ESRS adopted by the Commission

On 31 July 2023, the Commission adopted a Commission Delegated Regulation with the first set of the long-awaited European Sustainability Reporting Standards (ESRS) together with a related Q&A developed by EFRAG (previously the European Financial Reporting Advisory Group).  The ESRS support the CSRD in specifying the content and structure of the sustainability information to be disclosed by companies pursuant to the CSRD. 

A recap on the Corporate Sustainability Reporting Directive (CSRD)

The CSRD expands and replaces the Non-Financial Reporting Directive (2014/95/EU) (NFRD) and in doing so significantly increases the scope of companies required to publish sustainability disclosures. It introduces additional detailed reporting requirements in relation to a company’s impact on the environment, human rights and social standards and sustainability-related risks and how such matters affect the company’s development, performance and position. It aims to make businesses more accountable, end ‘greenwashing’ and lay the groundwork for sustainability reporting standards at global level.  The CSRD also notably contains the concept of double materiality, i.e. explicit reporting of the company’s impact on people and the environment (impact materiality) as well as reporting how social and environmental issues create financial risks and opportunities for the company (financial materiality).

The CSRD requires in-scope companies to disclose sustainability information in accordance with the mandatory ESRS which set out the environmental, social and human rights and governance factors including the specific reporting requirements as set out in summary below and further detailed under the heading “European Sustainability Reporting Standards (ESRS) – what needs to be disclosed?” below:

• A description of a company’s business model and strategy;
• Sustainability targets and the role of management in achieving those targets;
• The company’s policies on sustainability matters;
• A description of implemented due diligence process on sustainability matters;
• Information about the existence of incentive schemes linked to sustainability matters;
• The principal actual or potential adverse impacts on the company’s value chain and actions to remedy those impacts,
• Principal risks on sustainability matters and indicators relevant to those disclosures.

Scope of the CSRD

The ESRS create a common framework for sustainability reporting for all companies subject to the CSRD which entered into force on 5 January 2023 and will be applied in stages from 1 January 2024. The table below sets out the types of companies which are in-scope for the CSRD and when they need to start complying:

Penalties for non-compliance

The CSRD does not include direct sanctions for non-compliance.  However, a failure to report sustainability information or filing incomplete or inaccurate reports would breach the Accounting Directive (2013/34/EU).  The Accounting Directive gives Member States the discretion to set penalties for breaching the national provisions adopted in accordance with the Accounting Directive and Member States are encouraged to take all necessary measures to ensure the enforcement of such penalties.  As the CSRD has not yet been implemented in Member States, we will have to wait to see what the penalties will be and if they are different to the penalties imposed in each individual Member State in respect of the preceding NFDR (which the CSRD amends).

European Sustainability Reporting Standards (ESRS) – what needs to be disclosed?

The Delegated Regulation sets out the ESRS that apply to all undertakings under the scope of the CSRD regardless of which sector or sectors the undertaking operates in.  Annex I of the Delegated Regulation sets out the standards as explained below.  Annex II contains the list of acronyms and glossary of definitions to be used for the ESRS.

Cross-cutting ESRS

ESRS applicable subject to materiality assessment

The other standards (set out below) and the individual disclosure requirements and datapoints within them are the subject of a materiality assessment.  The standards are not voluntary but companies are required to report relevant information only and may omit information which is not relevant (“material”) subject to a materiality assessment process (which needs to be externally assured in accordance with the Accounting Directive).  If a company determines that the climate change is not a material topic, it has to provide a detailed explanation as to why it is not material reflecting the wide-ranging and systematic impacts of climate change across the economy. The Commission has asked EFRAG to prepare additional guidance for undertakings on carrying out a materiality assessment.

Points to Note

The Commission departed from the draft standards which were submitted by EFRAG. They have said these “modifications ensure that the standards are proportionate, without undermining the achievement of the policy objectives”1. We set out the main modifications below:

• Materiality – instead of certain Standards being mandatory for all companies, companies have the flexibility to decide what is relevant/material to them in respect of all the ESRS (excluding ESRS 2).  This reduces a company’s costs of complying with provisions which are not relevant.  Only ESRS 2 is mandatory for all companies.

• Phase-in provisions – the Commission has introduced additional phase-in provisions to those originally suggested by EFRAG.  These apply mainly to companies with fewer than 750 employees and reflect the relative costs of reporting being higher for smaller companies and the fact that they may not have previously done sustainability reporting.  The phase-in applies to certain reporting requirements, such as biodiversity and various social issues. The phase-in postpones such reporting requirements for 1 or 2 years depending on the reporting requirement for the companies concerned.

• Voluntary  standards – the Commission converted a number of the reporting requirements which were mandatory into voluntary provisions, such as reporting a biodiversity transition plan and certain indicators about self-employed people and agency workers in the undertaking's own workforce.  These datapoints were considered to be challenging or costly for companies to comply with. 

There have been criticisms of the Commission-adopted standards in the market, especially in relation to making certain disclosures voluntary or subject to materiality determinations rather than mandatory.  Some regard this as a roll back of the ambition compared to that envisaged by EFRAG.  Others are concerned about companies making materiality assessments, although this is tempered by the assurance required in respect of these determinations and the requirement to explain in detail if the climate change disclosures are not relevant.  Though it is difficult to envisage situations where the climate change impacts, risks and opportunities would not be relevant.

Any companies that determine disclosure of key climate indicators (including Scope 1, 2 and 3 greenhouse gas emissions), biodiversity plans and other indicators not to be relevant may present challenges for financial market participants when disclosing under the Sustainable Finance Disclosure Regulation ((EU) 2019/2088) (SFDR). This seems to be contrary to the aims of the EU’s Sustainable Finance Action Plan given that one of the Commission’s intentions for the ESRS is to ensure that:

• financial market participants have the information needed to comply with their disclosure obligations under the SFDR; and
• the ESRS are consistent with the EU Taxonomy by taking into account the indicators companies have to disclose about the extent to which their activities are environmentally sustainable. 

International interoperability?

ESRS will continue to work with the ISSB to optimise the interoperability of overlapping ESRS and the ISSB standards set out above.  The Commission has worked to ensure a high level of alignment of the ESRS with Global Reporting Initiative (GRI) and ISSB.  As previously mentioned, the intention for the UK SDS is for it to also closely align with ISSB standards.

For those companies reporting under ESRS, they will find that the same information is largely required for climate-related disclosures under ISSB.  However, the ESRS are more ambitious than the ISSB climate-related disclosure requirements and go further for example by requiring additional information on impacts relevant for users other than investors, such as business partners, trade unions, social partners and academics. 

Equivalent UK Sustainability Disclosure Standards

On 2 August 2023, the Department for Business and Trade published a webpage setting out the UK government’s intention to create UK Sustainability Disclosure Standards (UK SDS) which will cover corporate disclosures on the sustainability related risks and opportunities that companies face. The standards will form the basis of future legislative or regulatory requirements for corporate sustainability reporting in the UK.

The UK SDS will be based on the IFRS® Sustainability Disclosure Standards issued by the International Sustainability Standards Board (ISSB). The ISSB published its first two new standards on 26 June 2023.  They are:

• IFRS S1: General Requirements for Disclosure of Sustainability-related financial information

• IFRS S2: Climate-related Disclosures

By using the IFRS Sustainability Disclosure Standards as a baseline, the aim is for the information companies disclose under UK SDS to be globally comparable and decision-useful for investors. The disclosures required by these standards will help investors to compare information between companies, thereby aiding decision making; supporting the efficient allocation of capital, and smooth running of the UK’s capital markets.

As set out in the UK 2023 Green Finance Strategy, the UK is assessing the suitability of IFRS S1 and IFRS S2 for endorsement in the UK and the creation of the first 2 UK SDS.  The UK government aims to make endorsement decisions on the standards by July 2024. UK endorsed standards will only divert from the global baseline if absolutely necessary for UK specific matters.

Following endorsement, UK SDS may be referenced in any legal or regulatory requirements for UK entities. Decisions to require disclosure will be taken independently by the UK government, for UK registered companies and limited liability partnerships, and by the Financial Conduct Authority (FCA) for UK listed companies.

Next steps

The European Parliament and the Council of the EU will formally scrutinise the Delegated Regulation for two months, extendable by a further two months during which time they may reject it, but they cannot amend it.  The CSRD additionally requires that the Commission adopt sector-specific standards, proportionate standards for listed SMEs and standards for non-EU companies by June 2024. EFRAG is working on the second set of draft ESRS.

EFRAG will periodically publish additional non-binding technical guidance on the ESRS.  We expect EFRAG to focus on guidance for materiality assessments and reporting in value chains for public consultation in the near future.  EFRAG will host a portal for technical questions on the application of ESRS.  Where appropriate the Commission will consider providing guidance on legal interpretation of ESRS.

On the UK SDS, the UK government aims to make endorsement decisions on the first set of standards by July 2024.

Our Sustainable Finance & Investment practice brings together a multidisciplinary global team to support our clients in this mission-critical area. 

This note is intended to be a general guide and covers questions of law and practice.  It does not constitute legal advice.

Authored by Emily Julier, Melanie Johnson.