How the European Sustainability Reporting Standards Paves the Way for Greener Investments
7th August 2023
The European Commission has adopted the European Sustainability Reporting Standards. Following a 2-month scrutiny period, which can be extended by 2 months, in which the European Parliament and Council may object, the expectation is that the regulation will apply from Jan. 1, 2024 for the financial years beginning on or after Jan. 1, 2024.
Here is a quick overview of the key items:
Why is the Commission adopting European Sustainability Reporting Standards (ESRS)?
The European Commission is adopting European Sustainability Reporting Standards (ESRS) to rectify inconsistencies in sustainability reporting by companies. EU law mandates that large and listed companies disclose their environmental and social impacts, but the lack of standardised reporting has resulted in information gaps and comparability issues. By implementing ESRS, the Commission hopes to foster better transparency, comparability, and accountability, enabling investors and stakeholders to make informed decisions about a company’s sustainability performance. For investors specifically, this should help them meet their own disclosure requirements under the Sustainable Finance Disclosure Regulation (SFDR).
This move aligns with the Corporate Sustainability Reporting Directive (CSRD) and is expected to reduce long-term reporting costs for companies while bolstering sustainable finance by directing investments towards more environmentally friendly activities.
What will companies have to report?
Under the ESRS, companies must adopt a “double materiality” approach, reporting both on their through its business activities and value chain and on how financial risks and opportunities for the company itself. An example of the latter can be the risks posed by water scarcity intensified by climate change on a company in the agricultural sector.
There are 12 ESRS, covering the full range of sustainability issues in line with EFRAG proposals:
|Cross-cutting||ESRS 1||General Requirements|
|Cross-cutting||ESRS 2||General Disclosures|
|Environment||ESRS E3||Water and marine resources|
|Environment||ESRS E4||Biodiversity and ecosystems|
|Environment||ESRS E5||Resource use and circular economy|
|Social||ESRS S1||Own workforce|
|Social||ESRS S2||Workers in the value chain|
|Social||ESRS S3||Affected communities|
|Social||ESRS S4||Consumers and end users|
|Governance||ESRS G1||Business conduct|
ESRS 1 sets the general principles for reporting, while ESRS 2 mandates essential disclosures regardless of the sustainability matter being considered. ESRS 2 is mandatory for all companies under the CSRD.
What changes did the Commission make to the draft standards proposed by EFRAG?
The Commission made several modifications to EFRAG’s draft standards to ensure proportionality and achievability of policy objectives. These changes can be categorised into three main areas:
- phasing-in certain reporting requirements,
- providing more flexibility around what information is material, and
- converting some mandatory requirements into voluntary ones.
Phase-in provisions, primarily aimed at companies with less than 750 employees, postpone challenging reporting requirements for 1-2 years, granting time for preparation and spreading initial costs over several years.
The Commission also offers more flexibility in determining materiality, allowing companies to omit information not relevant to their specific circumstances, thus avoiding unnecessary reporting costs. With the exception of ESRS 2 (“General Disclosures”), all reporting requirements are subject to materiality.
Finally, some reporting requirements initially proposed as mandatory were made voluntary, such as biodiversity transition plans and certain workforce indicators. These changes aim to alleviate challenges and costs for companies, maintaining a balance between the requirements and practical applicability.
What implications does the approach to materiality have for consistency with other EU sustainable finance legislation?
The ESRS present specific datapoints, designed to align with the reporting needs of financial market players, benchmark administrators, and financial institutions under the SFDR, Benchmark Regulation (BMR), and the Capital Requirements Regulation (CRR). If companies consider a datapoint stemming from the SFDR, BMR or CRR not material, they must declare it so explicitly and provide a detailed table indicating their location in their sustainability statement or stating “not material” as appropriate. The purpose is to aid these financial market players in adhering to their own disclosure obligations under these regulations. Additional guidelines will be forthcoming, especially on the treatment of datapoints derived from SFDR, BMR and the CRR assessed as non-material by investee companies when reporting in line with ESRS. However, more clarity is expected on this point as pointed out in the ESRS Q&A.
What are the next steps?
The Commission’s adopted ESRS delegated act will be sent to the European Parliament and Council for scrutiny in late August. This review will last two months, extendable by another two. The Parliament or Council can reject but not amend the act.
Companies reporting under ESRS will follow a schedule.
- Initially, companies already under the Non-Financial Reporting Directive (NFRD) will start reporting in the 2024 fiscal year, with the first sustainability statements published in 2025.
- Other large companies, including non-EU listed companies will begin in 2025, with statements published in 2026.
- Listed SMEs, including non-EU SMEs, will start in 2026, with statements published in 2027, though they can opt to delay by two years.
Furthermore, non-EU companies generating over €150 million annually in the EU, having a branch or subsidiary meeting specific conditions, must report on sustainability impacts at the group level from the fiscal year 2028. Separate standards will be implemented for this case.