The European Sustainability Reporting Standards (ESRS) are a significant development in the world of corporate reporting. Introduced to enhance transparency and accountability, they aim to provide a comprehensive framework for businesses to disclose their sustainability-related information. This blog post will delve into what ESRS are, why they matter for businesses, and which companies they are relevant for, drawing directly from the official ESRS 1 General Requirements document.
What Exactly are the ESRS Standards?
The European Sustainability Reporting Standards (ESRS) specify the sustainability information that an undertaking shall disclose in accordance with Directive 2013/34/EU of the European Parliament and of the Council, as amended by Directive (EU) 2022/2464. Their primary objective is to ensure that businesses report on their material impacts, risks, and opportunities in relation to environmental, social, and governance (ESG) sustainability matters.
It’s crucial to understand that reporting in accordance with ESRS does not exempt undertakings from other obligations laid down in Union law. Furthermore, undertakings are not required to disclose information on environmental, social, and governance topics covered by ESRS if they have assessed the topic in question as non-material. However, this materiality assessment is a cornerstone of ESRS, guided by the principle of double materiality.
ESRS are structured into three categories:
- Cross-cutting standards: These apply to all undertakings regardless of sector. They include ESRS 1 General requirements and ESRS 2 General disclosures. ESRS 1 provides the architecture, drafting conventions, fundamental concepts, and general requirements for preparing and presenting sustainability information. ESRS 2 establishes Disclosure Requirements on general information across all material sustainability matters in the areas of governance, strategy, impact, risk and opportunity management, and metrics and targets.
- Topical standards (Environmental, Social, and Governance standards): These cover specific sustainability topics and are also sector-agnostic. Examples include ESRS E1 Climate change, ESRS E2 Pollution, ESRS S1 Own workforce, and ESRS G1 Business conduct. These topical standards are structured into topics, sub-topics, and sometimes sub-sub-topics, collectively referred to as ‘sustainability matters’. They can include specific requirements that complement the general level Disclosure Requirements of ESRS 2.
- Sector-specific standards: These will be applicable to all undertakings within a specific sector, addressing impacts, risks, and opportunities likely to be material for that sector and not sufficiently covered by topical standards.
The information to be disclosed under ESRS is structured under Disclosure Requirements, each consisting of one or more datapoints. Many ESRS also contain Application Requirements that support the application of Disclosure Requirements and have the same authority.
A key concept underpinning ESRS is double materiality, meaning that a sustainability matter is material if it is either material from an impact perspective (pertaining to the undertaking’s material actual or potential impacts on people or the environment) or from a financial perspective (if it triggers or could reasonably be expected to trigger material financial effects on the undertaking).
Why are ESRS Important for Business?
ESRS are important for businesses for several key reasons:
- Mandatory Reporting Framework: For companies falling within the scope of the amended Accounting Directive (CSRD), reporting according to ESRS is mandatory. This signifies a shift towards integrating sustainability considerations into mainstream corporate reporting.
- Enhanced Transparency and Accountability: ESRS aim to provide users of sustainability statements with the information needed to understand the undertaking’s material impacts on people and the environment and the material effects of sustainability matters on the undertaking’s development, performance, and position. This increased transparency can foster greater trust with stakeholders.
- Risk and Opportunity Management: By requiring the identification and reporting of material sustainability risks and opportunities, ESRS can help businesses better understand and manage these factors, potentially leading to improved resilience and new avenues for growth.
- Stakeholder Engagement: The process of determining material impacts, risks, and opportunities under the double materiality principle involves considering the views of stakeholders. This can lead to stronger relationships with affected stakeholders.
- Comparability and Consistency: The standardized nature of ESRS aims to enhance the comparability of sustainability information across different companies and reporting periods [4, 16, QC 10, QC 11]. This allows investors and other stakeholders to make more informed decisions [QC 10].
- Value Chain Understanding: ESRS emphasize the importance of considering the value chain when assessing impacts, risks, and opportunities. This encourages businesses to look beyond their direct operations and understand their broader sustainability footprint. While obtaining value chain information can be challenging, especially initially, ESRS provide for estimation using sector averages and proxies in certain circumstances.
- Alignment with Due Diligence: The development of ESRS is closely linked to the concept of due diligence, which involves identifying, preventing, mitigating, and accounting for negative impacts on the environment and people connected with a business. The outcomes of the due diligence process inform the materiality assessment under ESRS.
Which Business Sizes are ESRS Relevant For?
The applicability of ESRS is primarily determined by the scope of the amended Directive 2013/34/EU (CSRD). While the detailed thresholds are defined within the Directive itself (as mentioned in our previous LinkedIn post with the Omnibus package proposals), the ESRS standards themselves are the technical backbone for the sustainability reporting required by this Directive.
Therefore, ESRS are directly relevant for companies that fall within the scope of the CSRD. This generally includes:
- Large undertakings meeting certain criteria related to balance sheet total, net turnover, and average number of employees.
- Listed companies (including SMEs, except for listed micro-enterprises).
- Non-EU companies with significant activity within the EU.
It’s important to note the transitional provisions within ESRS 1. For example, undertakings or groups not exceeding an average number of 750 employees may have certain phase-in periods for specific disclosure requirements, such as Scope 3 GHG emissions or the entirety of ESRS E4 (Biodiversity and ecosystems), ESRS S2 (Workers in the value chain), ESRS S3 (Affected communities), and ESRS S4 (Consumers and end-users) for the first or first two years of reporting. Similarly, value chain information may have a phased-in approach over the first three years.
Even if a company is not directly mandated to report under CSRD in the initial phases, understanding ESRS can be beneficial. As larger companies within value chains begin reporting, they will likely require sustainability information from their business partners. Furthermore, adopting robust sustainability reporting practices aligned with ESRS can enhance a company’s reputation, attract investors, and contribute to long-term value creation.
Conclusion
The ESRS represent a significant step towards a more transparent and sustainable European economy. By providing a detailed framework for reporting on material sustainability matters, they empower stakeholders with the information needed to assess a company’s impact and performance. While the direct applicability is tied to the scope of the CSRD, understanding and preparing for ESRS is increasingly important for businesses of all sizes operating within or engaging with the EU market. Staying informed about these evolving standards is crucial for navigating the future of corporate reporting and embracing a more sustainable business model.
