selected – before fully completing the understanding phase.
During the understanding phase, the company develops an overview of its activities and business relationships, the context in which it operates, and a clear understanding of its key stakeholders. This overview provides crucial inputs for identifying the company’s IROs (impacts, risks, and opportunities).
It is therefore essential that companies do not start the identification phase until the understanding phase is fully completed. Furthermore, it is necessary to document the entire process in the understanding phase to ensure compliance with the requirements for the double materiality analysis.
3. The defined sustainability topics in AR16 are not used correctly during the identification phase
Once a company has achieved and documented an understanding of its activities, products, markets, stakeholders, value chain, etc., this understanding must be applied to identify impacts, risks, and opportunities (IROs) related to individual sustainability topics.
Two overall methods are permitted for the identification phase. Both require the use of the list of sustainability topics in AR16 from ESRS 1. AR16 includes 10 overarching topics with associated subtopics and sub-subtopics. The purpose of using AR16 is to ensure the completeness of the identification phase.
At NORD advise, we often observe that the architecture of AR16 is not used correctly, which constitutes an error in the process of the double materiality analysis. If this is not resolved to ensure the correct application of AR16, it will, in most cases, lead to a qualification in the auditor’s opinion.
Our recommendation is to use the method where AR16 is applied directly without developing a separate list (long list) that must then be mapped to AR16. This approach eliminates an unnecessary step in the double materiality analysis.
4. Complete or partial lack of documentation for ratings of IROs and the materiality threshold
After identifying IROs, companies must establish company-defined ratings and a threshold for determining when an issue is material.
Ratings must ensure not only that individual criteria (severity, scale, scope, irreversibility, etc.) are assessed and calibrated against a defined scale but also that evaluations are conducted as objectively as possible.
At NORD advise, we often observe that companies have evaluated individual criteria – often on a scale of 1 to 5 – but lack established and documented rules and guidelines for how issues should be rated. This is a critical shortfall in ensuring compliance with the rules for assessing individual impacts, risks, and opportunities (IROs). These deficiencies are typically seen in both the materiality of impacts and financial materiality.
In addition to missing rules and guidelines for rating individual criteria, we frequently find that there is no clear determination or documentation of the threshold for when a sustainability topic is considered material overall. The establishment of this threshold must also be based on as objective an assessment as possible, taking into account stakeholder focus areas and the level of financial materiality.
5. Lack of argumentation and description of IROs (impacts, risks, and opportunities) creates challenges in reporting the results
Insufficient documentation of the reasoning behind identified impacts, risks, and opportunities (IROs) can lead to significant challenges when preparing the sustainability report. ESRS 2 requires a number of detailed disclosure requirements for describing IROs, meaning that initial weaknesses in reasoning and description create issues during the reporting process.
The requirements for how IROs are defined, aggregated, and disaggregated can significantly impact the scope of the writing process later. Additionally, the number of material disclosure requirements and data points in the report can be impacted by how IROs are defined.
When the description of IROs is inadequate and the arguments supporting their identification, assessment, and delineation are not clearly documented, companies often find themselves needing to redo parts of the double materiality analysis. This can lead to errors in the sustainability report and unnecessary delays.