"Sustainability is about embracing our responsibility to leave the world better than we found it, thriving in harmony with nature's abundance."
From its Binging
The ESRS were proposed as part of the Corporate Sustainability Reporting Directive (CSRD) by the European Commission in April 2021.
The CSRD aimed to establish a comprehensive sustainability reporting framework for companies operating within the European Union. Under the CSRD proposal, companies would be required to report using a double materiality perspective, considering both financial materiality and sustainability-related materiality.
The European Financial Reporting Advisory Group (EFRAG) was appointed as the technical adviser to the European Commission for developing the draft ESRS. The proposed standards were intended to define the reporting requirements and metrics that companies would need to adhere to when disclosing their sustainability performance.
Throughout the legislative process, the CSRD underwent the trilogue negotiations between the co-legislators (European Commission, European Parliament, and the Council of the European Union), the text of the CSRD was finalized on 21 June. Subsequently, on 10 November 2022, the European Parliament approved the final text of the CSRD, which confirmed the establishment of ESRS developed by EFRAG as the standard for sustainability reporting within the scope of the CSRD.
Project European Green Deal
The European Green Deal is a comprehensive and ambitious plan set forth by the European Union (EU) to make Europe the world’s first climate-neutral continent by 2050. It encompasses a wide range of initiatives and policy measures aimed at addressing climate change, promoting environmental sustainability, and fostering economic growth.
Key aspects of the European Green Deal include:
Climate Neutrality: The main goal is to achieve net-zero greenhouse gas emissions by 2050, meaning that the EU aims to balance the amount of emitted greenhouse gases with the amount removed from the atmosphere.
Circular Economy: The plan emphasizes transitioning to a circular economy where resources are used efficiently, waste is minimized, and products are designed for durability, repairability, and recycling.
Clean Energy: There’s a focus on increasing the share of renewable energy sources in the energy mix while phasing out fossil fuels.
Sustainable Mobility: The European Green Deal promotes cleaner and more sustainable transportation, including electric vehicles, improved public transportation, and alternative fuels.
Biodiversity and Farm-to-Fork Strategy: The plan addresses the loss of biodiversity by aiming to protect and restore ecosystems. It also includes strategies to ensure a more sustainable and healthier food system.
Renovation Wave: This initiative aims to improve the energy efficiency of buildings across Europe to reduce energy consumption and greenhouse gas emissions.
Just Transition: The plan acknowledges the need to support regions and industries that are heavily reliant on fossil fuels in transitioning to cleaner technologies and jobs.
Innovation and Research: Investment in research and innovation is a critical component of the European Green Deal to develop new technologies and solutions for a sustainable future.
Carbon Pricing: The EU aims to establish a carbon pricing mechanism to encourage companies to reduce their carbon emissions.
The European Green Deal represents the EU’s commitment to addressing the climate crisis while fostering economic growth and creating a more sustainable and resilient future. It covers a wide array of policy areas, reflecting the comprehensive nature of the challenge posed by climate change and environmental degradation.
Its Adaptations and Development
The standards approved by the Commission are based on advice from EFRAG, which used to be called the European Financial Reporting Advisory Group. EFRAG is an independent group supported mainly by the EU. They make these standards with input from investors, companies, auditors, civil society, unions, academics, and national standard-setters.
EFRAG gave its suggested standards to the Commission in November 2022 after getting feedback from the public about their initial ideas last year. They changed a lot of things in their initial ideas based on this feedback, especially to make it easier for companies by reducing how much they have to report. They cut down the number of things companies need to report by almost half.
Better Sustainability Reporting
- The European Union (EU) has put in place a law that requires larger companies and those listed on stock exchanges (with the exception of small listed companies) to share information about the risks and opportunities they see from social and environmental issues.
- They’re also required to disclose how their activities impact people and the environment.
- This information is crucial for various stakeholders, such as investors, civil society organizations, and consumers, as it helps them assess how companies are performing in terms of sustainability. It’s also a part of the EU’s broader initiative called the European Green Deal, which focuses on making the EU’s economy more sustainable.
Importance of Better Reporting:
- However, the sustainability information that companies currently report is often inadequate. They might leave out important details that investors and other stakeholders find crucial.
- Comparing reported information from one company to another can be difficult due to inconsistencies in reporting.
- Users of this information, particularly investors, may not fully trust the information they receive.
- This lack of reliable sustainability reporting has consequences. Investors don’t have a clear understanding of the sustainability-related risks that companies face.
- Investors need to be aware of the impact of companies on people and the environment, as well as their plans to improve this impact in the future. This knowledge helps them meet their own disclosure requirements under the Sustainable Finance Disclosure Regulation (SFDR).
- For the market for environmentally friendly investments to be credible, investors need to know how companies’ activities impact sustainability. Without this information, it’s challenging to direct funds towards environmentally beneficial activities.
When to start reporting under ESRS
Reporting for SMEs?
Reporting Requirements for SMEs:
- The Accounting Directive, as changed by the CSRD, doesn’t introduce new reporting rules for Small and Medium-sized Enterprises (SMEs), except those that are listed on stock exchanges.
- For listed SMEs, there is a balanced reporting system in place.
- Listed SMEs are not obligated to report sustainability information until their financial year 2026.
- After that, they have the option to skip reporting for two additional years.
- Furthermore, listed SMEs have the choice to follow separate standards tailored to their size, which will be less extensive than the full European Sustainability Reporting Standards (ESRS) set.
Proportionate Reporting for Listed SMEs:
- The concept of proportionality applies to listed SMEs, ensuring that reporting requirements are appropriate to their scale and resources.
- EFRAG, the European Financial Reporting Advisory Group, is currently in the process of developing draft versions of these proportionate standards specifically for listed SMEs.
SMEs without Reporting Requirements:
- Some non-listed SMEs, even though they’re not required to report sustainability information by the Accounting Directive, might still receive requests for such information from various stakeholders like customers, banks, and investors.
- EFRAG recognizes this and is working on creating simpler, voluntary standards designed for non-listed SMEs.
- These voluntary standards will help non-listed SMEs efficiently and proportionately respond to these information requests.
Supporting SMEs and Value Chains:
- The Accounting Directive also includes a provision indicating that the standards applied to listed SMEs will define the extent of information that European Sustainability Reporting Standards (ESRS) can require large companies to obtain from SMEs within their supply chains.
- This provision safeguards against placing excessive reporting demands on SMEs that are connected to larger companies’ value chains.
- The intent is to prevent a situation where reporting obligations trickle down disproportionately from larger enterprises to smaller ones in value chains.
The Accounting Directive, modified by the CSRD, adjusts reporting rules for SMEs. It introduces proportionate reporting for listed SMEs, allowing them flexibility and time. EFRAG is working on standards for both listed and non-listed SMEs to make reporting efficient.
Additionally, safeguards are in place to prevent excessive reporting demands from affecting SMEs within larger companies’ value chains
How companies will report on?
The European Sustainability Reporting Standards (ESRS) adopt a “Double Materiality” approach. This means that companies are required to report not only on their effects on people and the environment but also on how social and environmental matters can lead to financial risks and opportunities for the company. In other words, ESRS consider both the impact of the company on the world and how the world’s social and environmental conditions can affect the company financially.
There are 12 ESRS
ESRS 1 (“General Requirements”):
- ESRS 1 outlines general principles for reporting according to the European Sustainability Reporting Standards (ESRS).
- It doesn’t define specific details that must be disclosed. Rather, it sets the overall guidelines for reporting.
ESRS 2 (“General Disclosures”):
- ESRS 2 specifies important information that must be disclosed regardless of the specific sustainability matter being addressed.
- This standard is obligatory for all companies covered by the Corporate Sustainability Reporting Directive (CSRD).
Materiality Assessment for Other Standards:
- For all the other standards and the specific information they require, a “materiality assessment” is conducted.
- This assessment determines whether the information is relevant (“material”) to the company’s business model and operations.
- If a piece of information is not material, the company can omit it from their reporting.
Mandatory Disclosure Requirements:
- Disclosure requirements linked to materiality are not optional.
- If information is material, the company must disclose it.
- The company’s materiality assessment process is externally reviewed to ensure accuracy and transparency, following the Accounting Directive’s rules.
Ensuring Comprehensive Sustainability Reporting:
- The standards ensure that companies conduct a thorough materiality assessment.
- This assessment guarantees that all sustainability information necessary to fulfill the Accounting Directive’s goals and requirements will be reported.
Addressing Climate Change Reporting:
- If a company decides that climate change is not a material topic for their reporting, they must provide a detailed explanation for this conclusion.
- This is to acknowledge the wide-ranging and significant impact of climate change across various sectors.
In summary, the European Sustainability Reporting Standards (ESRS) provide guidelines for sustainability reporting. ESRS 2 outlines essential information to be disclosed, and other standards’ details are determined through a materiality assessment. The assessment ensures relevant information is reported, and the process is externally verified. If a company chooses not to report on climate change due to materiality, they must explain their reasoning
Benefits of ESRS
To address these issues, the European Commission is following the Corporate Sustainability Reporting Directive (CSRD). This directive emphasizes that companies should use common standards to fulfill their legal obligations for sustainability reporting. The Commission is creating European Sustainability Reporting Standards (ESRS), which are a set of rules and guidelines.
These ESRS are meant to help companies communicate their sustainability performance more effectively. This, in turn, should make it easier for companies to access sustainable finance.
Companies that are required to report certain sustainability information under the Accounting Directive will be obligated to use these ESRS.
The goal is to make sure that companies all over the EU report similar and reliable sustainability information.
The adoption of common standards is expected to reduce the costs of reporting for companies over time.
Currently, there’s a problem with the quality of sustainability reporting, which creates an “accountability gap.” Better, reliable reporting will enhance public accountability.
Investors and the public will have greater confidence in the information companies share, leading to more trust and understanding about sustainability practices.
Alignment with International Sustainability Standards:
Alignment with International Sustainability Standards:
- The European Commission has made significant efforts to ensure a high level of consistency between the European Sustainability Reporting Standards (ESRS) and the standards set by the International Sustainability Standards Board (ISSB) and the Global Reporting Initiative (GRI).
- Right from the start of ESRS development by EFRAG, the GRI’s standards have served as a valuable reference point. Many reporting requirements in ESRS were inspired by GRI’s standards.
- The development of ESRS and the initial two standards from ISSB happened concurrently. Ongoing discussions involving the Commission, EFRAG, and ISSB have led to a strong alignment between the two sets of standards in areas of overlap.
Harmonization with ISSB Standards:
- ESRS and the ISSB standards for climate-related disclosures are closely aligned. Companies reporting on climate change using ESRS will largely report the same information as those using ISSB’s climate-related standards.
- While ESRS address broader user needs beyond investors, such as business partners, trade unions, and academics, they still maintain a high level of alignment with ISSB standards.
- This alignment prevents companies from having to report separately under ISSB standards if they’re required to report under ESRS.
EU’s Leadership in Global Framework Development:
- The EU’s adoption of ESRS takes a pioneering step by integrating ISSB standards into its legal framework more extensively than other jurisdictions have done so far.
- This integration contributes significantly to establishing a cohesive global framework and enhancing the global comparability of sustainability reporting.
- The approach of merging ISSB disclosure requirements into ESRS aligns with IOSCO’s decision to support ISSB’s sustainability-related disclosure standards.
Consistency with EU’s Sustainable Finance Goals:
- ESRS are in line with the EU’s own goals concerning sustainable finance and the European Green Deal.
- ESRS cover a wide spectrum of environmental, social, and governance issues, unlike ISSB, which has primarily published detailed standards on climate.
- ESRS explicitly require reporting on the company’s impacts on people and the environment, along with the financial risks and opportunities associated with social and environmental matters. ISSB, on the other hand, focuses more specifically on how these issues affect a company’s financial circumstances.
In essence, the European Commission has put considerable effort into aligning ESRS with global standards, particularly ISSB and GRI. This alignment supports harmonization, prevents redundancy, contributes to a global framework, and fits well with the EU’s sustainable finance and environmental objectives.