A company getting ready to report under the European Sustainability Reporting Standards (ESRS, the EU’s mandatory sustainability rulebook under the Corporate Sustainability Reporting Directive, CSRD) usually starts with the wrong question. The question is not “how do I disclose my physical climate risk?” It is “do I have to, and how do I defend that decision if a regulator asks?”
That second question is a materiality question. For physical climate risk, flooding, heat, storm, drought and the rest of the hazards that damage assets and interrupt operations, the answer runs through one specific test. And for climate, the test comes with a rule that applies to no other environmental topic.
- Physical climate risk is judged on the financial-materiality lens of double materiality: the climate’s effect on the company, not the company’s effect on the climate.
- Climate is the one environmental topic you cannot quietly drop. Omitting ESRS E1 needs a detailed explanation plus a forward-looking analysis (ESRS 1 paragraph 32, the standard in force).
- There is no percentage threshold. Materiality is a reasoned judgement on likelihood and magnitude, made across three time horizons and location by location, not at the sector level.
- The Wave 1 phase-in defers the quantified ESRS E1-9 numbers to financial year 2027. It does not defer the materiality decision, which runs qualitatively from the first report.
Physical climate risk is the climate’s effect on the company, not its emissions
ESRS E1 is the climate standard. It covers two very different things. One is the company’s effect on the climate, mostly greenhouse gas emissions and the plan to cut them. The other is the climate’s effect on the company, the physical hazards that hit buildings, plants, inventory and supply lines.
This piece is about the second one only. The emissions side, the targets, the transition plan, all of that has its own materiality logic and sits outside what we cover here. When the text below says “physical risk,” it means the outside-in question: could a changing climate damage the business enough to matter to the people who fund it?
Double materiality has two lenses, and physical risk sits on the financial one
ESRS uses “double materiality.” ESRS 1 (the general-requirements standard) paragraph 37 (2023 issuance) sets it out:
“Double materiality has two dimensions, namely: impact materiality and financial materiality.”
In plain terms, there are two ways a topic can matter. It can matter because of the company’s effect on people and the environment (impact materiality, the inside-out view). Or it can matter because of its effect on the company’s finances (financial materiality, the outside-in view).
Physical climate risk sits almost entirely on the second lens. A flood does not make the company a polluter; it makes the company poorer. ESRS 1 paragraph 49 defines the financial test:
“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 … 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.”
In plain terms: a physical risk is material if it could reasonably be expected to hit the company’s money, its assets, its earnings, its cash, its borrowing, badly enough to matter.
The drafters of the amended standard say this even more plainly. The November 2025 amended ESRS 1 draft, paragraph 37, tells the company to look beyond its own impacts for risks that exist on the financial side alone:
“The undertaking shall as well evaluate whether there are material risks or opportunities that are not related to the undertaking’s impacts, such as physical risks.”
In plain terms: physical risk is the textbook case of a matter that is financially material without being about the company’s own footprint. The amended draft names it directly.
| Materiality lens | What it asks | Where physical climate risk sits |
|---|---|---|
| Impact materiality (inside-out) | The company’s effect on people and the environment | Not the physical-risk lens |
| Financial materiality (outside-in) | The climate’s effect on the company’s finances | This is where physical risk sits |
Climate is the one topic you cannot quietly drop
Most topics in ESRS work on a simple basis: if it is not material, you leave it out, and you can say so briefly. Climate is different. ESRS 1 paragraph 32 (2023 issuance) carries a rule that applies to no other environmental topic:
“If the undertaking concludes that climate change is not material and therefore omits all disclosure requirements in ESRS E1 Climate change, it shall disclose a detailed explanation of the conclusions of its materiality assessment with regard to climate change … including a forward-looking analysis of the conditions that could lead the undertaking to conclude that climate change is material in the future.”
In plain terms: you can decide climate is not material, but you cannot do it silently. You owe a detailed written explanation, plus a forward-looking account of what would have to change for climate to become material later. For every other topic, by contrast, the standard lets you “briefly explain.” Climate alone gets the heavier burden.
The EU body that writes the standards, EFRAG, reinforces this in its Implementation Guidance on materiality (IG-1, paragraph 31). A company “is required to provide explanations if it concludes that it has no material IROs with respect to climate change.” IROs here are the impacts, risks and opportunities a company assesses.
In practice almost nobody clears that bar by claiming climate is immaterial. The EU markets supervisor, the European Securities and Markets Authority (ESMA), reviewed 91 first-year reporters and found that every single one treated climate as material:
“All issuers of the sample disclosed at least one IRO related to the Climate change topic or one of its three related sub-topics.”
The climate-adaptation sub-topic, the part that sits closest to physical risk, was treated as material by 73.6% of them.
A note on versions, because the numbers move. The full “detailed explanation plus forward-looking analysis” wording above is the binding 2023 text, the one in force today. The November 2025 amended draft keeps the obligation but states it more briefly and moves it into ESRS 2, the general-disclosures standard, as “the basis for concluding that climate change is not material.” The duty to explain survives; the wording is shorter. Until the amended standard is adopted, the 2023 version governs.
What makes a physical risk material: financial effects, judged over three horizons
There is no percentage that decides this. Reporters often want a bright line, a “1% of revenue and it counts” rule. ESRS does not give one. IG-1 paragraph 131 is direct:
“The ESRS do not prescribe the use of a specific threshold definition for financial materiality.”
In plain terms: you set the threshold and you justify it. The standard asks for a reasoned judgement built on two things, how likely the effect is and how large it could be, not a number handed down from Brussels.
The judgement is also forward-looking, and it runs across three defined time windows. ESRS 1 paragraph 77 fixes them: short term is your financial-reporting period, medium term is up to five years, long term is beyond five years. EFRAG’s guidance (IG-1, FAQ 9) calls time horizon “an essential component of the materiality assessment.”
This matters more for physical risk than for almost anything else, because the hazard curve bends over decades. A site that looks safe against today’s flood return periods can move into a materially exposed band by 2050. Chronic hazards such as rising heat and sea-level rise may be immaterial in the short term and clearly material in the long term. A materiality assessment that only looks at last year’s losses misses the part of the risk the standard is most interested in.
How you reached the answer is itself a disclosure
The materiality decision is not a private internal exercise you keep in a drawer. ESRS 2 has a disclosure requirement (DR) called IRO-1, and paragraph 51 states the obligation plainly:
“The undertaking shall disclose its process to identify its impacts, risks and opportunities and to assess which ones are material.”
In plain terms: you have to show your working. Paragraph 53 then lists what that means, including the methodologies and assumptions used, how financial effects were judged for likelihood and magnitude, the input data and sources, and how the assessment will be revisited.
So a weak process is a weak disclosure before you reach a single line of E1 content. ESMA’s first-year review found this is where many reporters fell short: the IRO-1 disclosures met the requirement’s objective for only 61.7% of the sample. The decision and the description of how you reached it are both on the page, and both are supervised.
Two companies in the same sector can reach different answers
Physical-risk materiality cannot be answered at the sector level, and this is the point most generic readiness checklists miss. It is answered location by location. ESRS 1 builds in this entity-specific logic: paragraph 11 requires additional, company-specific disclosure where a matter is “material due to its specific facts and circumstances.”
ESMA’s review shows supervisors already think this way. Describing good practice on scoring the severity of an environmental issue, the report ties severity to geography:
“‘low’ corresponds to an issue observed in one location only and ‘medium’ in a few locations, while ‘high’ is widespread and ‘very high’ observed in all locations.”
And it warns, in plain supervisory language, that vague or templated assessments hurt comparability “for instance when considering two issuers from the same sector.” Two retailers with the same revenue can land in different places because one’s distribution centres sit on a floodplain and the other’s do not. The sector tells you almost nothing; the asset footprint tells you the answer.
This is also what ESMA asked EFRAG to push harder on: that materiality disclosures should show “how issuers adapt the materiality concepts and steps defined in ESRS 1 to their specific facts and circumstances.”
The phase-in defers the number, not the decision
There is a common misread worth clearing up. The Wave 1 Quick Fix (a July 2025 Commission delegated act) lets the first wave of reporters defer some disclosures. Its operative clause replaces the phase-in appendix to allow “wave one undertakings” not to report certain items “until financial year 2027.” The deferred list includes “the information prescribed by ESRS E1-9,” the 2023 issuance’s anticipated-financial-effects requirement, plus the related anticipated-financial-effects datapoint in SBM-3 (the strategy and business-model disclosure in ESRS 2).
In plain terms: the relief is about the quantified financial-effect figures. It is not about the materiality decision. The double-materiality assessment under ESRS 1 and the IRO-1 process disclosure are not on any deferral list. You still have to conclude whether climate is material and disclose how you reached that conclusion, qualitatively, from year one. As the amendments record puts it, “qualitative disclosure [is] still required,” and the financial year 2027 cycle is the first in which Wave 1 reporters must put the quantified numbers on the page.
The proof is in ESMA’s review itself: those first-year reporters were already being assessed on their materiality process for financial year 2024, well before any quantified-effects deadline.
| Wave 1 phase-in | What it covers | Timing |
|---|---|---|
| Deferred | The quantified ESRS E1-9 financial-effect figures and the SBM-3 anticipated-financial-effects datapoint | Until financial year 2027 |
| Runs from year one | The double-materiality decision and the IRO-1 qualitative process disclosure | From the first report |
A “not material” line has to be evidenced, not asserted
When a company does conclude a risk is not material, the conclusion has to carry evidence. ESMA’s central finding was that formal-looking process did not always mean meaningful disclosure:
“some disclosures were boilerplate and did not provide meaningful insight on the judgements made regarding the materiality of their IROs.”
Its recommendation to reporters is one sentence: “Avoid boilerplate disclosures in the description of their materiality assessment process and provide clarity on how they have exercised judgements.”
The weak spot was sharpest exactly where the explain-yourself rule bites. For topics a company eventually judged not material, only 54.3% of reporters gave sufficient information. And assurance providers are watching: two of the 91 reporters received a qualified audit opinion, one tied to the materiality assessment, and four more drew an emphasis of matter on materiality. A bare “climate is not material to us” does not survive that kind of scrutiny.
Clearing the gate is what opens the rest of E1
Materiality is the gate. Once a physical risk passes it, the rest of the E1 chain follows: identifying and scoping the risk, testing resilience, and quantifying the anticipated financial effects. Two companion pieces walk those steps in detail, the physical-risk identification methodology and the anticipated-financial-effects disclosure (E1-9 in the 2023 issuance, expanded to E1-11 in the November 2025 amended draft). The materiality decision in this piece is what determines whether a company ever gets to them.
How this lines up with IFRS S2
Companies that also report under the global standard, IFRS S2, will recognise the financial test. The joint EFRAG and IFRS Foundation interoperability guidance confirms that “the definition of financial materiality in ESRS is aligned with the definition of materiality in” the IFRS Foundation’s standards. An assessment under one regime, it adds, “is aligned with the assessment of whether that disclosure is financially material in accordance with ESRS.” For physical risk, the two regimes ask the same financial question. ESRS adds the second, impact lens on top, but that lens rarely changes the physical-risk answer. A side-by-side of the two standards is covered in a separate piece.
Where the asset-level work fits
A defensible materiality call on physical risk needs evidence, and the evidence is forward-looking, scenario-aware exposure at the level of individual locations. This is where the Continuuiti platform fits. It scores twelve physical hazards at any site, under a middle and a high-emissions scenario, across a historical baseline and 2030, 2040 and 2050, and produces a monetary flood-damage estimate built from published depth-damage curves.
The boundary, stated plainly: we supply the asset-level exposure and the expected physical damage, location by location. Your team applies its own financial thresholds and maps the result onto its own carrying amounts to decide what is material and, later, to report the figures. We give the exposure; you bring the money. Two limits are worth naming, because an auditor will ask: the monetary damage estimate today covers flooding, not wind, wildfire or drought, and it does not price business interruption. Those are gaps across the industry, not just here.
Where to go next
- The physical-risk identification methodology under ESRS E1 (how a material risk gets scoped, screened and scenario-tested).
- The anticipated-financial-effects disclosure, E1-9 in the 2023 issuance and E1-11 in the November 2025 amended draft (the number the materiality gate eventually leads to).
- ESRS E1 versus IFRS S2 on physical risk (the same financial test, with EU-specific additions).
- The ESRS E1 overview hub.
Frequently asked questions
Is physical climate risk impact materiality or financial materiality?
It is financial materiality, the outside-in view. Physical climate risk is the climate’s effect on the company’s finances, not the company’s effect on people or the environment. ESRS 1 paragraph 49 sets the financial test, and the November 2025 amended draft names physical risk directly as a matter that can be financially material without being about the company’s own impacts.
Is there a percentage threshold for materiality under ESRS?
No. EFRAG’s Implementation Guidance (IG-1, paragraph 131) states the ESRS do not prescribe a specific threshold for financial materiality. You set and justify your own threshold, based on a reasoned judgement that weighs the likelihood of the effect against its potential magnitude across the short, medium and long term.
Does the Wave 1 phase-in delay the double materiality assessment?
No. The Wave 1 Quick Fix, a July 2025 Commission delegated act, defers the quantified ESRS E1-9 financial-effect figures until financial year 2027. It does not touch the double-materiality assessment or the IRO-1 process disclosure, both of which run qualitatively from the first report. First-year reporters were already assessed on their materiality process for financial year 2024.
How do you decide if a physical climate risk is material under ESRS?
There is no bright line. You judge the likelihood and the potential magnitude of the financial effect across three defined horizons: short term (the reporting period), medium term (up to five years) and long term (beyond five years). The answer is location-specific, not sector-wide, because two companies in the same sector can land in different places when their asset footprints differ.
Sources
- Commission Delegated Regulation (EU) 2023/2772, Annex I: ESRS 1 General Requirements (paragraphs 11, 32, 37, 38, 42, 43, 48, 49, 77) and ESRS 2 General Disclosures (DR IRO-1, paragraphs 51 and 53). 2023 issuance, in force.
- EFRAG, ESRS amendments November 2025 exposure draft: amended ESRS 1 (paragraphs 36, 37) and amended ESRS 2 (IRO-2, paragraph 37(b)). Not yet adopted.
- EFRAG Implementation Guidance IG-1 Materiality Assessment (paragraphs 31, 131; FAQ 9).
- Commission Delegated Act of 11 July 2025 (Wave 1 Quick Fix), amending Delegated Regulation (EU) 2023/2772, Appendix C of ESRS 1.
- ESMA, “Materiality matters (!): Results of a fact-finding exercise on 2024 corporate reporting practices under ESRS Set 1” (ESMA32-846262651-5288, 14 October 2025).
- EFRAG and IFRS Foundation, ESRS-ISSB Standards Interoperability Guidance (2 May 2024), section 1.1.
- Continuuiti methodology documentation, continuuiti.com/methodology.
