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European Sustainability Reporting Standards

Unpacking the Commission’s first Delegated Act

At a glance

  • The European Commission (‘Commission’) has published its adopted 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 Commission has made 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 Commission conducted a consultation on the draft DA on the first set of ESRS from 9 June – 7 July 2023, and then adopted the DA on the first set of ESRS on 31 July. The DA adopted by the EC is expected to be formally transmitted in the second half of August to the European Parliament and to the European Council for scrutiny. The scrutiny period will run for two months, which can be extended by a further two months. The European Parliament or the Council may only reject the DA as a whole; they cannot amend it. If this scrutiny period passes without comments, the ESRS DA will only be in force once it has been published in the EU Official Journal (EUOJ). If this timeline is adhered to, the European Sustainability Reporting Standards (ESRS) will become effective from 1 January 2024.
  • Based on the adopted DA, 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 31 July 2023 the Commission adopted the DA 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 included.

In this article, we unpack the main changes incorporated by the Commission compared to the version prepared by EFRAG, and highlight what they mean 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 the 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 in full is considered not material, and so all DRs of the topical standard are not deemed material, a company is no longer required to provide an explanation of why that standard is not material (except for E1 on climate change). Where climate change has been deemed not material and as such no information in ESRS E1 is disclosed, companies must provide a detailed explanation of the conclusions of their materiality analysis in relation to climate change and a prospective analysis of the conditions that could lead a company to conclude that climate change is material in the future.

This revision in the applicability of DRs is likely also 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.

To help financial sector participants navigate the availability of datapoints derived from such regulations, the Commission has introduced an additional disclosure obligation for companies to declare which datapoints in appendix B of ESRS 2, which lists information requirements from other European regulations like SFDR, have been disclosed. Companies will need to publish a table of all the datapoints in appendix B of ESRS 2, specifying where they are included in the company’s sustainability report, or alternatively stating that the datapoint has been omitted because it was deemed not material.

The Commission has stated that it will provide further clarification regarding the approach to be taken when a datapoint derived from such regulations has been deemed not material. Financial market participants and financial advisers may assume that any indicator reported as not material by an investee company does not contribute to the respective indicator of the principal adverse impacts in the context of the SFDR disclosures.

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 changed 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:

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). For instance, the Commission has aligned the definition of financial materiality to bring it into line with IFRS S1. ESRS 1 previously considered relevant stakeholders more broadly and as such included stakeholders beyond the ’primary users’ of financial reports. This has now been updated as follows: ‘financial materiality assessment corresponds to the information that is considered material for primary users of general-purpose financial reports in making decisions relating to providing resources to the entity’. The amendments, unless objected, 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 DA adopted by the Commission is expected to be formally transmitted in the second half of August to the European Parliament and to the European Council for scrutiny. The scrutiny period will run for two months, which can be extended by a further two months. The European Parliament or the Council may only reject the DA as a whole; they cannot amend it. If this scrutiny period passes without comments, the ESRS DA will only be in force once it has been published in the EUOJ. We expect it 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.