Sustainability reporting gets a makeover: EU unveils bold standards to woo green investors

The European Commission achieved a significant milestone on July 31, 2023, by adopting the European Sustainability Reporting Standards (ESRS), a crucial step towards implementing the EU's upcoming Corporate Sustainable Reporting Directive (CSRD). These standards will require companies to report on sustainability-related impacts, opportunities, and risks. The CSRD is set to take effect from the beginning of 2024, and reporting will commence for some companies during the 2024 financial year.

While the announcement was welcomed by many, sustainability-focused investor groups raised concerns about the EU Commission's decision to ease certain aspects of the new rules, particularly the removal of the mandatory nature of many sustainability disclosures, which remained in the adopted ESRS. The CSRD aims to update the current EU sustainability reporting framework, the 2014 Non-Financial Reporting Directive (NFRD), and will significantly expand the number of companies required to provide sustainability disclosures from around 12,000 to over 50,000. The new rules will also introduce more detailed reporting requirements on environmental impacts, human rights, social standards, and sustainability-related risks.

The European Financial Reporting Advisory Group (EFRAG) was tasked by the European Commission in June 2020 to develop new EU sustainability reporting standards. In November 2022, EFRAG submitted its final ESRS draft, making modifications to reduce administrative burdens on companies and cut the number of reporting requirements in half.

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In June 2023, the European Commission released a proposed version of the final ESRS, introducing its own changes. Notably, the Commission proposed that all disclosure requirements, except for a set of general disclosures, undergo materiality assessments. This would allow companies to focus reporting on sustainability factors they consider significant to their businesses. The changes also involved phasing in certain reporting requirements, such as Scope 3 emissions and biodiversity-related topics, as well as 'own workforce' disclosures for companies with fewer than 750 employees in their first year of applying the standards.

However, investment and finance groups expressed concerns, stating that the amendments would impact their ability to obtain crucial sustainability-related information required for investment decisions. It would also hinder their ability to meet reporting requirements, including those under the EU's Sustainable Finance Disclosure Regulation (SFDR).

In response to investor concerns, the Commission published a Q&A following the adoption of the ESRS. It clarified that 'disclosure requirements subject to materiality are not voluntary' and emphasised that information must be disclosed if deemed material. The materiality assessment process would also be subject to external assurance. Companies deciding not to report on climate change, for instance, would need to provide a detailed explanation for their decision due to the widespread and systemic impacts of climate change across the economy.

The Commission also highlighted the high level of interoperability between the ESRS and other sustainability reporting standards from the International Sustainability Standards Board (ISSB) and the Global Reporting Initiative (GRI). Companies required to report under ESRS on climate change would largely report the same information as those using the ISSB standard on climate-related disclosures.

With the adoption of the new sustainability reporting rules, the Commission's ESRS delegated act will be reviewed by the EU Parliament and Council during a two-month scrutiny period. Both bodies have the authority to reject the act but cannot amend it.

Once implemented, companies previously subject to the NFRD and large non-EU listed companies with more than 500 employees will need to start reporting under ESRS for the financial year 2024, with the first reports issued in 2025. Other large companies will begin reporting a year later. Listed SMEs, including non-EU-listed SMEs, will start issuing their first ESRS sustainability statements in 2027, with the option to opt-out for up to two years. Additionally, non-EU companies generating over €150 million of revenue annually in the EU and having a branch in the EU with revenue over €40 million or a subsidiary that is a large company or a listed SME will begin reporting from the financial year 2028 with the first reports due in 2029.

Mairead McGuinness, Commissioner for Financial Services, Financial Stability, and Capital Markets Union, praised the ambitious standards, emphasizing their role in supporting the EU's sustainable finance agenda. As per her, the standards strike a balance between minimising the reporting burden on companies and enabling them to showcase their efforts to meet the Green Deal Agenda, providing access to sustainable finance opportunities.