The European Sustainability Reporting Standards (ESRS), which affect 50,000 companies, could allow greenwashing, say critics.
Publication of the final version of the European Sustainability Reporting Standards (ESRS) by the European Commission (EC) has produced a predictably mixed reaction, given the tightrope the authors had to walk to address the diverse concerns of multiple stakeholders in the process.
The ESRS govern how an estimated 50,000 EU companies should report on environmental and social impacts relating to their business and their value chain.
The rules fall under the EU’s Corporate Sustainable Reporting Directive (CSRD), which is intended to improve transparency in sustainability reporting by companies. For larger companies, the rules will start to apply in the 2024 financial year requiring disclosures in company reports published in 2025. The standards will be phased in for other companies by 2026.
When the draft standards were unveiled in August 2022, concern was voiced by the European Securities and Markets Authority (ESMA), some institutional investors and others that the ESRS would place reporting demands on companies in some sectors that could prove overwhelming and that a more nuanced approach to the introduction of the measures was needed.
A revised draft duly followed in June, which provided more latitude over what needed to be reported and allowed a slower phase-in for some aspects, but this then attracted criticism from other stakeholders for being too lax given the accelerating climate emergency. Following a month-long period for feedback, that draft has been updated to form the final version, which has provoked a further wave of dissent.
A major bone of contention is that companies have been granted more leeway than in the originally envisaged to decide which environmental and social factors they consider relevant to sustainability reporting following so-called materiality assessments.
Companies can decide to omit data for some standards if they can justify that action. If they decide climate change impacts are not material to their activity, they need to provide a detailed explanation of the conclusion of their materiality assessment. For other themes, such as biodiversity impacts, less detailed explanations will be required.
The less strict reporting requirements are intended to reduce the burden placed on companies to record and report on the impacts of their wider activities, even where they may not seem relevant to ESRS.
However, critics say allowing companies to decide on the relevance of their own activities could allow them to avoid disclosing some harmful impacts. They contend this would make it more difficult for investors to be sure they are comparing like with like when making investment decisions based on sustainability criteria. They also say it would also affect the ability of institutional investors and banks to accurately report on the impact of the companies in their portfolios, as required under the EU’s Sustainable Finance Disclosure Regulation (SFDR).
‘Loopholes for greenwashing’
WWF is a member of European Financial Reporting Advisory Group (EFRAG), the panel of experts which developed the ESRS for the commission, but it was unhappy at the outcome.
“Sustainability reporting is nothing new – the Global Reporting Initiative has existed for decades. Yet the European Commission still caved in to pressure from conservative industry groups and has weakened the standards to the point that loopholes have become motorways for greenwashing,” Philippe Diaz, senior manager, sustainable finance at WWF Germany said.
WWF Germany also said the elimination from the final ESRS of a requirement for companies to disclose whether they have a transition plan on biodiversity in place went “against the experts’ advice” and was crucial because many businesses’ operations are highly dependent on nature.
The European Sustainable Investment Forum (Eurosif), the Brussels-based industry association promoting responsible investing, said that, while it welcomed the coverage of the entire ESG spectrum in the standards, it was disappointed that the EC had decided to move away from mandatory core sustainability disclosures.
A number of other ESRS reporting requirements have also been made less onerous for companies since last year’s draft.
All companies now have an extra year before they need to make some disclosures relating to environmental financial implications, while companies with fewer than 750 employees get extra concessions to lighten the administrative load, such as a delay in reporting on conditions and equality in their workforce, and on emissions from across their value chain, known as Scope 3 emissions.
Net-zero campaigners believe reporting on Scope 3 emissions should be prioritised to allow investors to accurately assess a company’s sustainability credentials.
The act covering the ESRS is to be submitted to the European Parliament and European Council later in August for scrutiny over a two-month period, extendable for a further two months, during which time they could choose to reject the act, but not amend it.
Commission stands its ground
The Commission has countered criticism of the revised rules. Mairead McGuinness, the European commissioner for financial services, financial stability and capital markets union, said the standards were ambitious and important tool underpinning the EU’s sustainable finance agenda.
“They strike the right balance between limiting the burden on reporting companies while at the same time enabling companies to show the efforts they are making to meet the [EU’s] green deal agenda, and accordingly have access to sustainable finance,” she said.
The EC insists that disclosure requirements subject to materiality in the ESRS should not be regarded as voluntary.
“The information in question must be disclosed if it is material, and the undertaking’s materiality assessment process is subject to external assurance in accordance with the provisions of the CSRD,” the regulation’s text states. The commission said it had asked EFRAG to prepare additional guidance for undertakings on materiality assessment.
Eurosif said performing those materiality assessments robustly would be key to the success of the ESRS, so reporting companies, advisors, consultants, auditors and assurance providers involved in the process needed to upskill key staff to ensure a sufficient degree of expertise on sustainability.
Alignment with GRI and ISSB
There is more harmony among stakeholders on the steps taken to ensure the ESRS are compatible with global reporting standards in an effort to simplify life for companies faced with the need to satisfy the requirements of several reporting frameworks.
The Commission said the rules had been drawn up to “ensure a very high level of alignment” between ESRS and the standards of the International Sustainability Standards Board (ISSB) and the Global Reporting Initiative (GRI), with which it worked closely in drawing up the rules.
GRI’s CEO Eelco van der Enden said: “As provider of the world’s most widely used standards for impacts, we support the maximum level of interoperability between ESRS and GRI, which will mean double reporting by companies can be avoided.” He also said GRI remained committed to continued collaboration with the ISSB to arrive at the global comprehensive baseline for sustainability reporting.
