In May 2024, the European Financial Reporting Advisory Group (EFRAG) released three documents: "Guidelines for the Implementation of Materiality Assessment", "Guidelines for the Implementation of the Value Chain", and "List of ESRS Data Points". EFRAG aims to support enterprises and other stakeholders in implementing ESRS by issuing implementation guidelines, helping enterprises to focus on the standard content related to them, and explaining the reporting requirements through frequently asked questions. Among them, the "Guidelines for the Implementation of the Value Chain" (hereinafter referred to as the "Guidelines") defines the boundaries of the value chain in the sustainable development report, explains the participation of the value chain in materiality assessment to policies, actions and goals, and outlines the disclosure requirements for the impact of each dimension of ESRS on the value chain.
1. Definition of value chain
In the Guidelines, the value chain is defined as the various activities, resources and relationships related to a company's business activities and its external operating environment. The activities, resources and relationships refer to: the personnel involved in the company's own operations, namely human capital; supply, marketing and distribution channels, procurement of materials and services, sales and delivery of products and services; the financing, geographic, geopolitical and regulatory environment of the company's operations, etc.
In addition, the Guidelines define business relationships as relationships between a company and its business partners, entities in the value chain, and entities directly related to its business operations, products, or services. Business relationships are not limited to contractual relationships, but also include indirect business relationships outside the first layer of the company's value chain and equity-invested companies. Whether a company has influence, risks, and opportunities on an investment company is not affected by its shareholding ratio and control ability; however, the company's shareholding ratio affects its ability to obtain information on equity-invested companies.
The following decision diagram summarizes the content that needs to be paid attention to in ESRS E1 "Climate Change" greenhouse gas emissions and ESRS E2 "Pollutants", and this approach is also applicable to the disclosure of information on important sites in ESRS E4 "Biodiversity and Ecosystems".
Figure 2 Value Chain Environmental Dimension Information Disclosure Decision Diagram
2. Importance of the value chain
The material impact of the value chain refers to the impact caused or contributed to by the company's operations, products or services. Value chain participants that are not related to the company's operations, products and services are not considered to be material impacts. Material impacts are not limited by neighboring or contractual relationships, but are generated by processes at various stages in the value chain and are mainly related to business activities. In addition to the material impacts, risks and opportunities generated by its own upstream and downstream value chains, companies should provide personalized entity information based on their own circumstances to further reflect the material impacts, risks and opportunities.
3. Materiality Assessment: Obtaining the Materiality, Impact, Risks and Opportunities of the Value Chain
Companies should design a reasonable assessment process based on the specific circumstances and comprehensively consider the results of the materiality assessment and the content that needs to be disclosed. Considering that no process is suitable for all companies' economic activities, locations, business relationships or value chains, ESRS does not stipulate how companies should conduct materiality assessments or how to design the process, but provides several aspects that companies should consider when designing a materiality assessment process:
- Assess the company’s involvement in the value chain
Companies need to distinguish between direct and indirect business relationships to determine the type of impact on the value chain. A company's direct business relationships may have a value chain impact. For example, the company's procurement and payment policies and practices may violate labor standards, or even purchase from suppliers with labor rights violations. Indirect business relationships can also have a value chain impact. If a company purchases products or services produced by suppliers with negative information, it may indirectly lead to significant systemic impacts.
- Materiality Assessment:
Step A: Understand the environment in which your company operates
(a) Companies need to understand the business actors, size, industry or nature of activities, geographic locations and processes involved in their value chain; (b) The company's strategy affects its business model, which affects all aspects of its operations and its upstream and downstream value chains. Companies need to understand how their strategy and business model are linked to impacts, risks and opportunities; (c) Companies can identify which parts of the value chain are in high-risk areas by tracking the actors in their value chain activities. In particular, if a company does not have reliable information about the geographic location of its value chain, it can assess the significant global value chain impacts, risks and opportunities related to the materials, products and services it uses or produces.
Step B: Identify actual and potential impacts, risks and opportunities; Step C: Assess and determine significant impacts, risks and opportunities
Identifying and assessing the impact of the value chain is challenging for companies. Companies should collect reliable data from value chain participants. If reliable data cannot be collected after making reasonable efforts, they may use secondary data as appropriate. Secondary data includes public reports and research, data from local or national official agencies, newspaper articles, databases, etc. Companies can use secondary data to estimate significant impacts, risks and opportunities.
Assessment of the importance of environmental dimensions:
When companies conduct importance assessments on environmental dimensions, they can introduce the “life cycle” concept to conduct product life cycle assessments.
The Value Chain Implementation Guide provides the following two feasible paths:
(a) Companies may consider using an environmental footprint approach to measure and communicate the life cycle environmental performance of their products; (b) Companies may rely on primary, secondary or simulated data collection or other relevant approaches to assess significant impacts, dependencies, risks and opportunities.
4. Disclosure of value chain information involved in the materiality assessment process
From a disclosure perspective, companies need to disclose the materiality assessment process and materiality assessment results. The Guidelines also require companies to disclose the extent and scope of coverage of the upstream and downstream value chains as the basis for preparing sustainable development reports.
- Disclose the links between market position, strategy, business model and value chain
To help companies understand where significant impacts, risks and opportunities may occur in the value chain, companies should describe the value chain as follows:
(a) The main characteristics of the company's upstream and downstream value chains; (b) The company's position in the value chain; (c) A description of the relationship between the main business participants and the company, including suppliers, distributors, consumers and end customers. The specific situation of the company's value chain is reflected by judging the key participants, taking into account the impact and financial importance.
Companies should use sustainability due diligence processes to assess impacts along their value chain wherever possible and identify potential “tipping points” by cross-referencing material origins with social and environmental risk databases.
- Disclosure of value chain considerations in materiality assessment
The company should describe the materiality assessment process that includes the value chain, as well as the information provided by due diligence, outlining the company's process for identifying, evaluating, prioritizing and monitoring risks and opportunities that may have financial impacts through its own operations or business relationships. The disclosure can be structured as follows:
(a) Types of value chain relationships considered in the materiality assessment; (b) Methodology used by the company; (c) Sustainability issues identified.
For significant impacts, the company should focus on areas where impacts may occur or are potential, reflecting areas where negative impacts are already severe or may be severe; for risks and opportunities, the materiality assessment process should consider other factors in the value chain that can generate risks and opportunities, including dependence on natural and social resources.
During the materiality assessment process, the company should first determine the key sustainability issues for different types of business relationships and value chain links; secondly, identify areas with higher risks of adverse impacts and rank the key sustainability issues based on stakeholder involvement and the severity of the impact.
- Disclosure of materiality assessment method and its assumptions
The company should provide information on the methods and assumptions used in the materiality assessment, taking into account the value chain, including the thresholds for determining materiality, and describe the limitations of the materiality assessment procedure with respect to the value chain.
- Disclosure of the results of the materiality assessment
When a company provides information on significant impacts, risks and opportunities or policies, actions or targets, it should focus on disclosing the following:
(a) The areas in which significant impacts, risks and opportunities are concentrated in the company’s business model, its own operations and its upstream and downstream value chains;
(b) describe the company's involvement in the activities or business relationships and determine whether its activities or business relationships involve significant influence;
(c) the current and expected impacts of material influences, risks and opportunities on its business model, value chain, strategy and decision-making, how the company expects to respond to those impacts, and the changes it has made to address them;
(d) When key points of strategic and material impact on the value chain are identified, the Guidelines require disclosure of discussions of the company’s management or governance bodies on those impacts;
(e) the information disclosed should be consistent with the information taken into account in the materiality assessment along the value chain;
(f) The information disclosed should enable people to understand the company’s significant impacts on itself and the external environment, risks and opportunities, as well as the potential impact on the company’s future.
At the same time, quantitative information can serve as a useful supplement to qualitative information. Companies disclosing quantitative information can help stakeholders understand the severity of the impact and track the effectiveness of subsequent management actions.
5. Disclosure of policies, actions or targets including value chain information
Companies should disclose information related to value chain participants when they have an influence on the formulation of policies, actions or targets. For example:
(a) Policies developed by value chain participants to prevent and control pollution; (b) the company’s anti-bribery and anti-corruption policies and training for value chain participants; (c) the company’s actions and resource commitments related to pollution and its targets to reduce pollution generated by suppliers; (d) clauses in the company’s contracts with value chain participants on respect for fundamental human rights; (e) the company’s audits of high-risk suppliers; (f) the company’s selection criteria for new suppliers, such as the existence of an effective grievance mechanism or measures to protect human rights and freedoms; and (g) the suppliers’ own targets for sustainable material use.
To comply, companies can disclose why they have not yet developed targets, policies and actions related to sustainability matters, and can report when they expect to develop such policies and take actions.
In addition, ESRS4 Biodiversity and Ecosystems contains specific requirements for corporate value chain information disclosure:
(a) Set transition plans and targets for biodiversity and ecosystems in corporate strategies and business models; (b) Disclose the process for identifying and assessing significant biodiversity and ecosystem-related impacts, risks, dependencies and opportunities, and setting targets related to biodiversity and ecosystems.
6. Disclosure of indicators including value chain information
Companies not only need to disclose indicators covering their own business, but also need to measure and determine whether to disclose indicators related to the value chain. The ESRS lists the following indicators that need to disclose information related to the value chain:
(a) Scope 1, 2, 3 and total GHG emissions; (b) Support for GHG removal and GHG mitigation projects through the purchase of carbon credits ; (c) When companies disclose the materials used in the production of products and services, it is generally only related to their own operations, but they also need to determine whether to provide additional value chain information on an entity-specific basis; (d) Companies should describe the use of resources in the upstream value chain. Although specific value chain information indicators are not specified, the impact of the upstream value chain is covered by the company's procurement information.
Note: Companies may also disclose their land use based on a life cycle assessment if they have determined that they have significant impacts on land use, or on the extent and condition of surrounding ecosystems.
The Guidelines provide additional special instructions on the social dimension: employees, consumers and end users are all included in the value chain; at the same time, community impact includes not only the social impact caused by the company, but also the impact caused by value chain participants. Based on the results of the materiality assessment, the company should determine whether it needs to provide additional value chain information indicators from its own perspective or integrate value chain data into its indicators so that stakeholders can understand the impact of the company's actions or track the effectiveness of the company's initiatives. For example:
(a) When companies are involved in upstream value chain activities that have a greater dependence on and impact on the environment, reporting indicators should include supplier impact data; (b) the proportion of workers covered by social security programs in high-risk industry value chains; (c) the percentage reduction in health and safety accidents compared to the previous period.
7. Conclusion
The "Value Chain Implementation Guidelines" are of great significance to understanding the CSRD and ESRS frameworks, and provide companies with a complete set of systematic methods to understand and report on their sustainability performance in the value chain. The release of the "Value Chain Implementation Guidelines" will not only help improve the transparency and consistency of corporate sustainable development information disclosure, but also guide companies to better manage their sustainable development factors in the value chain; companies can use this to more comprehensively understand the impact of their operations and upstream and downstream value chains on ESG factors, and formulate more effective sustainable development strategies, goals and action plans, thereby promoting green and low-carbon transformation and the realization of sustainable development goals.
