EU Commission’s advisory group publishes the first set of sustainability reporting standards

Posted on 29 November 2022

Sustainability reporting experts and NGOs welcome the adoption of the EU sustainability reporting standards (ESRS) by EFRAG submitted this week to the European Commission. Whilst the ambition of the ESRS remains limited in several areas, they represent a major improvement for companies as well as for users of sustainability information and address the biggest problems in quality and reliability of corporate reporting. 

The ESRS will provide a common European framework on corporate disclosure. They are indispensable to get relevant and reliable reporting on companies’ climate transition plans and their alignment with the 1.5°C goal, the exposure of companies to sustainability-related financial risks, as well as to actual and potential severe impacts on people and the environment in the value chain, and companies’ management of such impacts and risks, among others. This is essential to help investors, consumers, financial institutions and, in fact, society as a whole, to make the switch to a sustainable economy that operates within planetary boundaries.

Following the legal mandate provided by the EU Corporate Sustainability Reporting Directive (CSRD), the EU must develop and adopt standards covering all sustainability areas, in line with the broader EU policy framework, including sustainable finance legislation, EU Climate Law and the bloc’s objectives and commitments on climate, nature and human rights. The EU standards are urgently needed to tackle major gaps on the quality, consistency and comparability of corporate disclosures and provide a comprehensive picture of companies’ management of their risks and impacts on people and planet. 

The standards have been developed in an extensive and transparent multistakeholder process, and were approved without a dissent by EFRAG’s Sustainability Reporting Board, which includes representatives of Accounting Standards Committee of Germany, the Autorité des Normes comptables of France, the Dutch Accounting Standards Board, Organismo Italiano di Contabilità (OIC), as well as European stakeholders including Accountancy Europe, European Issuers, EFAMA, European Banking Federation, and representatives of civil society and of the European Trade Union Confederation, among others. 

Whilst we would appreciate a greater level of ambition on a number of sustainability issues, we welcome the following key aspects:
  • In line with the CSRD mandate, the ESRS provide a common system for reporting on all ESG topics, making it easier for companies to understand which data is needed from them and how to approach sustainability matters in a holistic manner, and significantly reduce the risks of greenwashing. 
  • EFRAG’s proposal aligns with the draft international sustainability-related financial disclosure standards developed by the ISSB (building on the TCFD), both in terms of content and structure; it is highly aligned with the GRI, as regards impacts and indicators, and ensures disclosures needed by investors to inform their decisions (including EU Taxonomy-related information) as well as to meet their own transparency obligations under the Sustainable Finance Disclosure Regulation (SFDR).
  • The ESRS adopted by EFRAG’s multistakeholder board addressed the inputs and concerns emerging from the public consultation, resulting in standards that are manageable for preparers (i.e. reporting companies) and ensure focused and relevant disclosures for users. In the original exposure drafts of the standards, all disclosure requirements were considered material (and thus mandatory) for all companies, even though a burdensome possibility to rebut was granted (i.e contest their materiality). This is now replaced by a much simpler and clearer system, that allows companies to determine and report only on their material issues, whilst clarifying a balanced set of simple mandatory disclosures indispensable to users of sustainability information. Studies commissioned by the EU Commission show the costs of standardising and mandating companies' sustainability reporting to be negligible
  • Disclosures that relate to Climate change mitigation and adaptation include scope 1-2-3 emissions and are always mandatory. This will allow reporting systems to capture the true carbon footprint of large parts of the economy. In transport, for example, scope 3 emissions represent more than 90% of total emissions, and are rarely reported. It also excludes shady offsets, carbon credits and carbon removals from the corporation’s climate targets.
  • Life cycle analysis is confirmed as the cornerstone in assessing environmental sustainability in the EU; 
With regards to the matters that must be protected from political pressure and further developed in sector-specific standards in future:
  • Following the public consultation, the number of datapoints in the ESRS was reduced by approximately 50%.  Such a massive simplification, however, led to a reduction in the granularity of data and requirements for value chain disclosures. As proven by the Corporate Human Rights Benchmark in 2020, the most common types of allegations related to instances of forced labour, health and safety, and child labour occur in developing countries. The worst cases of environmental destruction also take place upstream in companies’ value chain, such as deforestation, which the latest UN report on net-zero emphasises will have to end by 2025 if we are to reach net zero by 2050. 
  • The ESRS provide a helpful general framework for reporting on the identification and assessment of impacts and risks across the value chain, which is aligned with international standards. However, in terms of value chain metrics, the ESRS lay down specific sector-agnostic indicators only with respect to the companies’ own activities and own workforce, with the sole exception of the climate standard, which requires disclosures of Scope 3 GHG emissions. The other environmental standards, as well as the social standards regarding workers in their value chain, communities and end users and consumers, do not prescribe any value chain indicators.
  • The CSRD provides flexibility for companies’ reporting of specific value chain data during the first 3 years. This addresses concerns that companies may otherwise have difficulty reporting on their value chains during the initial application of the reporting standards. The transition period removes any justification for further watering down these standards, which are essential to fully understand the performance, resilience and behaviour of companies operating in the EU. Indeed, under the existing legal mandate, the first set of standards applicable to companies across all sectors will be followed by the development of sector-specific standards, where more specific rules on critical value chain issues will have to be considered. This will be important to complete the standards so that they provide a useful tool to help meet sustainability goals. Ultimately, incomplete or oversimplified disclosures will not be relevant or useful for decision-making.
  • The S (social) pillar is also incomplete when it comes to inclusion and diversity. The standards do not include yet any datapoint on ethnic diversity, thus failing to address the issue of systemic discrimination based on ethnicity or race.

The proposed ESRS lay down an urgently needed baseline for sustainability reporting which is aligned with international standards and addresses the most pressing conceptual and methodological challenges companies are facing. Therefore, we call for the adoption of the ESRS framework by the European Commission and endorsement by the EU Parliament and Member States. We warn against further cuts into the proposed standards, which would severely undermine its functionality and hinder EU’s efforts to create a more sustainable and just economy. 


 
[1] For example in the studies published by the Alliance for Corporate Transparency, 32% of the analysed corporations in 2021 obliged to report under the Non-Financial Reporting Directive disclosed their full GHG emissions, 39 % reported their climate targets and 28 % claimed the targets to be science-based or aligned with the Paris Agreement goals. Another recent study from World Benchmarking Alliance shows that  37% of leading financial institutions assessed have disclosed long-term net-zero targets. However, from these commitments, only 2% have been translated into interim targets applied across the institution’s financing activities, of which only 1% are backed by scientific evidence.