European Sustainability Reporting Standards – why it’s important
European Sustainability Reporting Standards - why it is important
The European Sustainability Reporting Standards (ESRS) are an ambitious set of standards to improve and codify corporate sustainability reporting across the EU. They are a key part of the EU’s broader Corporate Sustainability Reporting Directive (CSRD) which aims to make sustainability reporting part of “business as usual” across the EU.
Theoretically it only applies to about 1% of European companies but in practice almost all of us will be involved eventually.
what are the esrs?
The ESRS are an enhanced set of standards that will require organisations to treat their sustainability reporting on a par with their financial reporting.
They are the main pillar of the EU’s CSRD which in itself is an extension of the EU’s Non-Financial Reporting Directive (NFRD) - a framework introduced in 2018 that mandates “sizeable public interest entities” to report on their sustainability performance.
As with financial reporting, the new regulations will have specific requirements as to what is disclosed, and the format it should take. The dual aims are, first, to ensure that sustainability reporting takes on a standardised template format which is recognised regardless of industry or sector, allowing for meaningful comparisons and assessment. The second aim is to enshrine in law the need for businesses to take responsibility for their environmental and societal impacts.
who will need to start reporting?
Initially, the directive will apply to all companies listed on the EU regulated markets, except for listed micro companies. It will also apply to companies defined as a ‘large undertaking’ ie. those companies with:
A net turnover of €40 million
A balance sheet total of €20 million
250 employees on average over the financial year
Large undertaking’ also applies to organisations that aren’t headquartered in the EU but have a net turnover above €150 million in the EU and/or have at least one subsidiary or branch with a net turnover of more than €40 million in the EU. A company could be based anywhere from the UK to Singapore, and if it has a business footprint that satisfies the above requirements, ESRS will still be applicable.
Standards will also apply to insurance undertakings and credit institutions regardless of their legal form.
Companies that are already subject to the NFRD will need to begin data collection on or after 1 January 2024 to report in 2025, on 2024 data.
what are they expected to report on?
Key to the widened scope of ESRS is the concept of ‘double materiality’ with both financial materiality and, now, ‘impact materiality’ being disclosed in their own right but without ignoring the interactions between them. In effect, it is an exploration of how sustainability and its related concerns affect the company and the company’s impact on society and environment.
The list of required disclosures is long but the European Commission has acknowledged the burden of reporting and will publish mandatory sustainability reporting standards for large companies and separate, proportionate standards for SMEs. Whilst there will still be an increase in regulatory requirements, the hope is that these proportionality rules mean that those organisations expected to produce highly complex, detailed reports are also those with access to the deepest pools of finance and manpower, whilst SMEs will have a lesser burden of reporting to reflect their smaller scale operations and resources.
Broadly speaking, businesses will be expected to disclose more sustainability and human rights-related information than before about their business models, strategy and supply chains.
Areas of focus will include:
Environmental protection
Social responsibility and treatment of employees
Respect for human rights
Anti-corruption and bribery and
Diversity on company boards
Along with precise, data driven reviews, reports will need to include more forward looking information such as targets and progress, plus information on ‘intangibles’ including social, human and intellectual capital. Companies could even be scrutinised on their decision-making processes and how they share their sustainability stories with their stakeholders.
Regulators are keenly aware that well put together reports do not necessarily reflect well put together sustainability policies so one of the ESRS’s key quality standards will be ‘verifiability’ i.e. all claims made in a report must be supported by either pre-existing data, provable policy or provable outputs related to the claim.
They also expect a level of ‘understandability’ ensuring that information is clear and concise and the language used allows all the intended readers to grasp what is being communicated in the document.
why is this all so important?
Whilst the first rollout will only scoop up about 1% of European companies, this translates to nearly 50,000 companies in the EU who will adhere to the updated standards, corresponding to 75% of total turnover from EU companies
Crucially these companies are expected to provide relevant information on worker rights and environmental impacts across their value chain – regardless of where those suppliers are based or the size of their organisation. So whilst the detail of the rules applies to a very limited number of businesses, the extent of the information required and associated responsibility is potentially global.
The European Commission are working on EU-wide standard penalties for companies that do not comply fully with reporting requirements. For now, for example, if a German business does not report compliantly with the German version of the Non-Financial Reporting Directive (the Directive being amended with the CSRD) they face fines of up to either €10 million or 5 % of the total annual turnover of the company or twice the amount of the profits gained or losses avoided because of the breach – whichever is highest. Yet in France businesses face no fines if they don’t report according to the NFRD unless an interested party asks for the information.
It is also worth noting that this EU directive is part of a much broader set of initiatives towards the standardisation of sustainability reporting on a global scale. In spring 2022, the US Securities and Exchange Commission (SEC) and the International Financial Reporting Standards Foundation (IFRS) individually released drafts for sustainability-related disclosures. Whilst all these initiatives remain separate for now, the IFRS in particular is pushing for a globally accepted set of global templates that allow for worldwide standardisation and consistency. The European Commission plans to review the ESRS every three years to take into account these international developments.
what next?
This is just the initial roll out of the regulations.
All 27 EU member states are expected to codify the ESRS into national law and the European Commission has a timeline for expansion of the rules which envisages a rapid inclusion of many parts of the economy by 2028.
In this first phase the rules are a uniform set of standards, but the Commission aims to adopt a second set of reporting requirements by 30 June 2024, with more detailed sector-specific standards, standards for listed SMEs and standards for non-EU companies to report on.
Other large companies that fall outside this year’s parameters must start reporting from 1 January 2025 onward (reporting in 2026 on 2025 data). In turn, SMEs need not start reporting until 1 January 2026 (reporting in 2027 on 2026 data). For non-EU companies, the new requirements apply from 1 January 2028 (reporting in 2029 on 2028 data).
Mandatory sustainability reporting is a fast moving and exciting area. ESGmark® will be keeping a close eye on how the ESRS roll out develops and the changes it brings to European business practice.
Click here for more on the UK’s own set of sustainability standards for publicly listed and very large companies.
While the ESRS reporting requirements will directly affect a minority of businesses by number, they will impact the majority of organisations as participants in larger supply chains. ESGmark® is here to help your business stay ahead of the curve and get ready for change - contact us at info@esgmark.co.uk.