On July 31 2023, the European Commission (EC) adopted a delegated act containing the first set of European sustainability reporting standards (ESRS).
These are standards that both large and small and medium-sized companies, whose securities are admitted to trading on EU regulated markets, as well as the parent companies of large groups, must refer to and include in a specific section of their management reports. This is in accordance with Directive 2013/34/EU on annual financial statements (the Accounting Directive), consolidated financial statements and related reports of certain types of companies, as amended by Directive (EU) 2022/2464 (the Corporate Sustainability Reporting Directive – CSRD).
This first set of standards relates to the information that companies are required to report under Article 19-A(1) and (2) (“sustainability reporting”), and Article 29-A(1) and (2) (“sustainability reporting at consolidated level”), of the Accounting Directive. The standards were based on the technical opinion issued by the European Financial Reporting Advisory Group (EFRAG) on November 22 2022, as well as input from stakeholders and a public consultation.
The EC has made changes to EFRAG’s technical opinion. Among other things, it has introduced a progressive and staggered application of some requirements, allowing companies with fewer than 750 employees to dispense with certain data and information in the first years of the rules’ application. The EC will further allow all companies to dispense with information in the first year of application of the standards on:
The expected financial effects related to non-climate environmental issues (pollution, water, biodiversity and resource use); and
Specific data related to their workforce (e.g., social protection systems, people with disabilities, work-related health problems and work-life balance).
In addition, the EC:
Favoured an approach based on the material impacts, risks and opportunities identified by companies;
Established the voluntary nature of certain disclosures (e.g., information on biodiversity transition plans and specific indicators on "self-employed workers" in the workforce); and
Introduced greater flexibility on certain disclosure topics.
The Delegated Act thus contains a first set of cross-industry standards aimed at specifying the information (and the corresponding disclosure-application requirements) that a company should disclose about its sustainability position and performance, as well as the ESG impacts, risks and opportunities arising from its operations, structure, strategy and business model.
What are the general principles for preparing and presenting sustainability reports? In identifying the material impacts, risks and opportunities to communicate – and therefore for sustainability reporting under the ESRS – the company also needs to assess the materiality of the issues. A sustainability issue becomes material to a company when it meets the materiality criteria established for impact (actual or potential, positive or negative, on people or the environment in the short, medium and long term, including those related to operations and the value chain downstream and upstream of the company, without limitation to direct contractual relationships), financial relevance (triggers or is likely to trigger material financial effects on the company by generating risks or opportunities that have a significant influence, or can reasonably be expected to have a significant influence, on the development, financial position, financial performance, cash flows, access to finance or cost of capital of the company in the short, medium or long term.), or both.
As to the structure of the sustainability report or statement, it should be broken down into four parts:
General information;
Environmental information;
Social information; and
Information on governance.
The information required by the ESRS disclosures must be presented in a human and machine-readable format, to allow it to be distinguished from other information in the annual report and to facilitate access to and understanding of the disclosures.
Recognising that some doubts may arise in practice, and to assist companies in their reporting obligations, the EC is establishing a formal interpretation mechanism for the ESRS and has also asked EFRAG to issue additional guidance on the materiality assessment process and other issues.
The standards
Two annexes complement the Delegated Act. Annex I describes in detail the architecture of the cross-cutting and topical standards. Annex II includes the list of acronyms and the glossary with the definitions to be used to carry out sustainability reporting.
In addition to two cross-cutting standards (ESRS 1 General Requirements and ESRS 2 General Disclosures, with explanations on the drafting conventions, the basic concepts, and the requirements for preparing and presenting sustainability topics, including the disclosures expected for each standard), which apply to all covered companies, regardless of their sector, Annex I includes standards on ESG, which will be variably applicable depending on the sector and business where the companies operate, as follows:
ESRS E1 Climate change;
ESRS E2 Pollution;
ESRS E3 Water and marine resources;
ESRS E4 Biodiversity and ecosystems;
ESRS E5 Resource use and circular economy;
ESRS S1 Own workforce;
ESRS S2 Workers in the value chain;
ESRS S3 Affected communities;
ESRS S4 Consumers and end-users; and
ESRS G1 Business conduct.
Timeline
The CRSD requires the EC to adopt further delegated acts for additional sets of standards. By June 2024, the EC must adopt and publish:
Sector-specific standards (i.e. applicable to all companies in a sector);
Proportionate standards for listed SMEs; and
Standards for third-country companies.
In August, the EC was due to formally submit the ESRS proposal to the European Parliament and the Council, which now have two months (extendable for a further two months) to accept or reject it.
The Delegated Act will apply from January 1 2024 to companies that were already subject to the non-financial disclosure requirements introduced by Directive 2014/95/EU (the Non-Financial Disclosure Directive). These companies will have to incorporate the rules in their reports for the financial year 2024, to be published in 2025.
For other companies, the application will follow the phased approach set out in Article 5 of the CSRD. Small and medium-sized listed companies will be able to choose to fulfil their reporting obligations under the CSRD by reporting in accordance with separate and proportionate standards to be adopted by the EC by the end of June 2024.
