Need for a universal sustainability reporting framework

The European Commission’s proposal for a Corporate Sustainability Reporting Directive (CSRD) envisages the adoption of EU Sustainability Reporting Standards (ESRS). In June 2020, the European Financial Reporting Advisory Group (EFRAG), a private association primarily financed by the EU, was mandated by the European Commission to develop this universal European standard as part of the revision of the current Non-Financial Reporting Directive with the new CSRD.

This new ESRS is driven by the need of the European Commission to reduce corporate greenwashing through the standardizing and codifying of material sustainability reporting for companies in Europe and to ensure the careful articulation of reporting on sustainability information.

At the time of writing, the ESRS is still in draft form and under public consultation until the 8th of August, and the adoption of ESRS requirements into law is expected in 2022. European companies that have specific capital and financial characteristics will have to publish an ESRS-compliant report according to a first set of sustainability reporting standards for the fiscal year 2024, in 2025. This means that organizations must prepare and plan to implement the ESRS requirements by 2024 to be ready for the 2025 reporting cycle.

The framework is the embodiment of the CSRD, therefore companies that will be subject to the adoption of this framework are those that meet the following requirements:

• All large organizations adhering to at least 2 out of these 3 criteria:

1. Over 250 employees and/or
2. More than 40 million (euro) turnover and/or
3. More than 20 million (euro) total assets

• Listed companies on EU-regulated markets, except listed micro-companies (less than 10 employees or below 20 million euros in turnover).

Structure and content of the ESRS

To date, the ESRS framework consists of the following different (draft) standards listing requirements to be addressed by all reporting companies within the below scope:

• ESRS 1: prescribes the mandatory concepts and principles to apply for the preparation of sustainability statements under the CSRD.
• ESRS 2: sets out the disclosure requirements of sustainability reporting that are cross-cutting and will require companies to disclose about their strategy and business model in relation to sustainability, the governance, and organization in relation to sustainability, the materiality assessment, and sustainability-related impacts, risks, and opportunities.
• ESRS E, S, G: these drafts set out disclosure requirements related to each sustainability topic on environmental, social, and governance matters as per Article 19b_(2) of the CSRD. This will require of companies to disclose about policies, targets, actions, resources, and performance measurement metrics for each sustainability topic.

Moreover, the framework will provide sector-specific disclosure requirements (ESRS SEC), which are not yet included in the current public consultation since they are still to be developed.

Double materiality, time horizon, and expanded boundary: new elements to be monitored

In addition to the possibility of having a common European reporting standard, the requirements described in the drafts present a new approach to non-financial reporting for European organizations.

The main new element is the mandatory requirement to develop a materiality analysis using the double materiality approach, considering the most important sustainability topics over the short-, medium-, long-term. To understand the material impact, risks, and opportunities linked to the material topics, organizations have to consider both the upstream and downstream value chain of the organization’s activities all the way to the boundary of the financial statement.

For example, in assessing the impact of their material issues, particularly those related to climate change, organizations within the chemical sector will need to consider the impact that the entire supply chain has on these issues. Therefore, when considering the GHG-emissions status quo of the chemical producers, the impact of chemical distributors and their decarbonization targets are relevant.

The reporting boundary has to be expanded when this extension of the perimeter is necessary so that stakeholders can better understand the organization’s material impact and to produce a complete information set that meets the qualitative characteristic of information quality (relevant, faithful, representative, comparable, verifiable and understandable).

Although still under consultation, this approach is expected to become a key element in sustainability reporting for the European Commission and therefore organizations must begin preparing for integrating these new aspects into their sustainability reporting activities. The article Double Materiality: 3 Tips For A Practical Approach, shares useful examples and tips on how to approach and implement a successful double-materiality assessment.

ESRS, climate change and TCFD

Among the various ESRS drafts, one of the most anticipated is the draft related to climate change (ESRS E1 - Climate change). There are many detailed requirements within this standard that aim for consistency with EU regulations, e.g. EU Emission Trading System, EU Taxonomy regulation, Sustainable Finance Disclosure Regulation, and the Eco-Management and Audit Scheme.

Many of these requirements are also aligned with the recommendations from the Task Force on Climate-Related Financial Disclosures (TCFD), as is detailed in the specific correlation table developed by EFRAG (available as a download at the top of this article). Therefore, incorporating the TCFD recommendations into sustainability reporting can already be a step toward meeting ESRS requirements, as well as a strategic tool for integrating climate risks into organizations’ strategy and business.

Finch & Beak provides TCFD and double materiality support

At Finch & Beak, we provide support for organizations as they prepare for compliance with ESRS through materiality assessments, including a double materiality approach, and, together with our fellow companies from SLR Consulting, we offer a wide range of TCFD-related services.

If you require assistance with your double materiality assessment or want to take the next steps in your TCFD journey, then reach out to Johana Schlotter, at johana@finchandbeak.com or call +31 6 28 02 18 80 to discuss how Finch & Beak can support you.

^{Photo by Christian Lue on Unsplash}