Understanding the ESRS Thresholds | Q&A with Mike Jennings

Q&A | Gabriella Lovas was chatting with Mike Jennings, Director in Sustainability and ESG Consulting at Anthesis Group, about ESRS threshold setting and new data-driven fact-based alternatives to #stakeholder surveys and interviews.

These are Mike’s personal views.

| How do those ESRS thresholds work?

They’re lovely, aren’t they?

Thresholds are the least well-understood part after affected stakeholders under ESRS.

ESRS set general principles and transparency requirements. You have to disclose about thresholds, but how you do it, they leave up to you. This doesn’t always make it easy.

As you do your #materiality assessment, you might identify 50 topics. But are all of those material and need to be included in the report? The threshold is there to enable you to decide what you put in the report and what to leave out due to immateriality. You might find that out of your 50 topics, 35 are immaterial. Thus, only 15 of those will go into your ESRS statements.

I would divide thresholds into financial materiality thresholds and impact materiality thresholds because they are viewed differently. One is the external impact, the other is the impact on the business.

Materiality from an auditing perspective means that if a piece of information was omitted or was not adjusted in the financial statements, would it change how the user, the reader of those financial statements, would perceive the company?

This would be done topic by topic, as ESRS anticipates that you will examine each sustainability matter separately. Then you’ll have two lists, an impact list and a financial list.

ESRS actually anticipates that you’ll do it one by one because different impacts may require different thresholds. If you’ve got impacts on #biodiversity on greenhouse gas emissions, you might have lower thresholds just because these are such important topics.

| Let’s start with thresholds for financial materiality,

ESRS1 Application Requirement 15 does give a bit of guidance on financial materiality thresholds. It says to look at the magnitude and the likelihood of occurrence and consider the long-term, short-term, and medium-term.

At the end of the day, you’re going to think of it in two ways.

One is going to be an absolute monetary threshold.

The second is the relative one, which is a percentage of sales, revenue, or profit or P&L on the balance sheet. Auditors generally use a percentage of a line item in the financial statements.

Now, that works if you’ve got financial information to look at. That means you’ve actually got a number.

However, financial materiality may not have a number in some cases. The estimate may be too difficult to do. In that case, you’re probably going to look at it more qualitatively and see if it is high, medium or low risk and determine a threshold on that basis.

| What about impact materiality thresholds?

On impact, there’ll be a few different types of thresholds that you would use. It may be quantitative or qualitative, depending on the type of data you’ve got. If, for example, you’ve polluted a  river and you’ve got a team that’s now looking after that, they’ll provide you with some information. Probably you will disclose it if they say it is really serious. If they think it’s not that serious, you might not. You need to have a threshold to help to determine whether to disclose or not.

So you might have information internally that helps you set a threshold. Note that this is a bit different to financial materiality thresholds, where you might have a risk management process in place. They may have more information and they can say whether something’s really going to have a big impact or not..

| Let’s discuss how sustainability due diligence can assist materiality assessments!

Traditional materiality assessments involve a lot of stakeholder interviews. In some cases, you might see surveys of customers, clients and suppliers.

However, some of those surveys don’t really bring back a lot of answers because customers and clients have other things to do. Suppliers might answer because they know they have to sell to you, but you don’t necessarily get a lot of quality information through that. You may, you may not.

Moreover, in terms of interviews, your stakeholders have different understandings of different topics around ESG and sustainability. Someone in HR is going to spend much more time talking about social, whereas the CFO may have a completely different perspective. A lot of that information is subjective. It may be based on something that they have heard or they have seen. How do you pull that together?

The ESRS approach should be much more objective, data-driven, and fact-based.

Companies, at least the larger ones, already have supplier due diligence and other due diligence processes in place. They could use the information that’s coming in through those processes that are already set up to include that information in the materiality assessment.

The traditional approach involves talking to stakeholders and asking them if, for instance, human rights may be an issue in the supply chain. But isn’t it better to use the data and insight from your human rights due diligence process in your double materiality assessment if you already have that process in place?  It’s going to be so much more detailed and include more information than you’re ever going to get through interviewing people.

There are a number of other processes that you can pull into your double materiality assessment, such as a process around environmental impact studies. That information is factual, documented information.

EFRAG is trying to bring in that type of data. However, these processes probably need to be updated at some Companies as they should feed into the materiality assessment not only that we have an issue but also its scope, scale, irremediability, and likelihood if it’s potential. A lot of processes might not have that type of data, yet.

So it’s those processes that really inform impact materiality, both on identification but also on assessment, which are stages two and three of the materiality assessment. You’ve got so much data in the business that can support that double materiality assessment that it’s a shame not to use it.

| Why do companies not use that data?

Never really been done that way, that’s all.

It’s slightly changing the model to bring in more data from the ‘coal face,’ from people who really do the work on a daily basis. For example, when I say at the coalface for suppliers, it would be people working in procurement and supply chain management. They are working with their suppliers on a daily basis. They’ll hear that some of the suppliers might have an environmental or human rights issue. And they’re asking questions of their suppliers.

People who do this on a daily basis have so much insight. They’ve probably got lots of information on this topic, policy on that matter. And that can all be pulled in to bring some level of objectivity to the process about what the main issues might be and whether you can do anything about them as a company.

| Is it about the company’s own departments working together better? 

It’s about the flow of information.

ESRS does require lots of different parts of the business to work on sustainability, not just the sustainability team.

You start with those charged with governance, including the board and management. You’ve got maybe a chief sustainability officer,  a chief financial officer,  or a chief operating officer.. You’ve got a head of compliance, head of legal and head of controlling. You’ve got your supply chain team. You’ve got people that might be interacting with unions, non-governmental bodies, and communities. You’ve got health and safety. I’ve had clients bring in taxation because the tax person wants to know what’s going on in case he has a tax impact.  Another key thing is getting information from whistleblowing or rather grievance mechanisms.

| So with ESRS, we’re moving to a new level of development?

We’ve had very good standards so far, such as GRI, TCFD, SASB and so forth. But the ESRS is moving up a level and saying, now it is real double materiality and you’ve got to really talk about this.

We’re not just talking impact, we’re not just talking financial materiality. But wouldn’t it be good if we did both of them, because then we’ve probably got a much better view of what’s really happening in the environment, in society, but also in the company?

EFRAG is just looking for more information and a lot more disclosure about how things really work.  All of that information needs to be reported to those charged with governance and, you need to say if it changes or influences your strategy and business model.

Impact materiality is your starting point because a lot of impacts will have a financial materiality aspect. If you pollute a river, it is impact materiality, if you get fined for it or you think you’re going to get fined for it is financial materiality.

Financial materiality is a bit of a different beast to impact materiality. It needs a different skillset to some extent because you’re thinking about P&L, cash flow, and balance sheet.

The next step is looking within your business. Go to the risk managers, who haven’t always been well involved in a materiality assessment, and ask them what risks they are seeing to the business from your enterprise-wide risk management process. You can get a good idea of what they see as potential risks by looking at their reports and talking to them.

Contact the finance guys, because they are doing the financial statements and there could be risks included within there.

Then you would look at dependencies. That is access to resources and to relationships. You can take various approaches there.  I don’t think anyone in materiality would have ever spoken to salespeople. You might come away with nothing, but they might say one of the customers has a reputational issue at the moment. There could be things that emerge.

| Do you use the topics from sector standards?

I would always pull those in as part of the identification of risks or impacts. I would do desk research and look at the key reporting frameworks to see if they have an industry perspective. I would examine what rating agencies look for, how they score things, and what they consider to be the key topics in an industry.

I would look at peers, too to see what topics they are raising. Do they have the same topic? Are they purchasing from similar suppliers or the same suppliers in the same countries?

Looking at frameworks, rating agencies and peers is important because it gives you an outside in perspective of what others are doing in similar businesses. It doesn’t mean their issues have to be material for that business. But again, it’s an objective point of view.

| brief bio

Mike leads the Anthesis Sustainable Finance team working in the areas of finance, business, regulation and reporting on ESG matters. Mike is currently involved in developing Anthesis’ services in the area of mandatory ESG reporting (CSRD, SEC, IFRS Sustainability Standards).

Mike has spoken recently on webinars concerning the introduction of the CSRD in the EU and is the author of a number of posts and documents about the impact of CSRD and ESRS on businesses. Mike brings a unique blend of ESG expertise and years working with regulations and financial reporting.

Mike has been an assurance and advisory leader in both Deloitte and PWC. Mike was an audit partner in Deloitte until 2007 working with multinational institutions on audit and financial reporting matters. Mike has extensive experience working with those charged with governance at the Supervisory Board and Audit Committee level.

In 2007 he moved to Consulting and led governance, finance, risk and regulatory consulting projects with clients until 2021, in both Deloitte and PwC. Mike led ESG consulting for financial services across 27 countries in PwC.

Mike is a Chartered Accountant with the Institute of Chartered Accountants in England and Wales, a member of the Chartered Institute of Marketing in the UK and previously a member of the Institute of Internal Auditors.

You can find his posts about CSRD and mandatory reporting on LinkedIn here:   https://www.linkedin.com/in/mike-jennings-anthesis-sustainable-finance/

Gabriella Lovas is a GRI Certified Sustainability Professional with a CFA Certificate in ESG Investing and a Masters in Economics. She specialises in ESG and corporate sustainability reporting.