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WATERING DOWN THE EUROPEAN REPORTING STANDARDS: A STEP BACK IN AMBITION OR A STEP FORWARD IN CONVERGENCE IN GLOBAL SUSTAINABILITY REPORTING?
What are the ESRS, and why are they important?
European Sustainability Reporting Standards (ESRS) are instrumental in supplying all large and listed companies with the necessary rules to facilitate the disclosure of risks and opportunities arising from social and environmental issues to evaluate their sustainability performance in line with the European Green Deal.
By EU law, companies are required to make said disclosures to avoid problems in the quality of sustainability reporting. This facilitates investors’ understanding of the sustainability impacts of the companies they invest in.
Consequently, the Commission is adopting what is called ‘common standards’, which will guide companies’ communication of their sustainability performance. The obligation for companies to use those standards to fulfil their legal sustainability reporting standards is outlined in detail in The Corporate Sustainability Reporting Directive (CSRD), which amends the existing rules on non-financial reporting introduced in the Accounting Directive by the 2014 Non-Financial Reporting Directive (NFRD). Failure to follow those common standards could lead to issues for the companies and investors.
What changes will the European Commission make?
The European Commission has reportedly published the final set of corporate environmental, social and governance (ESG) disclosures rules. The latest regulations address the mounting costs of environmental practices by cutting ‘unnecessary’ red tape and watering down the sustainability standards. The Commission elected to disclose most ESRS climate and sustainability indicators conditional on a materiality assessment. Therefore, companies will be in charge regarding what information is considered ‘material’ and what information should be reported. Furthermore, more disclosures, such as core disclosures, would now be voluntary instead of mandatory.
In a Reuters article, HSBC analysts describe these changes as a ‘step back’ in ambition and robustness. At the same time, the European Insurance and Occupational Pensions Authority (EIOPA) considers that the new European standards should reduce the risk of inconsistent reporting requirements. The information companies publish would be ‘globally comparable and decision-useful for investors’.
The broader societal implications
The ESRS, as they are currently drafted, i.e., based on conditional materiality assessment, could be seen to significantly increase the risk of greenwashing, which means organisations would spend more time and money on marketing themselves as environmentally friendly than on minimising its environmental impact. Companies could also underreport, making it harder for banks and investors to access quality data for their reporting requirements, seriously undermining the European Green Deal. This could be considered a significant rollback of ambition compared to that envisaged by the EFRAG and would potentially undermine the purpose of the entire transparency framework.
To the contrary, it is worth considering that the European Commission has clarified the following: a company that states, for example, that climate change is not material to its business ‘has to provide a detailed explanation’ for this conclusion, therefore making sure companies know that providing this information ‘is not a voluntary process’. This means the organisation’s process for judging materiality is ‘subject to external assurance’, and it will not be easy to let corporate polluters off the hook.
How are companies affected by the potential issues arising from not following the new ‘watered down’ ESRS?
Following the debate on how effective the new ESRS will be, it begs the question: would they facilitate reporting in their current form? Companies want to be a part of the solution and achieve more sustainable supply chains. Still, they need a clear, workable, uniform set of rules that should not contradict or overlap with the other sustainability legislation. Any uncertainty about whether the company is too vague or potentially underreporting otherwise would delay getting the information to the investors.
What would companies need to do?
Large undertakings, listed undertakings and non-EU undertakings with substantial activity in the EU and parent undertakings of large groups, fall under the CSRD and need to disclose information regarding their business models, strategies and transition plans which are to be aligned with the Paris Agreement targets, such as absolute greenhouse gas emission reduction targets for 2030 and 2050, governance, policies, due diligence process and principal adverse impacts.
Companies will need to start reporting gradually between 2025 and 2029. Companies should ensure they have the capacity and personnel to gather all the necessary information to introduce a sustainability report. Companies will have to ensure suitable governance structures are put in place to coordinate considerations of risks, opportunities, and impacts regarding sustainability.
Preparation includes companies’ business relationships and supply chain along with information regarding their supply chain and engagement with suppliers to collect the necessary data and understand the underlying methodologies to make them more sustainable.
