The release of the European Sustainability Reporting Standards (ESRS) earlier this year was met with mixed reactions. Whilst there are those who see the standards as a step in the right direction for corporate sustainability disclosure, others believe that the last-minute changes have diluted them, allowing companies more leeway in their reporting. But is this really the case, and what exactly has changed?
First, let’s explore some background; the ESRS was developed by the European Financial Reporting Advisory Group (EFRAG) to provide a structure for companies to report on their progress in becoming more sustainable in accordance with the EU’s Corporate Sustainability Reporting Directive (CSRD).
The CSRD is a new EU law which requires large companies to report on their environmental, social, and governance (ESG) impacts by addressing key shortcomings in current ESG regulation around reporting and strengthening the output of non-financial reporting from businesses.
The ESRS features 12 different sections, covering ‘cross cutting’ standards along with specific environmental, social and governance standards.
Below are the key features included in the standard to improve the reporting landscape.
Reporting across a broad range of topics
The ESRS requires businesses to disclose material impacts, risks, and opportunities across a broad range of sustainably focused topics including; climate change, biodiversity & human rights, and business conduct.
Following a materiality assessment, businesses will need to ensure they have the data, processes, and expertise to report on topics that may be new to them, such as biodiversity or the circular economy.
Double materiality is an extension of single materiality, which is the traditional approach to sustainability reporting. Single materiality focuses on the sustainability issues that are material to a company’s financial performance. Double materiality, on the other hand, also considers the sustainability issues that impact on the wider world, such as climate change, human rights, and social inequality.
We explain more on materiality here.
Companies must clearly articulate their governance framework for addressing sustainability-related topics, including how sustainability KPIs are linked to executive pay.
Reporting on impacts, risks, and opportunities across the value chain
The standards require companies to identify and report on impacts, risks, and opportunities from across the value chain, this impacts their reporting and data gathering.
Reporting on policies, action plans and targets
Although the standards themselves do not require companies to set new targets or adopt new policies, they are meant to act as a means of increasing transparency and scrutiny of any action plans or targets.
Therefore, implementing the standards is an opportunity for companies to identify and address specific areas which may require strengthening or specific issues which will need to be overcome.
The materiality assessment process is subject to external assurance in accordance with the provisions of the Accounting Directive and must be supported by a clear audit trail and documentation of the processes and controls used. This will ensure that the disclosures are transparent, reliable, and defensible.
Key changes between previous versions of ESRS
The standards were released after a 15-month public consultation process and the basic principles, such as using double materiality principles and requiring reporting from across the value chain on a broad range of topics, were retained. But, the structure was tweaked to align more closely with the Task Force on Climate-related Financial Disclosures (TCFD), and some requirements were simplified, removed, or made voluntary.
These changes are explained below.
Material and mandatory disclosures
The European Commission has decided to give companies more flexibility in deciding what information to disclose in their sustainability reports.
Previously, all disclosure areas were mandatory, regardless of whether they were considered material to the company’s stakeholders or not. However, under the new rules, all disclosures except those in ESRS 2 “General disclosures” are now subject to materiality assessment.
This means that businesses can determine which information is material to their stakeholders based on their own assessment, and therefore what they will need to report on in more detail.
The EU’s reasoning for this change is that it will “avoid the costs associated with reporting information that may not be relevant,” however some feel this allows businesses to avoid reporting on areas where sustainability performance is poor.
Companies who conclude that an issue is not material will still need to provide a detailed explanation of their conclusion. This will help to ensure that investors and other stakeholders can understand why the company has chosen not to disclose the information.
Additional phase-in provisions
The final release of the ESRS introduces relief measures for one, two, or three years to help companies, especially small ones, implement data collection and reporting procedures.
For the first year of reporting, all companies can choose not to disclose the expected financial impacts of environmental risks. For the next two years, they may provide qualitative disclosures of these impacts, but are not required to provide specific numbers or amounts.
Companies can also exclude certain workforce-related disclosures (social protection, people with disabilities, work-related illnesses, and work-life balance) in their first year of reporting.
Smaller companies with fewer than 750 employees can omit disclosures on Scope 3 emissions, as well as other workforce-related disclosures, in their initial reporting year. They can also exclude disclosures on biodiversity, workers in the value chain, affected communities, and consumers in the first two reporting years.
Voluntary vs mandatory disclosures
The original draft standards submitted by EFRAG included a number of voluntary and mandatory reporting areas. However, the final release of the standards saw a number of those mandatory data points become voluntary.
According to the commission, these data points were considered the most challenging or costly for companies, such as reporting a biodiversity transition plan and certain indicators about self-employed people and agency workers in the undertaking’s own workforce.
What do these changes mean for your business?
Depending on where your business primarily operates, you may be required to report under the CSRD, which requires companies to account for their sustainability performance in line with the ESRS. If you report through platforms like CDP or GRI, you may already be reporting with the level of detail necessary.
However, if you are reporting for the first time, now is the time to begin putting a clear plan in place. The good news is that the burden of the reporting process has been reduced slightly with the final release of the standards, at least for the next three years. This should allow you enough time to establish a strong reporting process.
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