European Sustainability Reporting Standards: A mixed bag for promoting sustainable practices
By On 31 July 2023, the European Commission adopted the first set of European Sustainability Reporting Standards (ESRS). A significant stride towards promoting sustainable practices. These standards - set to be used by all companies under the Corporate Sustainability Reporting Directive (CSRD) - come with a mixed bag of progress made and loopholes to be closed.
The progress made:
- Comprehensive impact reporting: Companies will now be mandated to disclose their impacts on both people and the planet; information that was previously elusive. Impact reporting will empower stakeholders with reliable data to assess companies’ sustainability performance effectively.
- Linking impacts to business models: Companies are now obligated to disclose how impacts on people and the planet are connected to their business models, and how they plan to rectify adverse effects. This requirement could drive companies to re-think linear and unsustainable business models. A big win for the transition towards more sustainable practices!
- Value chain reporting: Companies must now go beyond reporting internal operations and consider the entire life cycle of products and services. For example, a paper company will need to report the impact of harvesting trees to produce their paper products. By reporting impacts throughout the value chain, companies will be encouraged to collaborate with supply chains, promoting greater accountability and sustainable practices throughout the industry.
The loopholes:
- Materiality assessment flexibility: The ESRS rely on a materiality assessment to determine the information that companies must disclose. However, the standards lack detailed guidance on how to define scores and thresholds. This means that companies are left to self-determine which topics are material to a company, putting reliable and comparable results at risk.
- Limited disclosure obligations: Companies are only required to describe the results of their materiality assessment when they determine that climate and workforce issues are not material. For other issues, such as pollution or resource use, companies are not obliged to explain how they reached their conclusions. This only raises transparency concerns.
- Voluntary disclosures: The standards include many voluntary disclosures, meaning that when a company deems a topic as material, it may not need to report on all relevant disclosures. This opens the door to greenwashing and makes it challenging for stakeholders to make informed decisions.
- Unnecessary additional phase-ins: The European Commission introduced additional phase-ins for companies smaller than 750 employees. Consequently, and despite the urgent need to address environmental and social challenges, sustainability data users (such as investors) will have to wait until 2030 for the full picture of data from the ESRS. In addition, limited value chain reporting during the initial three years will hinder much needed transparency and collaboration across the value chain.
Strengthening the ERSR effectiveness
These standards – the first of their kind – represent one of many steps towards more sustainable business practices. While the ESRS offer much needed advancement in sustainability reporting, there is work to be done to make them airtight against greenwashing.
Implementation guidance – currently being drafted – will be key in bolstering the ESRS and promoting corporate sustainability. By providing clear instructions on materiality assessments and value chain reporting, the EU can ensure transparency and reliability in sustainability reporting. Ultimately, this will empower stakeholders to make well-informed decisions and drive overdue progress toward more sustainable practices.
The timeline
It is now expected that the ESRS will pass into law (as is) by the end of 2023. Large companies already subject to the Non-Financial Reporting Directive must comply with the CSRD from 1 January 2024.
