A step closer to the European Sustainability Reporting Standards

Advisory body EFRAG published "final draft" standards in November 2022, having earlier released exposure drafts which were subject to fairly extensive revision based on public comments (see our earlier briefing for full details). The European Supervisory Agencies (e.g. ESMA) largely supported EFRAG's ESRS draft, and EFRAG was confident that the final standards (which will be implemented into binding law) would look quite similar to its own drafts. However, a week or so before publication it was rumoured that the Commission drafts would be significantly watered down, with notable changes including the removal of any mandatory disclosure requirements.

In its explanatory memorandum, the Commission noted that stakeholder feedback gathered by the Commission services in the last few months raised concerns that the disclosure requirements were too challenging in places, particularly for those never before required to undertake sustainability reporting. The Commission noted biodiversity, own workforce, value chain workers, affected communities, and consumer and end users as being areas where the disclosures could be too demanding. The Commission also noted its commitment to proportionality and "a regulatory system that ensures that objectives are reached at minimum costs".

Some key points arising from a first look at the latest drafts:

• No mandatory disclosures. With the exception of ESRS 2 (General Disclosures, which addresses things like the business model, strategy and methodology used in reporting), every disclosure point will be subject to a materiality assessment. An organisation will, therefore, need to reach its own conclusion on whether or not the impacts, risks and opportunities posed by the matter in question are material to its organisation on a double materiality basis. EFRAG had previously recommended a list of disclosures that it deemed material in all cases, as well as others that would always be material for organisations over a certain size; these included the entire ESRS E1 standard on climate, and all the disclosures equivalent to principal adverse indicators ("PAIs") under the Sustainable Finance Disclosure Regulation ("SFDR"). Under the Commission drafts, if an undertaking concludes that a matter is not material and therefore omits the disclosures, it "may" briefly explain the conclusions of its materiality assessment. This change is already gaining significant attention. The Commission has previously championed the CSRD as being the regulatory stick to drive data collection and disclosures which would help asset managers in their own sustainability reporting under SFDR. With the removal of the mandatory disclosures linked to the PAIs, this may well continue to produce ongoing data gaps; it will require asset managers to take a leap of faith and assume that the absence of a disclosure on, say, water emissions in a portfolio company's CSRD report equates to a nil return on the PAI disclosure. Furthermore, some commentators are asking, perhaps with justification, how an organisation could conclude that climate change is ever not a material risk, particularly in light of the recent warning that the world will likely breach the key 1.5 degree warming threshold in the next five years. However the Commission noted that the consistency of the ESRS with the climate-neutrality goal in the EU Climate Law had been assessed.
  
  
• Phasing-in of requirements. EFRAG had already, in previous drafts, suggested some phasing in of disclosures, particularly in relation to value chain information which is acknowledged to be a particularly challenging aspect of CSRD reporting. The Commission takes the phase-in period further, with undertakings with less than 750 employees permitted to omit other datapoints in the first year or two years of reporting. For the first year of reporting, scope 3 greenhouse gas emissions data may be omitted, as well as financial effects of environmental matters other than climate. For the first two years, the ESRS E4 (biodiversity), S2 (workers in the value chain), S3 (affected communities) and S4 (consumers and end users) may all be omitted. While potentially welcome news in terms of alleviating the initial reporting burden, the already staggered phase-in of CSRD implementation (based on different sizes, locations and statuses of undertakings) adds an additional layer of complexity and may well lead to a lack of comparable data for several years to come.
  
  
• Mandatory datapoints into voluntary datapoints. The Commission has taken some previously mandatory datapoints and reframed them to be voluntary. The rule of thumb is that any requirement phrased as "the undertaking may disclose" rather than "the undertaking shall disclose" is voluntary and good practice, rather than required.

Comments can be submitted on the draft standards until 7 July 2023. They are expected to be finalised and published in the Official Journal by the end of August, but will apply from 1 January 2024. As the ESRS are enacted via a delegated regulation, there is no need for Member States to implement them into national law – they will apply immediately.