The European Sustainability Reporting Standards (ESRS) Draft – An Overview

December 14, 2022by Team IRIS CARBON0

With the EU parliament recently adopting the Corporate Sustainability Reporting Directive (CSRD) and the EU Council giving its final nod to the legislation, it is now time for European companies to prepare to comply with the upcoming compliance requirements.

The draft European Sustainability Reporting Standards (ESRS) prepared by the European Financial Reporting Advisory Group (EFRAG) now come into focus. The EFRAG, a private association financed by the EU, was tasked in May 2021 with developing a reporting framework under the CSRD. The EFRAG submitted its first set of draft ESRS to the European Commission in November 2022. Companies will have to use the ESRS to make sustainability disclosures in accordance with the CSRD. To know more about the CSRD legislation and how it affects companies, read one of our recent blogs here.

In this write-up, we provide readers with an overview of the European Sustainability Reporting Standards.

The Draft European Sustainability Reporting Standards

EFRAG’s Advice Package to go with its draft European Sustainability Reporting Standards includes a Cover Letter, Due Process Note, Explanatory Note, Annex to the Explanatory Note, EFRAG’s Cover Letter on the Cost-benefit analysis of the First Set of draft ESRS, and a Cost-benefit analysis of the First Set of draft ESRS prepared by CEPS and Milieu and six appendices.

Then come the twelve draft European Sustainability Reporting Standards, which are further divided into Cross-cutting Standards and Topical Standards. The Cross-cutting Standards spell out the General Requirements for companies to consider and the General Disclosures they must make. The Topical Standards spell out disclosure requirements under the Environmental, Social, and Governance categories.

Cross-cutting Standards

General Requirements: This section of the draft standards sets out the general requirements for entities to comply with while furnishing sustainability information under the Accounting Directive, as amended by the Corporate Sustainability Reporting Directive (CSRD).

General Disclosures: This section deals with disclosure requirements for all entities regardless of industry sector and sustainability topic (cross-cutting).

Topical Standards

Environmental

Climate Change: This draft standard specifies disclosure requirements that will help the users of sustainability statements to understand how the reporting entity affects climate change. The entity must spell out the material positive and negative actual and potential impacts of its activities. It must also mention its past, current, and future efforts to stay on course with the Paris Agreement, or any updated global agreement on climate change, and limit global warming to 1.5°C. The reader can refer to the complete list of climate change disclosure requirements here.

Pollution: The draft standard dealing with pollution specifies disclosure requirements that spell out how an entity affects pollution of the air, water, and soil – again in terms of the material positive and negative actual and potential impacts. Any actions that the company takes – and the result of such actions – to prevent or mitigate such pollution must be mentioned. The undertaking must also discuss its plans and capacity to adapt its strategy and business model to transition to a sustainable economy, working towards the creation of a zero-pollution environment in keeping with the EU action plan. The reader can refer to the complete list of pollution disclosure requirements here.

Water and Marine Resources: Under this draft disclosure requirement, companies must spell out their actions to prevent a negative impact on those resources and efforts to protect water and marine resources. This includes a reduction in water consumption. Companies must also mention how and to what extent they contribute to the European Green Deal’s ambition for fresh air, clean water, healthy soil, and biodiversity, and how they ensure the sustainability of the blue economy. Refer to the complete section here.

Biodiversity and Ecosystems: Under this draft requirement, companies must disclose how they affect biodiversity and their actions to prevent potential or actual negative impacts on ecosystems. They must also spell out efforts to restore biodiversity and ecosystems. This disclosure requirement includes entities’ plans and capacity to adapt their strategy and business models to “respecting the planetary boundaries of the biosphere integrity and land-system change”. This includes adherence to the EU Biodiversity Strategy for 2030 with targets set under the EU Nature Restoration Plan and Enabling Transformative Change and comparable frameworks and strategies. More here.

Resources and Circular Economy: This draft standard specifies disclosure requirements that mention how an entity affects resource use. This includes it’s material positive or negative impact in terms of regenerative production of renewable resources and depletion of non-renewable resources. Companies must disclose their plans and capacity to adapt their strategy and business models with the principles of a circular economy – which include, but are not limited to, minimizing waste, maintaining product value, safeguarding materials and resources, and enhancing their efficient use in production and consumption. Read more here.

Social

Own Workforce: This draft standard intends specific disclosure requirements for an entity’s material impact on its own workforce. This includes the positive and negative actual or potential impacts of its actions – especially in terms of its dependencies on its workforce and how the entity manages them. It further includes the financial impacts of the material risks and opportunities that accrue to the entity from its dependencies over the short, medium, and long term. Read more here.

Workers in the Value Chain: This draft standard specifies disclosure requirements that help understand the material impacts of an entity’s actions on its value chain workers. Such actions can be linked to the entity’s operations (products/services) or through its business relationships and could include material positive and negative actual or potential impacts. More here.

Affected Communities: This draft standard aims to understand an entity’s impact on affected communities, either directly or through its business relationships. This would include its impact on such communities in areas where risks are likely and severe, and the entity can have a material positive and negative actual or potential impact. The entity can state its efforts – and the effect of its efforts – to prevent, mitigate, or remediate actual or potential negative impacts. Read more about these disclosure requirements here.

Customers and End-users: This standard specifies disclosure requirements that help understand an entity’s material impact on its consumers and/or end users. These could be linked to the entity’s direct operations or through its business relationships. Read more here.

Governance

Business Conduct: This draft standard is concerned with an entity’s strategy, approach, processes, and performance in terms of business conduct. A company’s activities cover a wide range of behaviors that are intended to promote transparent and sustainable business practices for all stakeholders. This standard focuses on practices specified by the Corporate Sustainability Reporting Directive (CSRD) as matters of business conduct. Those practices include corporate culture, supplier relationship management, avoidance of corruption and bribery, entities’ efforts to exert political influence through lobbying, whistleblower protection, animal welfare, and payment practices (especially timely payments to small and medium enterprises). Read more here.

The Road Ahead

Compliance with the CSRD will be phased in for various classes of companies. The largest companies will start complying in the fiscal year 2024, for reports to be published in 2025. Small and Medium Enterprises that are listed will start reporting under the CSRD in 2026. However, SMEs can voluntarily opt out of CSRD compliance until 2028. The EFRAG press release says SMEs will report according to separate, proportionate standards that EFRAG will develop next year.

Now that EFRAG has submitted its first draft ESRS, it will focus on Set 2 of draft standards that will be sector specific. The Set 2 draft will accommodate 5 sectors covered by the Global Reporting Initiative (GRI): Agriculture, Coal Mining, Mining, Oil, and Gas (upstream), and Oil and Gas (mid-to downstream); 5 high-impact sectors: Energy Production, Road Transport, Motor Vehicle Production, Food/beverages, Textiles. The Set 2 draft will also include standards for SMEs.

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