Just last week, the European Commission voted down an attempt to weaken the European Sustainability Reporting Standards (ESRS), which had only just been released in their final version in August, 2023. This paves the way for the ESRS to come into effect, with the first cohort of in-scope companies mandated to publish conforming sustainability reports in 2024.
For context, The EU Corporate Sustainability Reporting Directive (CSRD) had already been affirmed, requiring companies under scope to report on sustainability impacts, opportunities, and risks in compliance with EU reporting standards. The ESRS have now been developed, and are being affirmed, to spell out exactly what those ‘EU reporting standards’ are. ESRS 1 and ESRS 2 are the general disclosure standards, and now effectively in operation, and more industry-specific standards are anticipated to be developed over the coming years.
[Side Note: The CSRD applies to EU listed or large firms for financial years starting on or after January 1st, 2024 (to report in 2025), and for non-EU firms exceeding specified EU-based revenue thresholds for financial years starting on or after January 1st, 2028 (to report in 2029).]
As companies have time to review and understand the ESRS requirements, most will find that they are an exercise in compliance rather than a dramatic advance in operational sustainability. To be clear, the ESRS are not setting any sustainability objectives or mandating any particular ESG-oriented performance, rather they are standardizing how corporate sustainability information should be disclosed.
For most companies, complying with the ESRS should not be overly onerous nor costly. If a company already publishes an annual ESG or Sustainability report, or if they convey ESG data to PE-ownership for inclusion in an annual roll-up report, then they likely already have access to nearly all, if not all, the information that would be requested under the ESRS framework. The new ESRS simply presents a requirement as to how and where the information should be presented. Again, more so an exercise in compliance rather than sustainability.
With that said, however, a few points do merit further comment:
- Schedule: The ESRS will require that the sustainability report be published at the same time as financial statements. This comes as an attempt to move sustainability information onto a level playing field with financial information and may be the most consequential element of the ESRS. Many companies will be required to adjust their data monitoring and collection protocols to meet this new schedule.
- Materiality: The ESRS require a materiality assessment which considers both financial and impact materiality–or what is commonly referred to as double materiality. Although the premise of double materiality is present, the spirit of financial materiality reigns supreme. The consideration of a company’s impact on society or the environment has been greatly diluted from when the original draft entered the comment and review period. In the final approved draft, the ESRS was explicit in aligning with the IFRS view of financial materiality (here: https://www.ifrs.org/content/dam/ifrs/project/definition-of-materiality/definition-of-material-feedback-statement.pdf), while including a substantially reduced conceptualization of impact materiality. For most companies, this will not change how they collect and report data, but it may require how companies discuss the issue of materiality within their disclosures to be revisited.
- Transparency of Action Plans and Targets: The ESRS will require that any forward-looking action plans or targets be accompanied by more granular disclosures relating to timelines, strategies, and performance. The ESRS does not mandate any particular performance targets or objectives, but rather mandates more transparency in how these are evaluated and disclosed should a company choose to have such. It remains to be seen, but we anticipate this element of the ESRS could have an outsized effect in incentivizing companies to avoid targets and action plans and instead shift their sustainability disclosures to be more so evaluations of past performance rather than commitments to future goals.
- Assurance: Third-party assurance of the sustainability disclosures will be required. Up until now, all ESG and Sustainability reports providing any level of assurance–and there aren’t very many that do–have done so voluntarily. Most companies will find that limited assurance–the degree which is required within the ESRS framework–is not difficult to establish as long data collection protocols are developed knowing that such assurance will be sought. This need not be a substantial cost.
The ESRS do represent a novel compliance factor, and we recommend that all companies take a moment to review how these will apply to them. Large or listed EU firms are working with a much tighter timeline, but all other companies have time to determine if and how the ESRS will impact them.
The ESRS have been developed with care to harmonize with leading voluntary ESG disclosure frameworks as well as other prominent related regulatory frameworks. For most companies that the ESRS will apply to, the ESRS are not likely to present any meaningful deviations from a reporting trajectory they were already on…although the ESRS is likely to present a meaningful deviation from the reporting schedule they were on. Requiring sustainability disclosures to be reported at the same time as financial statements may very well be the most consequential element of the ESRS.