Sustainability Reporting Framework – Europe Makes Progress

Financial Reporting Brief: August 2021

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Our global news service on corporate reporting www.iasplus.com becomes more and more dominated by the drive for an effective and efficient model for sustainability reporting. A globally acceptable solution is needed, one that is compatible with regional and national initiatives and one that will work together with financial reporting standards to provide a comprehensive corporate reporting framework.

If sustainability is not at or near the top of your Board agenda, then think again. For practically all companies, it is central to corporate competitiveness and a company’s continued ability to operate. The common concept of ‘Save the Earth’ holds true, but it must be understood to mean topics as varied as climate change, bio-diversity, labour relations, public health and safety and many others. Sustainability affects all sectors and challenges even the most progressive companies and the most thoughtful directors.

Over the last eighteen months, significant progress has been made towards establishing sustainability standards. This Brief takes a ‘helicopter view’ of global developments and looks in some more detail at what is happening in Europe. The path towards globally accepted sustainability reporting is the coming together of a global baseline of sustainability-related disclosures with work by jurisdictions and regions to ensure consistency between the global baseline and their own initiatives.

The primary objective of reliable, consistent and comparable sustainability reporting must be to provide investors and other stakeholders in the market with the information needed for decision making and investment selection.

Global Developments

To enable progress to be achieved, the International Financial Reporting Standards Foundation (IFRSF) has proposed an International Sustainability Standards Board (ISSB) which would be under its governance and supervision as a sister body to the International Accounting Standards Board (IASB). It is due to launch in November and has the support of leading global organisations including the G7 Council of Finance Ministers and Central Bank Governors, the International Organisation of Securities Coordinators (IOSCO) and the Financial Stability Board (FSB). This will build on the work done in recent years by many leading standard setters in the area with the Task-force on Climate-related Financial Disclosures (TCFD), the Value Reporting Foundation (VRF), and others, affirming that a consolidated approach is required.

Many leaders are calling for mandatory climate-related financial disclosures. The UK Financial Conduct Authority has taken the lead by mandating that by 2025 all UK listed companies will be required to include disclosures in their annual reports compliant with the recommendations of the TCFD. This may set a precedent for Ireland and other jurisdictions to take similar action.

IOSCO has published reports and made statements with a focus on stressing the need for jurisdictional regulatory approaches to be fully inter-operable with the global baseline, to avoid rule conflicts or overlaps and to ensure that fragmentation of approach does not arise.

The FSB welcomes the IFRSF initiative towards developing a global baseline standard, building on the TCFD framework and the work of a global alliance of sustainability standard setters. The FSB has submitted to G20 a comprehensive roadmap to address climate-related financial risks, to which G20 has given strong support, and notes that it can play an important role in due course regarding the adoption and coordination of the ISSB standards.

European Developments

Substantial progress is being made in Europe with particular regard to the publication of a proposed new EU Directive and the groundwork being laid for Sustainability Reporting Standards.

EU Directive

The European Commission (EC) has published a proposal for a Corporate Sustainability Reporting Directive (CSRD) which will revise and ultimately replace the European Non-Financial Reporting Directive (NFRD). The objective of the CSRD is to improve sustainability reporting, to better exploit the potential of the European Single Market and to contribute to the transition to a fully sustainable and inclusive economic and financial system in line with the European Green Deal and the UN Sustainable Development Goals.

The proposals involve a very substantial broadening of scope to approximately 49,000 entities in the EU, compared with 11,600 under the NFRD. This includes foreign subsidiaries. All companies that meet or exceed certain thresholds are within scope; the NFRD applies only to listed companies, banks and insurance companies with a single threshold of 500 employees.

The thresholds are (two out of three):

Balance sheet total (gross assets) €20,000,000
Net revenue €40,000,000
Employees 250

All companies listed on an EU Regulated Market are within scope, with the exception of micro entities.

The EC proposes a transposition into National Law by 1 December 2022, so that it would be applicable for the first time for fiscal years beginning on or after 1 January 2023. The proposals provide an extended timescale for SMEs that are listed, with commencement on or after 1 January 2026.

The proposals in the CSRD require:

Mandatory provision of information in the management report;
All information to be prepared using European sustainability reporting standards;
Mandatory audit of information, on a limited assurance basis;
Information to be digitally reported in ESEF format with labelling of information using a prescribed taxonomy.

This Framework is substantially more defined than the NFRD, with significant development needed in a number of areas including standards and taxonomy. The audit requirement is expected to be difficult to respond to with a minimum set of requirements and an agreed approach as to what the scope of the audit will be.

Entities within the scope of the CSRD would have to report on:

Their business model and strategy;
The sustainability targets set and the progress made towards achieving them;
The role of the administrative, management and governance bodies in relation to sustainability factors;
Their policies in relation to sustainability matters;
The company’s most significant negative impacts on sustainability factors;
A description of their principal risks related to sustainability matters, including their principal dependencies on such matters, and how they manage their risks;
The manner in which they have identified the information that they report on.

The CSRD would require companies to provide qualitative and quantitative information, forward-looking and retrospective information, and information that covers short, medium and long-term horizons. The reporting should also include information about the company’s value chain embracing the company’s operations, products and services, business relationships and supply chain.

Sustainability Standards

At the request of the EC and in parallel to the development of the CSRD, the European Financial Reporting Advisory Group (EFRAG) is carrying out extensive work on key governance and standard-setting matters related to sustainability reporting. EFRAG published two reports in February, one of which was on its governance structure as it pertains to the work of the European Reporting Lab on development of the required standards. The other report proposes a roadmap for the development of a comprehensive set of EU sustainability reporting standards.

The proposed roadmap published in February envisages two sets of standards, to be published as follows:

31 October 2022 – applicable to reporting periods beginning on or after 1 January 2023:

Two priority conceptual guidelines – double materiality and quality of information;
Cross-cutting ‘core’ standards covering reporting areas, reporting structure and entity-specific materiality assessment;
‘Core’ standards for most sub-topics and ‘advanced’ standards for some priority sub-topics such as climate change.

31 October 2023 – applicable to reporting periods beginning on or after 1 January 2024:

The remaining four conceptual guidelines – public interest, retrospective and forward-looking information, levels and boundaries of reporting, connectivity of financial reporting and sustainability reporting;
‘Advanced’ cross-cutting standards, to the extent required;
‘Advanced’ standards for other priority sub-topics.

EFRAG considers that standards should be elaborated from a target architecture based upon three layers of reporting, three reporting areas and three topics. The resulting standards must also provide a basis to develop a data taxonomy that facilitates the digitisation of sustainability reports.

The sets of three are:

Layers – sector-agnostic, sector-specific and entity-specific;
Reporting areas – strategy, implementation and performance measurement;
Topics – environmental, social and governance.

The topics, with comprehensive sub-topics, are:

Environmental – including climate change, water and marine resources, biodiversity and ecosystems, circular economy, pollution;
Social – including workforce, value chain workers, affected communities, consumers/users;
Governance – including governance structure, business ethics, relationships with stakeholders, organisation and innovation, brand management.

The project is of a massive scale, requiring the commitment of very substantial resources. The appendices to the February report give some idea of the daunting nature of the overall task to be undertaken. The appendices relate to:

EU Non-Financial Information Requirements – momentum and coherence;
Possible input from existing initiatives;
Current non-financial reporting formats and practices;
Conceptual framework for non-financial information standard-setting;
Focus on financial institutions;
Interconnection between financial and non-financial information.

In their development of standards it is important for the EC to avail of the work that has already been done by many leading global organisations in the area. It must work closely with the IFRSF and retain firmly in mind that investors and capital markets are in need of globally acceptable comparable and consistent standards.

Conclusion

The work has begun and while success is rarely certain, the efforts being made by the IFRSF and EFRAG offer realistic expectation of globally acceptable sustainability standards being developed in the foreseeable future.

Investors and stakeholders are demanding a much wider range of information about a company’s approach to governance, risk management and strategic planning. Pursuing short-term profitability at the expense of creating sustainable, long-term value is no longer an option.