On 5 January 2023, the Corporate Sustainability Reporting Directive (CSRD) entered into force.

The CSRD replaces the Non-Financial Reporting Directive (NFRD) and extends reporting requirements regarding people and the environment, responsible corporate governance, and supply chain responsibility (the CSRD is explained in our blog of 22 December 2022). Undertakings subject to the CSRD are required to report in compliance with European Sustainability Reporting Standards (ESRS). These standards must be adopted by the European Commission (EC) by means of delegated acts, specifying the content and, where relevant, the structure to be used to present that information. On 9 June 2023, the EC published the draft delegated act containing these ESRS which is open for feedback until 7 July 2023. The final ESRS are expected to be adopted in July 2023.

The EC based their draft ESRS on the drafts as published in November 2022 by EFRAG. The EC aimed to reduce undertakings’ burden and costs, making the draft ESRS less binding or less extensive. At a first glance we expect that there is more flexibility for undertakings to report on specific data, however the assessment itself is not likely to be less extensive or complex than under the previous draft versions. Undertakings will still need to perform a materiality assessment, according to a strict process. The reduction as proposed by the EC may eventually however result in less extensive disclosures to be included in management reports. 

On 14 June 2023, the EFRAG hosted its EFRAG Sustainability Reporting Board webcast which was dedicated to a presentation from the EC about the EC-ESRS. The EC explained its reasons for reducing the reporting requirements with approximately 25%. The primary reason being to account for proportionality and flexibility, at the start of the reporting period and especially for smaller undertakings. For ease of reference, this blog refers to EFRAG-ESRS (meaning the ESRS as proposed by EFRAG) and the EC-ESRS (as published for consultation by the EC).

  • Structure of the ESRS

    Before discussing the most important modifications to the EC-ESRS compared to the EFRAG-ESRS, this section provides a high-level overview of the structure of the ESRS.

    There are three categories of ESRS:

    • Cross-cutting standards
    • Topical standards (Environmental (E), Social (S) and Governance (G)
    • Sector-specific standards: these (draft) standards are not yet available; the EC should adopt sector-specific standards by June 2024

    The structure of the EC-ESRS has not changed from the EFRAG-ESRS: the EC-ESRS consists of 12 standards, including two cross-cutting standards and 10 topical standards (five on environmental, four on social and one on governance).

    NB. Topical ESRS can include specific requirements that complement the general level disclosure requirements of ESRS 2. For example, the minimum disclosure requirements regarding policies, actions, metrics, and targets of ESRS 2 should be applied together with the corresponding disclosure requirements in the topical (and later on the sector specific) ESRS. Appendix C of ESRS 2 provides a list of the additional requirements in topical ESRS that undertakings shall apply in conjunction with the general level disclosure requirements of ESRS 2. 

    The disclosure requirements included in the ESRS are structured into the following reporting areas:

    • Governance (GOV)
    • Strategy and business model (SBM)
    • Impact, risk and opportunity (IRO)
    • Metrics and target (MT)

    What this means is that, for example, ESRS 2 IRO-2 refers to the second disclosure requirement on ‘impact risk and opportunity’ of ESRS 2.

  • Important modifications to the EC-ESRS compared to the EFRAG-ESRS

    1. Less mandatory materiality
    Under de CSRD, undertakings must perform a materiality assessment to determine which ESRS, disclosure requirements and datapoints are ‘material’ for the undertaking. However, in the EFRAG-ESRS, certain parts of specific ESRS were automatically designated as material (i.e. mandatory to report on). The EC-ESRS are now amended in such a way that all ESRS, disclosure requirements and datapoints are subject to a materiality assessment, except for the disclosure requirements specified in ESRS 2 ‘General disclosures’. ESRS 2 must be reported on regardless. 

    This modification does not mean that undertakings are entirely free to choose whether or not to perform a materiality assessment or to determine whether a topic is material. This decision must be based on a materiality assessment made in accordance with the reporting requirements, which will also have to be audited. The modification does allow more flexibility in disclosure on the reasons why a topic is material or not. Under the EC-ESRS, undertakings are no longer required to report on why a topic covered by a specific standard is not material; they can however voluntarily choose to do so anyway. While this provides undertakings with more flexibility in their reporting obligations, it may also lead to further complexities and questions by third parties on how an undertaking came to a conclusion that a topic is not material. For example, the EC-ESRS now allow undertakings to determine that climate change is not a material topic, which is likely to raise questions as almost every undertaking has published a climate strategy. For that reason alone, it may be beneficial for undertakings to voluntarily explain why certain topics are not considered material. 

    Appendix E of ESRS 1 contains a flowchart which provides an (non-binding) illustration of the impact and financial materiality assessment.

    2. Phasing-in of certain requirements
    In addition to the phase-ins proposed by EFRAG, the EC has provided for further phase-ins for disclosure requirements or datapoints in topical ESRS.

    Generally, a distinction can be made between phase-ins for specifically undertaking or groups with an average number of 750 employees, and for all undertakings.

    All undertakings may omit in the first year: anticipated financial effects related to non-climate environmental issues (pollution, water, biodiversity, and resource use), and certain datapoints related to their own workforce (social protection, persons with disabilities, work-related ill-health, and work-life balance) (light green in the above-mentioned schedule). For the first three years, for some ESRS, a lighter reporting form may be used (dark green in the schedule).

    Undertakings or groups not exceeding on their balance sheet dates the average number of 750 employees during the financial year (on a consolidated basis where applicable) may omit:

    a) In the first year they apply the standards (orange in the schedule): scope 3 GHG emissions data (ESRS E1, disclosure requirement E1-6) and the disclosure requirements specified in the standard on 'own workforce' (ESRS S1). 

    b) In the first two years they apply the standards (blue in the schedule): the disclosure requirements specified in the standards on biodiversity (ESRS E4), on value-chain workers (ESRS S2), affected communities (ESRS S3), and consumers and end-users (ESRS S4). However, undertakings shall nevertheless disclose whether the sustainability topics covered in these ESRS have been assessed to be material as a result of the materiality assessment, and if so the undertaking shall, for each material topic: 

    1.) Disclose the list of matters (i.e. topic, sub-topic or sub-sub-topic) in AR 16 in Appendix A of ESRS 1 that are assessed to be material and how the undertaking’s business model and strategy take account of the impacts of the undertaking related to those matters. The undertaking may identify the matter at the level of topic, sub-topic or sub-sub-topic.

    2.) Briefly describe any time-bound targets it has set related to the matters in question, the progress it has made towards achieving those targets, and whether its targets related to biodiversity and ecosystems are based on conclusive scientific evidence. 

    3.) Briefly describe its policies in relation to the matters in question. 

    4.) Briefly describe actions it has taken to identify, monitor, prevent, mitigate, remediate or bring an end to actual or potential adverse impacts related to the matters in question, and the result of such actions. 

    5.) Disclose metrics relevant to the matters in question.

    3. Making certain disclosures voluntary
    In addition to the EFRAG-ESRS, the EC has further converted a number of the mandatory datapoints of the EFRAG-ESRS into voluntary datapoints. In that regard, the following terms are used in ESRS to distinguish the different degrees of obligation on the undertaking to disclose information:

    • 'Shall disclose': indicates that the provision is prescribed by a disclosure requirement or datapoint 
    • 'May disclose': indicates voluntary disclosure to encourage good practice

    In addition, the term 'shall consider' is used when referring to issues, resources or methodologies that the undertaking is expected to take into account or to use in the preparation of a given disclosure if applicable.

    An example of a mandatory datapoint that has now been turned into a voluntary datapoint is the datapoint on biodiversity transition plans (ESRS E4, disclosure requirement E4-1). Where the EFRAG-ESRS stated that an "undertaking shall disclose its plan", the EC-ESRS states that an "undertaking may disclose its transition plan." Another example is the datapoint on targets related to pollution (ESRS E2, disclosure requirement E2-3). Where the EFRAG-ESRS stated that an "undertaking shall specify whether (local) ecological thresholds (…) and entity-specific allocation were taken into consideration when setting targets", the EC-ESRS states that an "undertaking may specify whether ecological thresholds (…) and entity-specific allocation were taken into consideration when setting targets."

    Another important change, as mentioned above, is that, as part of their materiality assessment, undertakings are no longer required to explain why an item was found to be immaterial. In that case, undertaking may voluntarily disclose a brief explanation of the conclusions of the materiality assessment for that topic (ESRS 2, disclosure requirement IRO-2).

    4. Further flexibility in certain disclosures
    The EC has also introduced certain flexibilities for some of the mandatory datapoints. For example, there are additional flexibilities in the disclosure requirements on the financial effects arising from sustainability risks and on engagement with stakeholders, and in the methodology to use for the materiality assessment process. Furthermore, the EC has modified datapoints regarding corruption and bribery and regarding the protection of whistleblowers that might be considered to have infringed on the right not to self-incriminate.

    5. Coherence with EU legal framework and interoperability with global standard-setting initiatives
    The EC-ESRS have been amended in such a way that there should be a high degree of interoperability with the International Sustainability Standards Board and the Global Reporting Initiative. The EC-ESRS also no longer contain references to private sector data sources and the EC suggested that the EFRAG provides further guidance on sources undertakings can rely on.

    6. Editorial and presentation modifications
    The EC-ESRS should improve the clarity, usability and coherence of the ESRS in general. For example, the EC-ESRS has one annex with all acronyms and terms used in all ESRS combined, as opposed to the EFRAG-ESRS where each ESRS had a separate annex of definitions.

    Being expected
    Lastly, a few items that are to be expected with regard to the ESRS:

    • The CSRD requires the EC to adopt by June 2024 sector-specific ESRS, proportionate ESRS for listed SMEs, and ESRS for non-EU undertakings.
    • The Commission is putting in place an interpretation mechanism to provide formal interpretation of the ESRS. Also, the EC has asked EF-RAG to publish additional guidance and educational material, addressing the materiality assessment process and other issues.

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