This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.
Author: Jochen A Berner, Vice-President Sustainability Strategy, ZF Friedrichshafen AG, Beate Stuis, Senior Manager, ESG Advisory, KPMG
- Impact valuation provides objective and quantitative insights and helps to inform the new demands of European sustainability reporting requirements.
- Translation of impacts into monetary terms enables a common understanding of the business relevance of sustainability.
- Deeper strategic insights and discussions within organizations are additional benefits of impact valuation that help transform business models.
As companies navigate the implementation of laws such as the Corporate Sustainability Reporting Directive (CSRD) and the EU Taxonomy, many are questioning the higher costs of these new sustainability reporting requirements.
Despite these concerns, it remains important that we keep the original intention of these regulations in mind. Namely, requiring companies to report sustainability information with the aim of providing investors and stakeholders access to robust and comprehensive information to make more informed decisions; and establishing greater transparency about a company’s impact on planet and people.
However, do the increased levels of reporting requirements meet these original expectations and support the transformation of companies towards sustainability? And if so, how can impact valuation contribute to this effort?
Double materiality under the CSRD
The CSRD specifies a double materiality analysis (DMA) that specifies that companies must assess both the financial effect of sustainability topics on their business, and the external impact of their business activities on the environment and society.
This includes a range of sustainability topics across the entire value chain of the environmental, social and governance pillars. From an impact perspective, the company must assess the severity of actual and potential impacts of their business on both the environment and people, based on scale, scope and irremediability, as well the likelihood that these impacts might take place.
Understanding impact valuation
Existing methodologies, such as that used by Frankfurt’s Value Balancing Alliance (VBA), employ widely accepted valuation techniques to translate the positive and negative impacts of companies’ activities into financial terms. VBA’s approach covers a broad range of environmental, social and economic impacts that results in impact values (e.g. for climate change, pollution or human rights) informing the DMA.
Impact valuation also offers additional insights, providing companies with a better understanding of their actual and potential impacts, and the resulting financial risks and opportunities they need to report information about under the CSRD:
- Understanding causality. Available methodologies provide a comprehensive description of environmental and social topics as well as the underlying cause and effect relationships of the described impact pathways. The resulting information is a good starting point for companies to drive better discussions with stakeholders during the DMA process.
- Insights into value chain stages. DMA requires the assessment of impacts across the value chain. Companies might have a good overview of their own operations, but insights from upstream and downstream activities are often limited. Impact valuation can help with this by using established techniques, such as input-output models and life-cycle analysis, to provide data points for all the value chain stages.
- Assessment of severity of impacts. The underlying analysis performed during impact valuation provides insights into the scale of the impact (e.g. local information about water scarcity or air pollution) as well as its scope (e.g. based on a geographical analysis).
- Comparability of different topics. Impact valuation translates sustainability topics into monetary units, which enables the direct comparison of previously difficult-to-compare impact topics, e.g. water consumption versus waste.
Using impact valuation in double materiality analysis
Though most first-time adopters of the CSRD are using a qualitative and often descriptive approach for the DMA consisting of external and/or internal stakeholder assessments, a few companies are currently working towards integrating impact valuation into their DMA, which brings advantages such as additional value chain insights, neutral and external data, and objectivity and comparability to the process.
There are different approaches used for the assessment of impact materiality using impact valuation:
Pre-assessment. Some companies use impact valuation to assist with qualitative assessments. This approach might prove advantageous for some organizations, for example, financial institutions with a lack of detailed data and a broad range of investments, in order to focus early on material CSRD topics per sector or investment class. No matter the circumstances, the double materiality requirements of CSRD must be fulfilled and in most cases, impact valuation only addresses current impacts, and not the full range of CSRD topics and sub-topics. In order to be fully CSRD-compliant, missing topics and future impacts also need to be assessed in the pre-assessment approach.
Fully integrated. The limitations seen in the pre-assessment approach can be overcome through a multi-pillar approach that combines impact valuation with external stakeholder surveys and internal expert workshops – the approach that was taken in our project.
We took an analytical approach for the integration of the three pillars, but qualitative combination could have also been used. If a qualitative approach is applied, the integration criteria must be clearly stated and applied consistently across all of the topics.
Our analytical approach included weighting the results of the different pillars and combining the results to reach a final assessment score. Any missing CSRD (sub-) topics and the consideration of future impacts were included through the integration of stakeholder and expert assessments. A final validation ensured overall consistency.
Final validation: A third option would be using impact valuation as a control mechanism for a final validation, ensuring that no major impacts are mis-stated.
Whether or not impact valuation can be used for the financial materiality analysis – which concentrates purely on the financial implications within an organization – remains an ongoing debate. The CSRD clearly states that impact and financial materiality are two different perspectives, and therefore two separate analyses should be undertaken. A better understanding of the impacts and their severity, as well as the related dependencies on natural, human and social resources, is helpful to identity financial risks or opportunities. Impact valuation can be used as a starting point for the financial materiality assessment. But even when a low impact is determined across their own value chain, companies might be highly affected by the negative impacts produced by third parties, with tangible effects on their own financial performance.
Our experience from our joint project shows that impact valuation not only provided an objective and quantitative additional tool for the DMA, but also enriched the qualitative discussions that took place during internal stakeholder and expert workshops. It provided a general overview of the magnitude of impacts for very different topics such as greenhouse gas emissions, pollution and social topics, helping us to remain objective. Additional valuable insights were gained on the upstream value stage analysis on regional, purchased material and pollutant levels.
Even more important was how using impact valuation opened the discussion to those colleagues with a stronger controller and finance background. The translation of impacts into monetary terms made it easier to have a common understanding about the business relevance of sustainability. Establishing a common narrative, one that directly fed into the DMA requirements, was a catalyst for deeper strategic insights and discussions within the organization that is important to the transformation of the business model.
Discover
How is the World Economic Forum helping companies navigate the CSRD?
The Corporate Sustainability Reporting Directive (CSRD) is the European Union’s legislative framework aimed at fostering greater standardization in the disclosure of Environmental, Social, and Governance (ESG) impacts by companies. The European Sustainability Reporting Standards (ESRS) under the CSRD provide specific guidelines and standards for ESG reporting, ensuring comparability across companies and sectors.
From 2024 onwards, approximately 50,000 companies worldwide will progressively be required to disclose their ESG performance.
To equip companies with the necessary skills for comprehensive ESG reporting on the ESRS and other global standards, such as those from the International Sustainability Standards Board, the Forum has established a Community of ESG Practitioners. This community is part of the Forum’s Stakeholder Metrics initiative.
Contact us for more information on how to get involved.
The collective involvement of the entire organization from operations to finance can guide and enable the sustainable transformation of business models. For us, the DMA project supported positive and ongoing engagement across the organization, and impact valuation served as a powerful tool in providing an objective and common language.
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