The future of sustainability reporting in Europe

Background

"The European Green Deal is a response to tackling climate and environmental challenges. It is a new growth strategy to transform the EU into a fair and prosperous society with a modern, resource-efficient and competitive economy, with zero net greenhouse gas emissions in 2050 and decoupling economic growth from resource use. It also aims to protect, conserve and enhance the EU's natural capital and protect people's health and wellbeing from environmental risks and impacts. The transition should also be just and inclusive."

With this communication (COM(2019) 640 final), the European Commission presented the new 2020 work program to the European institutions. In this context, the Commission also promised to propose a revision of the directive on the disclosure of non-financial information.

Criticism was voiced at an early stage regarding the previous regulation (Directive 2014/95/EU, effective for the first time for the 2017 financial year, applicable to capital market-oriented companies with more than 500 employees). In its resolution on sustainable finance from May 2018, the European Parliament called for the further development of reporting obligations. Specifically, it was stated that the current legal framework is not sufficient to meet the information requirements of report recipients. If information is provided, it is often not sufficiently reliable and is also not sufficient to compare companies with one another.

There is therefore a growing gap between the sustainability information provided by companies and the needs of the intended users of this information. This applies to investors, among others, who are unable to take sufficient account of sustainability-related risks in their investment decisions. But it also means that stakeholders are less able to hold companies accountable for their impact on people and the environment. And it is problematic for the companies themselves: they often find it difficult to obtain the information they need from suppliers, customers and companies in which they invest.

On April 21, 2021, the EU Commission presented a proposal to revise the Corporate Sustainability Reporting Directive (CSRD, COM(2021) 189 final). The aim is to ensure that information is available on the risks for companies on their business results, situation and business performance in connection with sustainability aspects ("outside-in perspective") and on the impact of the companies themselves on people and the environment ("inside-out perspective"). The information provided should be comparable, reliable and easy for users to find and use using digital technologies. The proposal also aims to change the status of sustainability information so that it is more comparable with financial information.

Essential Content

The Commission has commissioned the European Financial Reporting Advisory Group (EFRAG) to draw up the proposal. The first standards (European Sustainability Reporting Standards, ESRS), which were published for consultation at the end of April 2022, are intended to specify what information companies should provide on all listed sustainability aspects and reporting areas. The consultation drafts are currently being presented and explained together with the respective national accounting standard setters in almost all European countries.

The sustainability reporting standards are divided into topic-specific standards and sector-independent standards that contain general and overarching information. In detail, companies are required to provide information on

• Environment (E = Environmental)

  • ESRS E1: Climate change
  • ESRS E2: Pollution
  • ESRS E3: Water and marine resources
  • ESRS E4: Biodiversity
  • ESRS E5: Circular economy

• Social (S = Social)

  • ESRS S1: Own workforce
  • ESRS S2: Employees in the value chain
  • ESRS S3: Affected communities
  • ESRS S4: End users and consumers

• Corporate governance (G = Governance)

  • ESRS G1: Governance, risk management and internal controls
  • ESRS G2: Business conduct (compliant behavior)

For each of these ESG factors, EFRAG has defined disclosure requirements, some of which are very detailed and comparable in structure. The scope and depth of the required disclosures will pose a challenge even for companies that already report voluntarily or in accordance with CSR-RUG. For the majority of companies affected in the future (> 250 employees, >. 40 million turnover, > 20 million balance sheet total, two of these three criteria must be met), this will be an enormous effort, as the reporting requirements may also necessitate a revision of the business strategy, the business model or internal processes. Publication in the management report, the expansion of possible report addressees (from shareholder to stakeholder orientation) and the requirement for an audit by an auditor will force reporting to meet the same standards as financial reporting.

Looking ahead

The legislative process envisages that, following agreement between the Commission, Parliament and Council (trilogue negotiations) and the final formulation of the ESRS standards by the end of October 2022, the Commission will finalize its proposal and publish it in 2023. It is expected that initial reporting will be required in 2025 for the 2024 financial year. It is recommended that all affected companies address the content of the future European reporting standards as early as possible.