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European Sustainability Reporting Standards

Unpacking the Commission’s first draft Delegated Act

At a glance

  • The European Commission (‘Commission’) is consulting on a Delegated Act (DA) on the first set of European Sustainability Reporting Standards (ESRS), based on the draft sent by the European Financial Reporting Advisory Group (EFRAG) in November 2022.
  • The proposals make several targeted changes to the EFRAG draft, with the aims of achieving greater interoperability with ISSB standards; reducing the reporting burden in particular for smaller companies and new reporters; and making the Disclosure Requirements (DRs) across all standards, except for DRs and datapoints in ESRS 2 on general disclosures, fully subject to materiality considerations.
  • The consultation is open for a four-week period. Subject to feedback, the DA is expected to be agreed by the Commission before the end of July (and at the latest end of August). The scrutiny period by the European Parliament and the European Council would then begin and is expected to last for two months (with another possible two months’ extension). If this timeline is adhered to, the European Sustainability Reporting Standards (ESRS) will become effective from 1 January 2024.
  • Based on the final proposal, companies will be able to focus specifically on providing transparency on those sustainability topics and indicators that are material to their business strategy and operations. They will have more time to prepare for a number of requirements. However, the essential objective of the standards to require companies to report on their ESG impacts, risks and opportunities has not changed. Therefore, companies will need to continue (or start) preparations for the applicable disclosure requirements. To ensure consistency and accuracy of reported information, collaboration with stakeholders will be key to standardise ESG data collection, its quality and assessment.

On 9 June the Commission published a consultation on the first set of sector-agnostic standards under the ESRS, based on advice received from EFRAG in November 2022. Companies in scope of the EU Corporate Sustainability Reporting Directive (CSRD), which entered into force in January 2023, are required to prepare annual sustainability reporting according to ESRS.

Considering the feedback received from the EU Member States, EU agencies, industry and other stakeholders, the Commission has made several important changes to the first November 2022 EFRAG drafts. The amendments are aimed at easing the implementation and extending the time to prepare for reporting, by phasing in certain DRs including for smaller companies and new reporters. In addition, further updates to enhance interoperability with the ISSB’s standards have been proposed.

In this article, we unpack the main changes proposed by the Commission compared to the version prepared by EFRAG, and highlight what this means for reporting companies.

What are the proposed changes?

The Commission has made three key changes:

1. Most DRs are now subject to materiality assessment: With the exception of DRs and datapoints under ESRS 2, application of all DRs will be subject to the outcome of materiality assessments.

CSRD adopts a double materiality concept, whereby companies shall select the information to be reported based on an assessment of the impacts of sustainability matters on their performance, position and development, as well as effects of a company on the environment and population. Based on the initial draft ESRS proposed by EFRAG, a number of DRs were always deemed material for disclosure. The Commission has revised this approach and specified that a materiality assessment is now applicable to most DRs (with the exception of ESRS 2). As a result, the metrics listed across the topical standards in ESRS such as biodiversity and ecosystems (ESRS E4), and resource use and circular economy (ESRS E5) are now subject to the outcome of materiality assessments. Where a sustainability topic covered by a standard is considered not material, and so the DRs of the topical standard are omitted, a company is no longer required to provide an explanation why. It is now a voluntary disclosure.

This revision in the applicability of DRs is likely to have an impact on the financial sector, since ESRS are linked to other reporting obligations, for example the Benchmark Regulation, Pillar 3 disclosures and the Sustainable Finance Disclosure Regulation (SFDR), among others. Specifically, since the SFDR indicators included in ESRS are now subject to the materiality assessment, in some cases they may be considered as “not material for the undertaking” from the ESRS perspective, causing potential data gaps for those preparing to meet mandatory reporting requirements under the SFDR.

2. Steps taken to ease reporting requirements: Certain DRs will apply on a phased basis dependent on company size, and some mandatory DRs become voluntary.

The Commission has made changes primarily to help smaller companies and new reporters. Specific phase-ins have been granted for companies with fewer than 750 employees, including for the first year disclosures on GHG scope 3 emissions and their own workforce (ESRS S1), and for the first 2 years reporting on biodiversity (ESRS E4), value chain workers (ESRS S2), affected communities (ESRS S3) and consumers and end-users (ESRS S4). For all companies, there is also now the possibility to report only after the first year on certain topics, including certain DRs related to own workforce (ESRS S1) and anticipated financial effects related to non-climate environmental issues (pollution, water, biodiversity, and resource use). For the latter, companies are entitled to provide qualitative disclosures for the first 3 years. These changes are summarised in Table 1.

Table 1: Examples of changes to the phasing-in of DRs (applicability of DRs subject to outcome of materiality assessment)

In addition, previously, if a company had more than 50 employees in a given country, it was required to report social indicators by country for headcount and collective bargaining. This threshold has now been changed. Companies will only need to make country-based disclosures of material DRs within the social standards if they employ 50 or more employees representing at least 10% of the undertaking’s total employees.

The Commission has also proposed to change certain data points from mandatory to voluntary for all reporters. For example, biodiversity transition plans under ESRS E4 on Biodiversity and ecosystems, and certain indicators on non-employees under ESRS S1 on Own Workforce can now be disclosed on a voluntary basis.

3.Interoperability: Aligning ESRS with the IFRS Sustainability Standards.

The Commission has made changes to ESRS to ensure that it provides a high degree of interoperability with IFRS Sustainability Disclosure Standards S1 (General requirements for disclosure of sustainability-related financial information) and S2 (Climate-related disclosures) developed by the International Sustainability Standards Board (ISSB). The amendments, subject to finalisation, have been made with the aim to ensure that reporting under ESRS does not result in a conflict or create double reporting burden for companies if they wish to comply with IFRS S1 and S2 as well.

In addition to the three key changes highlighted above, the Commission has also made further modifications to the text to ease the implementation of the ESRS. For example, the text has moved from reporting on ‘potential’ financial impacts, risks and opportunities to reporting on ‘anticipated’ financial impacts, risks and opportunities. Also, some revisions have been made to ensure better coherence with the EU legal framework, and that the required disclosures do not infringe on the right not to self-incriminate (e.g. on corruption and bribery and the protection of whistle-blowers).

What does this mean for companies?

Companies will need to improve internal and external collaboration regarding the exchange and collection of ESG data, as reporting under ESRS will require increased transparency efforts across both their own operations and their value chains. Unlike financial reporting, sustainability data collection is not standardised yet and often different internal and external methodologies are used in the process. To ensure consistency and accuracy of reported information, collaboration with stakeholders will be key to standardise ESG data collection, its quality and assessment.

Companies will also need to plan their operations ahead of time to ensure material information can be identified and captured, and necessary data governance and control frameworks implemented. Importantly, the CSRD requires limited third-party assurance of sustainability reports. Therefore, appropriate systems and controls are needed so that third-party assurance can be provided.

The phase-ins proposed in ESRS are aimed at helping companies prioritise their reporting requirements in the short term, but companies will need to continue establishing processes to collect the data necessary to comply with DRs in the medium term. For example, although companies with fewer than 750 employees can exclude reporting information regarding Scope 3 GHG emissions under ESRS E1 (Climate change) for the first reporting year, they will still need to set up systems necessary to collect data, and design and implement required processes. This is to ensure they are equipped to report disclosure requirements regarding Scope 3 GHG emissions once the DR is phased-in for their cohort.

Next steps

The consultation period is open until 7 July. Subject to feedback received, we expect the final ESRS DA to be approved by the Commission by the end of July, or the end of August at the latest. The scrutiny period by the European Parliament and the Council will begin once the Commission approves the DA. We expect an initial scrutiny period of 2 months (which may be extended by another two months), allowing ESRS to become effective from 1 January 2024. Companies (depending on their size) will then be able to report their sustainability information following the CSRD requirements, based on the DA for ESRS, from January 2025.