European Sustainability Reporting Standards: the introduction and formalisation of concepts

Note: The European Commission on 31 July formally adopted the European Sustainability Reporting Standards (ESRS). Get the latest update here.  

With the publication of the first set of draft European Sustainability Reporting Standards (ESRS) came the introduction of new concepts, the formalising of definitions and an expansion of the previous expected scope of sustainability reporting. The publication of the draft ESRS is an integral part of the implementation of the Corporate Sustainability Reporting Directive (CSRD) and the EU’s vision for corporate sustainability reporting that will support the European Green Deal. This step is intended not only to boost the transparency and comparability of corporate reporting, but also to enhance stakeholder dialogues and engagement around sustainability issues. With this scale in mind, issuers will benefit from proactively engaging with the ESRS to continue to deliver impactful reporting that is appreciated by investors and regulators alike.

New coverage: What, how and when

Mandated under the CSRD, the greatest change being facilitated by the ESRS is the coverage of mandatory reporting requirements within the European Union. The reporting framework outlined by the ESRS will bring a host of topics previously limited to the purview of voluntary reporting initiatives into the realm of regulation. In November 2022, EFRAG, the body tasked with the development and oversight of the ESRS, presented 12 draft sector-agnostic standards to the European Commission. The body of work comprises two cross-cutting standards (ESRS 1 and ESRS 2) and 10 topical standards (5 environmental, 4 social and 1 governance).

EFRAG’s full set of draft standards and categorisations are as follows (further explanatory notes and guidance can be found here).

Recognisable from other voluntary initiatives, and popularised by the Taskforce on Climate-related Financial Disclosures (TCFD), the topical standards aim to cover the reporting areas of: a) governance, b) strategy, c) impact, risk and opportunity management, and d) metrics and targets. While most corporates in the Nordics will now be aware of the requirements of the TCFD and may have applied them to climate reporting in the past, the expansion of this reporting approach to other topics has significantly increased the scope of the exercise.

In order to disclose across these four reporting areas in earnest, corporates are likely to need to dedicate additional resources not just to reporting, but perhaps more importantly to data collection, analysis and forecasting. To provide the breadth and depth of insight that regulators and investors will come to expect, corporates must set aside ample time for the analysis of sustainability data and ensure that internal stakeholders throughout the business are brought into the exercise.

New concepts and definitions

The practical implementation of the CSRD, enabled by the introduction of the ESRS, is a broad and ambitious endeavour, expanding the number of companies mandated to report sustainability data from approximately 11, 700 to over 50,000 over a 5-year period. As is the nature of such tasks, the drafting of the ESRS has required the formalisation of complex ideas and definitions as well as the introduction of new concepts. Perhaps the most influential of these concepts is that of “double materiality” as the basis for sustainability disclosures.

Double materiality

The two dimensions of double materiality – “impact materiality” and “financial materialiy” – have been defined in ESRS 1, the general requirements draft standard. The two dimensions are considered to be interrelated, and any impact identified under either or both of these dimensions should be considered a “principlal material impact” and thus disclosed in sustainability statements.

Stakeholders

In addition to providing guidance for how to consider the interdependencies of the two dimensions of double materiality, ESRS 1 provides definitions of two main stakeholder groups, introducing the concept of “affected stakeholders” and “users of sustainability statements.” Broadly, affected stakholders are closer to the impact materiality dimension and users of sustainability statements are more closely connected to the financial materiality dimension, although these lines certainly cross.

The definitions and guidance provided in the latest draft ESRS are also applicable elsewhere and improve the usability of other European sustainability-related regulation. For example, ESRS 1 outlines that the “affected stakeholders” group should be considered as part of an organisation’s ongoing due dilligence, as well as informing the basis for the asessment and reporting of material sustainability impacts.  While some specific reporting requirements have been outlined in the ESRS 2, the general disclosures draft, the stakeholder definition provided aligns with wording used to identify appropriate stakeholders in the Corporate Sustainability Due Dilligence Directive (CDDD). This alignment across legislation and guidance improves the interoperability for users and provides opportunity for those who are early to engage.

Our recommendations

With the components of European sustainability regulation beginning to fall into place, our general recommendation is to engage with new concepts and definitions proactively. It is becoming increasingly common that definitions, disclosure requirements and incentives are shared across legislation. Early engagement in one area will likely save time and resources when pursuing compliance elsewhere. Furthermore, it will crate a strong position from which to approach the sector-specific standards, recently postponed and now expected approximately one year from now.

Specifically with regards to the concepts formalised in the ESRS, it would be prudent for reporting entities to:

1. Align on sustainability reporting requirements across internal teams and stakeholders. The investor expectation that sustainability-related targets are embedded within the organisation and that appropriate forecasting and analysis have been carried out is now a more formalised requirement under the draft ESRS.
2. Engage in data collection early, particularly across the value chain. Upstream and downstream impacts should now be considered under the draft ESRS. Sufficient consideration and reporting of these impacts will require data to be sourced from outside the organisation, potentially for the first time.
3. Involve key management members in the process, particularly for forward-looking and organisational perspectives. Investors have long appreciated sustainability reporting that provides insight into strategy, the business model and resource allocation – this is now expected under the ESRS too.