In recent times, there’s been growing emphasis on the importance of sustainability and transparency in the business ecosystem. Navigating the world of sustainability is a complex task for many businesses. EU law requires them to share insights into risks and opportunities emerging from social and environmental challenges, as well as their impact on the environment and society at large. This reporting is integral to the European green deal.
To improve the quality and completeness of sustainability information provided by companies, the European Sustainability Reporting Standards (ESRS) were developed in a draft version by the European Financial Reporting Advisory Group (EFRAG) and adopted by the European Commission on July 31, 2023.
In this blog post, we’ll dive into the EU Commission’s recent changes to the ESRS drafts and shed light on what they mean for sustainability professionals and the companies they represent.
Why the ESRS Adjustments Were Made
Sustainability has been at the forefront of European policies, especially with the EU’s commitment to the Paris Agreement and the 2030 Agenda for Sustainable Development.
In connection with the novel Corporate Sustainability Reporting Directive (CSRD), the EU Commission is empowered to issue regulations setting out detailed requirements for the sustainability report. These requirements are laid down in the ESRS.
The first set of ESRS drafts were submitted by EFRAG in November 2022. Since then, there have been consultations about the interoperability of ESRS with international standards and about the clarity of fundamental concepts such as double materiality or reporting on a company's value chain. Furthermore, companies and associations expressed concerns regarding the scope of the requirements for the drafted disclosures.
On July 31, 2023, the European Commission published the final ESRS and unveiled a series of amendments to the previous draft version, taking into account some of the stakeholders’ criticism. These adjustments, originating from more than 600 responses during the consultation process, aim to bring increased clarity and precision to the sustainability reporting landscape.
Understanding the Key Changes of the ESRS Drafts
The following key changes were made to the ESRS draft version:
1. Clarity on Financial Materiality (ESRS 1 - General requirements)
The updated ESRS 1 - General requirements now has more explicit definitions of what financial materiality entails. In essence, it boils down to the identification of data that’s deemed crucial for the primary users of general-purpose financial reports. These users rely on such material information to make informed decisions about resource provision.
2. Mandatory Reporting Requirements
In addition to the disclosure requirements detailed in the ESRS 2 - General disclosures, companies are required to adhere to all disclosure requirements and data points in the environmental standards (from ESRS E1 to E5) under the new amendments. Further, ESRS G1 - Business conduct related to ESRS 2 IRO-1 (Disclosure of processes by which impacts, risks and opportunities are identified, assessed and managed) is detached from a company’s materiality assessment and has to be followed regardless of the outcome.
3. Special Emphasis on Climate Change (ESRS E1 - Climate Change)
Climate change stands out as a pivotal concern in the ESRS adjustments. Should a company determine that the subject of "climate change" isn't material to their operations and hence chooses not to report in alignment with ESRS E1 - Climate Change, it's now obligatory to provide an in-depth explanation of their materiality assessment concerning climate change. This move underscores the European Commission's commitment to ensuring that companies recognize and report the systemic impacts of climate change on their operations.
4. Mandatory Materiality Disclosure for SFDR Reporting Requirements
The Sustainable Finance Disclosure Regulation (SFDR) remains a cornerstone for sustainability reporting in the European Union. The ESRS 2 outlines several data points related to the SFDR and other EU legislation. The adjustments make it clear that these data points are generally subject to materiality. However, a significant change is that companies must now explicitly state if the information in question is considered “not material”.
5. Refinement of GHG Emissions Reporting for Financial Institutions
For financial institutions assessing their greenhouse gas (GHG) emissions, there's a revision in the ESRS E1. Previously, the standard required these institutions to consider the Partnership for Carbon Accounting Financials (PCAF) standard in its entirety. The new adjustments have limited this to only Part A, which pertains to "Financed Emissions". The prior reference to Part C, addressing "Insurance Associated Emissions", has been removed.
Implications for Businesses and Sustainability Professionals
The adjustments to the European Sustainability Reporting Standards offer a refined pathway for companies striving for better sustainability reporting. These changes, particularly the clearer directives on materiality and the emphasis on climate change, underscore the European Commission's commitment to ensuring a transparent and standardized sustainability reporting ecosystem.
As sustainability professionals, staying abreast of these changes is essential and guidance towards compliance is key. EFRAG published guidelines on the topics of materiality analysis and value chains that were publicly discussed in EFRAG Sustainability Reporting Board Meeting on August 23, 2023.
For a detailed breakdown of the European Commission’s latest version of the ESRS, visit their official documentation.