ESRS European Sustainability Reporting Standards

On July 31, 2023, the European Commission adopted the European Sustainability Reporting Standards (ESRS), enhancing Directive 2013/34/EU of the European Parliament and of the Council regarding sustainability reporting standards for companies subject to the Corporate Sustainability Reporting Directive (CSRD).

This delegated act, grounded in Article 29b (1), first subparagraph, of the Accounting Directive, delineates the ESRS that companies must use to fulfill their sustainability reporting obligations in line with Articles 19a and 29a of the Accounting Directive. The adoption of ESRS represents a significant step towards harmonizing ESG disclosures across regulations and setting the stage for interoperability in ESG reporting.

For the first time at an EU-wide level, companies are required to report ESG and corporate sustainability information in a standardized, comparable, and consistent format, establishing high-quality ESG reporting as a business standard. Approximately 50,000 European companies, along with non-EU companies with significant branches in the EU, must comply with ESRS. While this progress helps combat corporate greenwashing, it also presents considerable challenges for many companies, especially those new to sustainability reporting.

Legal reporting obligations on corporate sustainability are often dispersed across multiple legal frameworks. Despite the inclusion of over 40 legal cross-references in the CSRD, their primary aim is to create consistency in disclosure requirements. By achieving this, the CSRD not only enhances the value of sustainability reporting but also simplifies the process for both preparers and users. The following briefing provides concise definitions of the essential cross-references, improving understanding of the mandatory measures outlined in the directive and clarifying implications for companies preparing their management reports.

By standardizing sustainability reporting, the CSRD ensures that the information provided is clear, comparable, and useful for everyone involved.

The Non-Financial Reporting Directive (NFRD) and the Corporate Sustainability Reporting Directive (CSRD) are two key legislative measures by the European Union aimed at enhancing corporate transparency and accountability on social and environmental issues.

The CSRD significantly expands its scope compared to the NFRD, increasing the number of covered companies from 11,000 under the NFRD to about 42,500 within the EU. Additionally, several thousand non-EU companies will also fall under these new rules.

The directive covers various types of companies as listed in Annex I of the Accounting Directive (2013/34/EU), primarily targeting public and private companies limited by shares or by guarantee. For non-EU companies, the directive applies to those with legal forms comparable to the listed types.

The CSRD applies to several categories of companies based on specific size criteria, including large, small, and medium public-interest entities (PIEs), such as:

• Listed companies on regulated markets recognized by national authorities and compliant with EU rules on financial instruments.
• Credit institutions and insurance companies, including cooperatives. Member States may exclude central banks and certain public credit institutions at their discretion.

In EU law, a branch is defined as a place of business distinct from the head office, lacking legal personality, and engaged in activities or investment services, including the reception and transmission of orders for financial instruments.

It's worth noting that some SMEs have been granted three additional years to achieve compliance with the CSRD and may opt out until 2028.

The rollout of the ESRS digital taxonomy for the Corporate Sustainability Reporting Directive (CSRD) reporting appears to be set for 2025.

The ESRS are the new mandatory standards set by the EU that companies under the CSRD must follow. These standards aim to ensure that relevant companies provide reliable, comparable, and pertinent sustainability data, clearly defining what needs to be reported. Developed by the European Financial Reporting Advisory Group (EFRAG) and adopted by the Commission through a delegated regulation, the first wave of companies will need to start disclosing this information as early as the 2024 reporting period.

Article 1 of the CSRD introduces new articles (19a and 29a) in the Accounting Directive, specifying with various levels of detail what information must be disclosed on environmental, social, and governance (ESG) matters. Companies are required to disclose information in five areas:

1. Business model
2. Policies, including due-diligence processes
3. Outcomes of these policies
4. Risks and risk management
5. Key performance indicators relevant to the business

Different sets of ESRS are designed for various types of companies within the CSRD’s scope: the full ESRS for listed and large companies, a standard for listed SMEs, and a standard for third-country companies.

The ESRS package includes the Commission’s Delegated Act, which outlines two Cross-Cutting Standards ( ESRS 1 and ESRS 2) and ten specific sustainability standards for reporting on environmental, social, and governance issues (Topical Standards). These standards reflecting ESG dimensions. Each standard is indicated by a letter and number (e.g., ESRS E1 focuses on environmental aspects related to the climate change). They are structured into sustainability topics, sub-topics, and sub-sub-topics.
Starting in 2027, companies will report on sector-specific disclosures once these standards are adopted by the EU. Until then, companies must determine sector-specific material information independently.

Standards for listed SMEs:
These standards are simpler than the full ESRS and are proportionate to SMEs' capacity to report, considering their scale and complexity. They include requirements on sustainability matters and targeted metrics for performance assessment. The standards for listed SMEs are expected to be adopted by June 2024 and will apply from fiscal year 2026, with a possible two-year opt-out option. ( currently published by EFRAG as draft)

Voluntary standards for SMEs:
Non-listed SMEs, which are outside the CSRD's scope, can use these standards voluntarily. They focus on narratives regarding the company's policies, actions, and targets without the need for data assurance. A materiality assessment is still required. ( currently published by EFRAG as draft)

Standards for third-country companies:
These standards specify the information required in sustainability reports for non-EU companies with significant EU operations, including an annual net turnover of EUR 150 million in the EU and at least one subsidiary or branch. These standards are to be adopted by June 2026 and applied from fiscal year 2028. They focus on the sustainability performance and impacts of these companies.

Additionally, the CSRD allows the European Commission to recognize equivalent sustainability standards from non-EU jurisdictions, enabling third-country companies to use these standards if granted equivalence status by the EU.

Disclosure Requirements (DR): These encompass all the information that must or can be disclosed within the different categories of the ESRS.

Application Requirements (AR): These support the application of Disclosure Requirements and hold the same authority. They provide further guidance for entity-specific disclosures and help determine the relevant disclosures for each company. The ARs ensure that the qualitative characteristics of the information, such as relevance and faithful representation, are maintained.

Datapoint (DP): The smallest, most specific reporting element within the disclosure requirements. Datapoints can be narrative (e.g., describing stakeholder engagement) or quantitative (e.g., the percentage of employees in collective bargaining agreements). ESRS 2 and the topical standards collectively include over 1,000 datapoints, but companies only need to report those deemed material.

Impacts, Risks, and Opportunities (IROs): These refer to environmental, social, and governance issues relevant to a company's operations and value chain that must be reported. Only material IROs need to be disclosed.

Entity-Specific Disclosure: When specific IROs are not covered or sufficiently detailed in the ESRS but are considered material by the company, additional disclosures can be provided. This helps users understand the specific impacts, risks, or opportunities. Until sector-specific standards are fully developed, companies must identify and report these material IROs themselves, potentially using other frameworks like IFRS or GRI Sector Standards.

Materiality Assessment: ESRS 1 requires companies to perform a materiality assessment using the principle of double materiality, which considers both the relevance of impacts and financial materiality. This assessment determines the material information to be disclosed and which IROs need reporting, based on the company's specific context and value chain.

The detailed structure and requirements of the ESRS are designed to provide a comprehensive framework for sustainability reporting, ensuring consistency and comparability across the EU (ESRS).

ESAP: A Centralized Digital Platform for EU Company Information

The ESAP (European Single Access Point) is designed to provide a single digital access point for both financial and non-financial information about EU companies and investment products.

The Corporate Sustainability Reporting Directive (CSRD) broadens the scope of reporting obligations to include international companies. It applies to:

• Third-country companies with securities listed on an EU regulated market (approximately 100 companies, according to the European Commission's estimate).
• Non-EU companies that generate over EUR 150 million in net turnover within the EU and have a subsidiary or a branch with a net turnover of at least EUR 40 million in the EU, or a listed subsidiary in the EU that is an SME or a large company.

Though there are no official figures on the number of third-country companies with significant EU business, Refinitiv, a global financial market data provider, estimates that around 11,000 companies headquartered outside the EU could be affected by these reporting obligations, including about 1,000 in the UK and over 3,000 in the US.

The directive mandates that branches or subsidiaries are responsible for publishing their controlling company's sustainability report. This report must be in a language accepted by the Member State where they are registered.

From 2028 onwards, third-country companies meeting these criteria have the following options for reporting their sustainability information:

• Use the standards for third-country companies.
• Use the full set of European Sustainability Reporting Standards (ESRS) available at that time.
• Use their own domestic reporting rules, provided these rules are deemed equivalent to the ESRS by the European Commission. This applies to both third-country companies and parent companies outside the EU consolidating their EU subsidiaries' reports. The European Commission assesses equivalence on a country-by-country basis upon request.

The European Commission will publish a list of third-country companies that have applied the ESRS on its website, based on information from EU Member States.

While the CSRD allows third-country companies to use equivalent sustainability standards, the specific standards deemed equivalent have not yet been decided. Equivalent standards will only be available for reporting at the parent-company level outside the EU; EU subsidiaries must use the ESRS for their reporting.

The criteria for assessing the equivalence of sustainability reporting standards used by third-country issuers will ensure that these standards require:

• Disclosure of information on environmental, social, and governance factors.
• Reporting the impacts the company has on sustainability matters and how these affect the company's development, performance, and position.

This means the standards must incorporate double materiality. Policymakers worldwide can align their national reporting standards with the ESRS to facilitate future equivalence and support their companies by adopting widely accepted global standards like those from the GRI and ISSB.

EU companies exceeding the CSRD thresholds with parent companies outside the EU must produce their sustainability statements according to the ESRS, unless their parent company issues a sustainability statement compliant with the ESRS or equivalent standards recognized by the European Commission. Until 2030, an EU subsidiary of a non-EU group with the highest turnover within the EU can prepare a consolidated sustainability statement for all EU subsidiaries within the group, provided they are not listed, to benefit from the exemption.

The Corporate Sustainability Reporting Directive (CSRD) has amended both the Audit Directive (Directive 2006/43/EC) and the Audit Regulation (Regulation EU No 537/2014). These changes establish laws and regulations for the statutory audit of annual and consolidated financial and sustainability statements in the EU. The Audit Regulation also sets specific requirements and rules for the conduct and oversight of statutory audits of public-interest entities.

Mandatory Assurance of Sustainability Information
The CSRD introduces a mandatory assurance (audit) of sustainability information by an independent third party. This can be the statutory auditor, who already audits financial information, or another auditor or Independence Assurance Service Provider (IASP), if allowed by national public authorities. The directive introduces a limited assurance review in the European Single Market, with a planned transition to reasonable assurance over time.
To promote diversity in the audit market, the directive allows shareholders with more than 5% voting rights or capital to request an accredited third party to prepare a report on some of the sustainability information. This third party cannot be affiliated with the same audit firm or network as the statutory auditor.

Assurance Engagements and Requirements
The CSRD introduces:

• Levels of assurance engagements (limited and reasonable)
• Assurance requirements for companies inside and outside the EU
• Organization of the audit market in Europe, especially for sustainability assurance services

The European Commission is mandated to develop assurance standards outlining the technical aspects of the assurance engagement of sustainability information by auditors and IASPs. These standards will be adopted through delegated acts. The Committee of European Auditing Oversight Bodies (CEAOB) will provide technical advice for drafting these standards, expected before May 2025.

General EU-Wide Audit Requirement
The CSRD establishes an EU-wide audit (assurance) requirement for reported sustainability information. This addresses investor and stakeholder concerns about the reliability of sustainability information reported by companies. Initially, the CSRD requires a "limited" assurance, aiming to introduce EU-wide standards for limited assurance by October 1, 2026. A "reasonable" assurance will be required from October 1, 2028, pending a favorable assessment by the Commission.

Sustainability Assurance Market
The directive allows Member States to open the sustainability assurance market to Independent Assurance Service Providers (IASP). This means that firms other than the usual financial auditors can assure sustainability information, promoting fairer access to the audit market for non-statutory auditors.
Member States choosing to open their market to IASPs must appoint a public authority or body to handle the accreditation process. This process must adhere to EU Regulation requirements on accreditation and market surveillance, ensuring objectivity and impartiality.

Passporting System
The CSRD establishes a "passporting system" for IASPs, allowing accredited service providers in one Member State to operate in another Member State without seeking additional accreditation. France currently offers this opportunity, with other Member States planning to follow.

Organization of the Assurance Profession
Member States authorizing IASPs must set requirements equivalent to those for statutory auditors under the Audit Directive. This includes professional ethics, independence, objectivity, confidentiality, and professional secrecy regarding sustainability reporting assurance. Statutory auditors and IASPs must meet specific educational, training, and examination requirements, as well as adhere to quality assurance systems, and rules on irregularities, investigation, and sanctions.

Equivalence with Third-Country Audit Companies
The directive provides a mechanism for recognizing third-country auditors if their regulatory framework is equivalent to the EU’s for statutory audits. Third-country auditors must register with the competent authority of the Member State where they intend to carry out audits.

Review Clause
By December 31, 2028, the Commission will review and report on the concentration of the sustainability assurance market and assess possible legal measures to ensure market diversification and the quality of sustainability reporting.

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The Importance of the Materiality Assessment
The Corporate Sustainability Reporting Directive (CSRD) emphasizes the importance of materiality assessment, recognizing the diverse users and purposes of reported information. Companies must evaluate materiality considering both impact and financial aspects of their activities, acknowledging their interconnections. Although separate and independent procedures are not required, identifying material impacts is typically the starting point, as financial evaluations often benefit from this assessment. Material impacts often lead to significant risks, opportunities, and financial consequences.
The European Sustainability Reporting Standards (ESRS) do not prescribe a specific method for conducting materiality assessments. Each company should develop a tailored process that fits its unique circumstances, including the depth of the assessment. Professional associations representing specific sectors can also help companies determine recurring impacts, risks, and opportunities, particularly in the absence of sector-specific standards in the EU.

Steps to Conduct a Materiality Assessment
Companies seeking guidance on materiality assessment can refer to guidance from EFRAG and GRI. The process starts with understanding the company’s context, including its activities, business relationships, and the broader environment. Key steps include:

• Identifying relevant stakeholders.
• Engaging with stakeholders to understand their concerns and expectations.
• Mapping potential sustainability issues based on industry standards, regulations, and best practices.
• Assessing the significance and potential impacts of these issues on the company and its stakeholders.
• Prioritizing issues based on their importance to the business and its stakeholders.

This inclusive approach enhances the credibility and relevance of sustainability reporting.

Including Value Chain Impacts, Risks, and Opportunities
The sustainability statement must cover all significant impacts, risks, and opportunities (IROs) related to all activities, including those from business relationships across the value chain. While not all data points require value chain information, it is necessary for significant IROs beyond the company’s operations. If primary value chain information is unavailable, companies should estimate using reasonable and supportable data, including proxies and sector data.

Responsibility of Supervisory Bodies and Audit Committees
Effective sustainability reporting requires collaboration among various teams and stakeholders, including top management and supervisory boards. The CSRD enhances accountability, mandating that administrative, management, and supervisory bodies ensure compliance with its requirements. This includes preparing and publishing management reports with all necessary sustainability disclosures, corporate governance statements, and assurance reports in electronic formats.
For listed companies, the directive strengthens the role of audit committees in supervising the assurance of sustainability data. These committees monitor the sustainability reporting process, ensuring accuracy and independence. Corporate sustainability reporting committees within companies or sectoral associations can also play a crucial role in coordinating and overseeing sustainability performance data collection and reporting.

Materiality Thresholds
In double materiality reporting, a materiality threshold refers to the criteria (qualitative and/or quantitative) used to determine which topics are material to the company. The ESRS prescribe rules for applying double materiality, evaluating IROs based on severity and likelihood. For negative impacts, severity considers scale, scope, and the irremediable nature of impacts. For risks and opportunities, criteria are based on the magnitude and likelihood of financial effects.

Understanding Secondary Legislation
EU delegated and implementing acts are considered secondary legislation, as opposed to primary legislation like regulations or directives. These acts provide a flexible and efficient mechanism for the European Commission to adapt and execute legislative measures. In some years, secondary legislation has represented up to 90% of the legislative volume produced by the European Union.

Delegation of Power to the European Commission
In EU law, delegation of power refers to the authority granted by the EU legislator (usually the European Parliament and the Council of the EU) to the European Commission to adopt legal acts in specific policy areas. This delegation is outlined in primary legislation and allows the Commission to supplement or amend non-essential elements of the legislation. However, this delegation comes with clear limits and conditions to ensure accountability and transparency, and the Commission must act within the framework set by the legislator.

Types of Secondary Legislation

National Implementation and Penalties

Transposition into National Law
The CSRD provides a harmonized framework for transparency, accounting, and audit, allowing flexibility for Member States to implement its provisions in their national legal systems. The directive must be transposed by all Member States into their national law by July 6, 2024. While Member States have little flexibility regarding the content of the reporting standards, they are required to incorporate the directive’s provisions into their national legal framework and publish the necessary administrative provisions to comply with the CSRD.

Penalties for Non-Compliance
The CSRD does not introduce new penalties but requires Member States to establish effective, proportionate, and dissuasive penalties for infringements, including sustainability disclosures. Member States are responsible for providing adequate resources for supervisory authorities to control corporate sustainability reporting practices.
For example, France has introduced criminal sanctions for directors who fail to appoint an auditor of sustainability information and for obstructing a sustainability audit. In Hungary, non-compliance with ESG reporting obligations can result in financial penalties imposed by the national Supervisory Authority for Regulated Activities.

Scope and Applicability
Member States must ensure that the directive’s requirements apply to specified companies, including public-interest entities (PIEs) and others meeting certain size criteria. They are responsible for ensuring compliance with the prescribed content and format of annual financial and sustainability statements, including electronic reporting requirements.

Compliance Oversight
To ensure compliance with reporting requirements, Member States must designate National Competent Authorities (NCAs) responsible for overseeing the CSRD implementation. Under the previous NFRD framework, these authorities were typically financial regulators or relevant bodies with limited supervisory powers. With the integration of financial and sustainability information, the supervisory measures for listed entities should now extend to sustainability reporting. Member States have the flexibility to decide whether to extend administrative supervision by NCAs to non-listed companies, opt for another competent body, or leave compliance checks to the judicial system.

Auditing Requirements
The directive includes provisions related to the audit of financial and sustainability statements. Member States are responsible for implementing rules on the statutory audit of annual and consolidated accounts, including the appointment and independence of auditors and Independent Assurance Service Providers. NCAs must monitor possible breaches of these provisions, imposing penalties such as fines or other disciplinary measures. In cases of serious misconduct, auditors could lose their authorization to conduct statutory audits. NCAs may also require audit firms and independent assurance service providers to take corrective measures to address deficiencies in their audit processes.

Public Oversight and Transparency
The directives emphasize the importance of transparency, requiring NCAs to make certain information related to penalties publicly available while respecting business confidentiality. The Committee of European Auditing Oversight Bodies (CEAOB) coordinates national audit oversight bodies at the EU level, including aspects of cross-border enforcement and penalties. The CSRD also mandates the European Securities and Markets Authority (ESMA) to issue guidelines on the supervision of sustainability reporting by national competent authorities.

By understanding these elements, companies and stakeholders can better navigate the requirements and implications of the CSRD and related secondary legislation in the EU.

EFRAG and GRI: Joint statement of Interoperability

September 4th, 2023, EFRAG and GRI published a joint statement on the high level of interoperability achieved between the European Sustainability Reporting Standards (ESRS) and the GRI Standards.

Following the requirement of the CSRD to adopt a double materiality approach and to take account of existing standards, ESRS and GRI definitions, concepts and disclosures regarding impacts are fully or, when full alignment was not possible due to the content of the CSRD mandate, closely aligned.

Existing GRI reporters will be well prepared to report under the ESRS. Entities reporting under ESRS are considered as reporting with reference to the GRI Standards and will therefore avoid the burden of multiple reporting.

Interoperability between ESRS and ISSB Standards. EFRAG Assessment and mapping table

August 23rd, 2023, EFRAG published the paper “Interoperability between ESRS and ISSB standards EFRAG assessment at this stage and mapping table“.

The objective of this paper is to present the EFRAG’s assessment at this stage on the interoperability between ESRS 2 General Disclosures and ESRS E1 Climate and IFRS S1 & S2 Climate-related Disclosures and to provide a supporting mapping table. This paper and the climate-related disclosures mapping table is a contribution to the ongoing joint work with the ISSB on interoperability guidance on ESRS and ISSB standards.

Background: The CSRD requires that in adopting the Delegated Acts the European Commission shall to the greatest extent possible take account of the work of global standard-setting initiatives. In addition, ESRS should contribute to convergence of global standards to reduce the risk of inconsistent reporting requirements for undertakings that operate globally. EFRAG stated that It is important to present the EFRAG’s assessment at this stage on the interoperability between ESRS 2 General Disclosures and ESRS E1 Climate and IFRS S1 & S2 Climate-related Disclosures and to provide a supporting mapping table, which is a contribution to the ongoing joint work with the ISSB on interoperability guidance on ESRS and ISSB standards.