Last week, the European Commission unveiled its long-awaited revision of the European Sustainability Reporting Standards (ESRS). These standards will govern the inclusion of sustainability information in companies' management reports, in line with the Corporate Sustainability Reporting Directive (CSRD). The Commission has made significant changes to the reporting standards, raising concerns about their ability to meet the ambitions of the CSRD.
The CSRD, and the ESRS by extension, are crucial elements of the EU's sustainable finance framework. By significantly improving the availability and quality of corporate sustainability information, it should play a key role in promoting transparency and enabling investors to make informed decisions based on environmental, social and governance (ESG) factors.
The European Financial Reporting Advisory Group (EFRAG) had previously released a draft version of the standards in November 2022. Among other things, this draft imposed a number of mandatory disclosures, irrespective of the materiality assessments made by report preparers. These include key disclosures such as GHG emissions, human rights abuses and gender pay gaps, in line with the Sustainable Finance Disclosure Regulation (SFDR). The draft standards were broadly in line with the EU's regulatory framework for sustainable finance and banking prudential legislation, and have been commended by European supervisory authorities.
ESRS lightened
However, most of these alignment efforts have disappeared in the revised ESRS. All mandatory disclosures have been removed from the revised standards, raising concerns about their effectiveness and impact on the wider sustainable finance landscape. The revised standards have introduced greater flexibility, allowing some disclosures to become optional and providing phase-in periods for others. This change reflects the European Commission's attempt to reduce the reporting burden while meeting the objectives of the Corporate Social Responsibility Directive (CSRD).
Not all ESG topics are relevant to a given company. Using a process called "materiality analysis", report preparers will have to select ESRS information for that which is relevant to their respective companies. But materiality analysis is not an exact science. It lacks standardised methodologies and companies are free to define their own thresholds for what constitutes a material ESG subject. Without a minimum set of mandatory indicators, ESRS would not meet the CSRD's objective of creating a fully harmonised transparency framework for ESG information.
If sustainability-related information is to be put on an equal footing with financial information, selective disclosure should be discouraged. No company would fail to publish its cash flow statement because it does not consider it particularly relevant. The same should apply to important sustainability information.
What about banks?
The timing of the adoption of the CSRD, after regulations such as the SFDR, has been the subject of debate. Nevertheless, its ambition to set robust sustainability reporting requirements for a wider range of companies has been heralded as an indispensable piece in solving the sustainable finance puzzle. Financial institutions will likely feel stood up, as the availability of comprehensive ESG data remains crucial for them to meet their own current and future reporting requirements. Unfortunately, the revised ESRS seems unlikely to help financial institutions fully achieve this.
The Sustainability Reporting Standards are now subject to a short public consultation until 7 July. The Commission is then expected to adopt the ESRS via a delegated regulation later this month. The European Parliament and the Council of the European Union will have a minimum of two months to examine the adopted text. It will enter into force if neither of them objects. In the meantime, stakeholders from various sectors, in particular financial institutions, will be eagerly following the development of the standards, given that the first round of sustainability reporting under the Sustainability Directive is already expected in 2025.
The draft delegated regulation and its annexes adopting the European Sustainability Reporting Standards are available here.