Plea for the advancement of the European Sustainability Reporting Standards

On 31 July 2023, the European Commission adopted the European Sustainability Reporting Standards (ESRS).[1] The standards formally provide guidance on how to implement the Corporate Sustainability Reporting Directive (CSRD). This EU law mandates all large and listed firms to report on both risks and opportunities stemming from social and environmental issues but also on their impact on society and the environment. The CSRD explicitly requires assurance of sustainability reporting.

Originally, the reporting scope of the ESRS included a whole range of mandatory indicators proposed by EFRAG, previously known as the European Financial Reporting Advisory Group, the Commission’s independent technical advisory body. Scope 1, 2 and 3 emissions[2] were among what firms would be required to disclose.

However, the version of the ESRS recently adopted by the European Commission, while keeping the indicators, introduces materiality assessment for most of them. In practice, this means that these indicators become ignorable as long as the firm commissions, i.e. pays, a third party – for example, financial services consultants with arguably limited experience with environmental impact assessment – to state that the indicator is immaterial for the firm.

It is noteworthy that a small list of disclosures remains mandatory, namely the ones listed under the ‘general’ category as cross-cutting standards. This, for example, features the ‘Integration of sustainability-related performance in managerial incentive schemes’. So generally, the materiality assessment is not uniform across the ESRS indicators. Strikingly, Scope 1, 2 and 3 emissions are among the indicators that are subject to materiality assessment. The result is that greenhouse gas (GHG) emission reporting under the adopted ESRS becomes voluntary, subject to materiality assessment.

Moreover, the following excerpt from the ESRS (3.2, 32) on disclosing why indicators are deemed immaterial could be interpreted to mean that as long as only a certain indicator, for instance scope 3 emissions, is excluded, no explanation is required: “If the undertaking concludes that climate change is not material and therefore omits all disclosure requirements in ESRS E1 Climate change, it shall disclose a detailed explanation of the conclusions of its materiality assessment with regard to climate change (see ESRS 2 IRO-2 Disclosure Requirements in ESRS covered by the undertaking’s sustainability statement), including a forward-looking analysis of the conditions that could lead the undertaking to conclude that climate change is material in the future.”  

The urgency of combating climate change has been sufficiently evidenced. It will soon be a decade since the 2015 Paris Agreement and we currently experience global warming at around 0.2°C per decade. Not only is there clarity of the science regarding the required speed of climate action, but the EU also has legal commitments under the European Green Deal. Corporate sustainability disclosure regulation is key for enabling investors to direct capital towards Paris-aligned economic activities. There is no doubt that GHG information is expected to inform investor decision-making across entire portfolios. The need for robust and mandatory GHG emission data is obvious. Leaving some firms to disclose voluntarily while mandating others to do so is less effective and has been argued to even harm the overall information environment when firms’ disclosures are endogenous.[3] Data is needed across all scopes and its relevance by different actors including the financial sector has been widely recognised. Emission data is always material for any firm that receives external financing.

Making GHG emission reporting voluntary, contingent on a materiality assessment, is inconsistent with the Green Deal. This approach misses the chance to establish a universally recognised gold standard and the absence of mandatory reporting in the EU is likely to lead to reduced ambition levels on a global scale. The EU claims climate leadership but now falls behind the United States for emission reporting, with the state of California having already adopted mandatory Scope 1, 2 and 3 emission reporting not only for publicly listed firms but also for private companies that operate in California and meet size thresholds.[4] Moreover, introducing materiality assessment for GHG emissions creates additional effort. This translates into costs to the reporting firm and time passing before crucial data is released to stakeholders. Removing the materiality assessment for the emission indicators simplifies the reporting process and frees up valuable resources, which can be employed for transition actions, beyond disclosure.

There have been strong reactions from a broad spectrum of stakeholders with regard to not having mandatory emission disclosure as part of the ESRS. This includes over 100 scientists who signed an open letter[5] to the European Commission, which was covered by the Financial Times.[6] On the other hand, this also includes the European Fund and Asset Management Association (EFAMA)[7], speaking for Europe’s €28.5tn investment management industry. Moreover, over 90 investors and financial market participants including the United Nations Environmental Programme Finance Initiative (UNEP FI) and the United Nations-supported Principles for Responsible Investment (UN PRI) voiced their concerns.[8]

GHG emission reporting should not be at the discretion of companies. It is of utmost importance to keep the ESRS on the agenda and unite the different voices to bring this to the attention of the European Commission, with the objective of advancing the ESRS in a way that Scope 1, 2 and 3 GHG emissions reporting becomes part of the remaining list of mandatory disclosures.

[1] ^{https://finance.ec.europa.eu/news/commission-adopts-european-sustainability-reporting-standards-2023-07-31_en}

[2]  ^{Please see the Greenhouse Gas Protocol for an explanation of the different scopes.}

[3]  ^{Hao, J. (2023): Disclosure regulation, cost of capital, and firm values, Journal of Accounting and Economics, https://doi.org/10.1016/j.jacceco.2023.101605}

[4]  ^{https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=202320240SB253}

[5]  ^{https://www.smurfitschool.ie/news/openletterexpertspleaforadvancementoftheeuropeansustainabilityreportingstandards.html}

[6]  ^{https://www.ft.com/content/a3216188-8e50-4a62-a8d9-e89172b3ddc7?desktop=true&segmentId=7c8f09b9-9b61-4fbb-9430- 9208a9e233c8#myft:notification:daily-email:content}

[7]  ^{https://www.efama.org/newsroom/news/ensuring-alignment-between-disclosure-requirements-investee-companies-and-sustainable}

[8] ^{https://www.unpri.org/driving-meaningful-data/joint-statement-from-efama-eurosif-iigcc-pri-and-unep-fi-on-european-sustainability-reporting-standards/11525.article} 

This article is part of our #COPerspectives series, find out more here. The views expressed in this #CriticalThinking article reflect those of the author(s) and not of Friends of Europe.