Questions & Answers
Regarding financial materiality, there are matters that trigger exposure to risks or opportunities only and others that trigger the exposure to both. In the case of a matter that triggers exposure to both risks and opportunities, should the assessment of materiality be made on each individually or is it on the combined financial risk and opportunity?
In addition to the question asked, the submitter provided the following background to the question: ‘For example, if we take energy as a topic, energy consumption is a financial risk because the cost of energy can fluctuate significantly. But there is also an opportunity in terms of reduced energy costs if the company invests in renewable energy and energy-efficient appliances. In this case, should the financial risk be assessed separately from the financial opportunity? Or should there be some assessment of what would weigh stronger in the balance, risk or opportunity and assess accordingly?
- Financial materiality
- sustainability matters generating sustainability risks or opportunities
Background
ESRS 1 paragraphs 49 to 51 state:
‘49. A sustainability matter is material from a financial perspective if it triggers or could reasonably be expected to trigger material financial effects on the undertaking. This is the case when a sustainability matter generates risks or opportunities that have a material influence or that could reasonably be expected to have a material influence on the undertaking’s development, financial position, financial performance, cash flows, access to finance or cost of capital over the short-, medium- or long-term. Risks and opportunities may derive from past events or future events. The financial materiality of a sustainability matter is not constrained to matters that are within the control of the undertaking but includes information on material risks and opportunities attributable to business relationships beyond the scope of consolidation used in the preparation of financial statements.
50. Dependencies on natural, human and social resources can be sources of financial risks or opportunities. Dependencies may trigger effects in two possible ways:
(a) they may influence the undertaking’s ability to continue to use or obtain the resources needed in its business processes as well as the quality and pricing of those resources; and
(b) they may affect the undertaking’s ability to rely on relationships needed in its business processes on acceptable terms.
51. The materiality of risks and opportunities is assessed based on a combination of the likelihood of occurrence and the potential magnitude of the financial effects.’
Regarding sustainability-related risks or opportunities, ESRS 1 paragraph AR 14 states: ‘The identification of risks and opportunities that affect or could reasonably be expected to affect the undertaking’s financial position, financial performance, cash flows, access to finance or cost of capital over the short-, medium- or long-term is the starting point for financial materiality assessment. In this context, the undertaking shall consider: …
(b) their classification as sources of:
i. risks (contributing to negative deviation in future expected cash inflows or increase in deviation in future expected cash outflows and/or negative deviation from an expected change in capitals not recognised in the financial statements); or
ii. opportunities (contributing to positive deviation in future expected cash inflows or decrease in deviation in future cash outflows and/or positive deviation from expected change in capitals not recognised in financial statements).’
ESRS 1 paragraph AR 15 states: ‘Once the undertaking has identified its risks and opportunities, it shall determine which of them are material for reporting. This shall be based on a combination of (i) the likelihood of occurrence and (ii) the potential magnitude of financial effects determined on the basis of appropriate thresholds. In this step it shall consider the contribution of those risks and opportunities to financial effects in the short-, medium- and long-term based on:
(a) scenarios /forecasts that are deemed likely to materialise; and
(b) potential financial effects related to sustainability matters deriving either from situations with a below the “more likely than not” threshold or assets/liabilities not, or not yet, reflected in financial statements. This includes:
i. potential situations that following the occurrence of future events may affect cash flow generation potential;
ii. capitals that are not recognised as assets from an accounting and financial reporting perspective but have a significant influence on financial performance, such as natural, intellectual (organisational), human, social and relationship capitals; and
iii. possible future events that may have an influence on the evolution of such capitals.’
Answer
When the nature of an opportunity or a risk relating to a sustainability matter is different, it shall be assessed separately.
In the example provided, the submitter states that energy consumption is a source of (financial) risk because the cost of energy can fluctuate significantly (upside and downside price risk). However, he has also identified an investment opportunity in terms of reduced energy costs in the case that the company invests in renewable energy and energy-efficient appliances.
In financial terms, an undertaking that is more exposed to a risk (higher prices for supplies, lower prices for sold products) than expected is also exposed to positive deviations when prices for supplies /sold products will be below /above expectations. The positive deviations are not necessarily identified as separate opportunities but assessed together with the risk. In the example above, it is the action of investing in renewable energy that creates the opportunity to reduce energy expenses.
Supporting Material
IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information also stresses regarding (financial) materiality in paragraph B15 the importance of expectations in the materiality assessment: ‘The decisions described in paragraph B14 [i.e. decisions of primary users related to providing resources to the entity] depend on primary users’ expectations about returns, for example, dividends, principal and interest payments or market price increases. Those expectations depend on primary users’ assessment of the amount, timing and uncertainty of future net cash inflows to the entity and on their assessment of the stewardship of the entity’s economic resources by the entity’s management and its governing body/bodies or individual(s).’
Relations
Paragraph | Content |
|---|---|
3.5 Financial materiality | |
3.5 Financial materiality | |
3.5 Financial materiality | |
Once the undertaking has identified its risks and opportunities, it shall determine which of them are material for reporting. This shall be based on a combination of (i) the likelihood of occurrence and (ii) the potential magnitude of financial effects determined on the basis of appropriate thresholds. In this step it shall consider the contribution of those risks and opportunities to financial effects in the short-, medium- and long-term based on: | |
The identification of risks and opportunities that affect or could reasonably be expected to affect the undertaking’s financial position, financial performance, cash flows, access to finance or cost of capital over the short-, medium- or long-term is the starting point for financial materiality assessment. In this context, the undertaking shall consider: | |
The materiality of risks and opportunities is assessed based on a combination of the likelihood of occurrence and the potential magnitude of the financial effects. | |
Dependencies on natural, human and social resources can be sources of financial risks or opportunities. Dependencies may trigger effects in two possible ways: | |
A sustainability matter is material from a financial perspective if it triggers or could reasonably be expected to trigger material financial effects on the undertaking. This is the case when a sustainability matter generates risks or opportunities that have a material influence, or could reasonably be expected to have a material influence, on the undertaking’s development, financial position, financial performance, cash flows, access to finance or cost of capital over the short-, medium- or long-term. Risks and opportunities may derive from past events or future events. The financial materiality of a sustainability matter is not constrained to matters that are within the control of the undertaking but includes information on material risks and opportunities attributable to business relationships beyond the scope of consolidation used in the preparation of financial statements. | |
Once the undertaking has identified its risks and opportunities, it shall determine which of them are material for reporting. This shall be based on a combination of (i) the likelihood of occurrence and (ii) the potential magnitude of financial effects determined on the basis of appropriate thresholds. In this step it shall consider the contribution of those risks and opportunities to financial effects in the short-, medium- and long-term based on: | |
The identification of risks and opportunities that affect or could reasonably be expected to affect the undertaking’s financial position, financial performance, cash flows, access to finance or cost of capital over the short-, medium- or long-term is the starting point for financial materiality assessment. In this context, the undertaking shall consider: |