Navigating the complexities of modern corporate compliance is increasingly critical. One of the most important frameworks to understand is the European Sustainability Reporting Standards (ESRS). This comprehensive guide aims to elucidate the intricacies of the ESRS standards, highlighting its relevance and benefits to businesses striving for compliance in an evolving regulatory landscape.
The European Sustainability Reporting Standards (ESRS) are a set of mandatory reporting guidelines established by the European Financial Reporting Advisory Group (EFRAG) to standardise sustainability reporting across Europe. Adopted by the European Commission in July 2023, these standards are part of the Corporate Sustainability Reporting Directive (CSRD) and require companies to disclose information on their environmental, social, and governance (ESG) impacts, risks, and opportunities. These standards aim to improve the quality and comparability of sustainability reporting across approximately 50,000 companies in the EU, with potential indirect effects on subsidiaries and branches abroad.
For businesses operating within or engaging with the European market, ESRS standards is not just a regulatory requirement but a strategic necessity. Adhering to these standards demonstrates a company’s commitment to sustainable practices, enhancing its reputation and building trust with stakeholders. Compliance with ESRS standards can mitigate risks associated with environmental, social, and governance (ESG) factors. Compliance with ESRS standards can also open up new investment opportunities, as more investors are prioritising sustainability in their decision-making processes. Some investors even mandate ESRS reporting as a requirement for investment.
The European Sustainability Reporting Standards (ESRS) are set to be implemented in a phased approach, reflecting the diverse capacities and readiness levels of different companies.
The ESRS framework is divided into three main standard areas: Environmental, Social, and Governance. Each area encompasses specific standards and guidelines that companies must follow. There are 5 Environmental Standards, 4 Social Standards, and 1 Governance Standard.
The framework is designed to be flexible, allowing companies to adapt it to their specific context and industry through performing a materiality assessment. This determines what is essential to report, and which ESRS standards apply to your organisation. Each standard outlines specific disclosure requirements and principles.
The two cross-cutting standards in ESRS apply to all the other standards. They provide foundational guidelines for sustainability reporting. These standards (ESRS 1 and ESRS 2) address general requirements:- such as the materiality assessment, stakeholder engagement, and mandatory minimum disclosure requirements. By adhering to cross-cutting standards, companies can provide a holistic view of their sustainability performance.
The environmental standards in ESRS cover a broad spectrum of issues, including climate change, pollution, water and marine resources, biodiversity, and resource use. These standards require companies to disclose their environmental policies, actions, and performance metrics, highlighting their impact on and response to environmental challenges.
Social standards in ESRS address a company's impact on society. This includes issues such as labour practices, human rights, community engagement, and diversity and inclusion. Companies must report on their policies and actions to address these issues, as well as their outcomes. Understanding social standards is crucial for companies to build strong relationships with their employees, customers, and communities.
Governance standards in ESRS focus on the structures and processes that ensure accountability and transparency in a company. This includes aspects such as board composition, executive compensation, risk management, and ethical conduct. By adhering to governance standards, companies can enhance their corporate governance practices and build trust with stakeholders.
Materiality assessment is a key component of ESRS reporting. The purpose is to identify significant impacts, risks and opportunities for the company within the short-term, medium-term and long-term. This process involves evaluating the impact and importance of all topics to the company and its operations, ensuring that the most relevant information is disclosed.
It is important to note that there is some mandatory information that must be reported, regardless of the outcome of the materiality assessment. In brief, this information is required:
The concept of double materiality in ESRS reporting acknowledges that sustainability issues can have both financial and non-financial impacts. Financial materiality considers the impact of sustainability issues on a company's financial performance, while impact materiality considers the broader impact on society and the environment. By addressing both perspectives, companies consider not only how ESG factors affect their financial performance but also their broader impact on society and the environment.
ESRS reporting extends beyond a company's direct operations to include its entire value chain. The value chain approach requires that you identify your impacts caused or contributed by the company linked both to your own operations, products, or services through direct and indirect business relationships. The scope of consolidation has been kept to their own operations, ensuring that it is the same scope as for financial reporting for simplicity.
If the impact is material, then you have to disclose the impacts, risks and opportunities using data from your value chain. If it’s not possible to collect information from suppliers, it should be estimated through: data from indirect sources, sector-average data, sample analyses, market & peer group data, other proxies or spend data.
However it is important to note that the value chain approach will be phased-in to ESRS reporting. For now, it is only necessary to report on your direct operations in-line with existing EU regulation and using in-house information - but from 2026 the obligation will extend to include the entire value chain.
This involves assessing the sustainability impacts of suppliers, customers, and other stakeholders. By incorporating the value chain into their reporting, companies can identify and mitigate risks, enhance their sustainability performance, and build stronger relationships with their partners.
Conducting a materiality assessment involves several steps. It is important to keep in mind that the purpose is to identify significant impacts, risks and opportunities for the company. First, companies need to use their knowledge of their operations and industry to identify which topics might be relevant. Next, they must assess the significance of these issues based on their impact and likelihood.
Once you have determined what it material there are several outcomes:
Engaging stakeholders is crucial for a successful materiality assessment. This involves consulting with employees, customers, investors, and other relevant parties to gather their perspectives on environmental, social and governance (ESG) topics.. Stakeholder engagement helps companies understand the expectations and concerns of their stakeholders, ensuring that their ESRS reporting is relevant and credible. This will become more critical when the value chain requirements come into play - where collaboration in the value chain will be critical for compliance.
Disclosure requirements in ESRS reporting specify the information that companies must include in their sustainability reports. This includes data on environmental performance, social impact, and governance practices. Companies must also disclose their policies, actions, and outcomes related to sustainability. Ensuring that all required disclosures are included and presented clearly is essential for compliance.
General disclosures under ESRS provide a framework for reporting on cross-cutting and overarching topics, such as governance, strategy, risk management, and the materiality assessment process. These disclosures form the backbone of a comprehensive report.
ESRS E1 focuses on climate change, requiring companies to disclose their greenhouse gas emissions, climate-related risks and opportunities, and strategies for mitigation and adaptation. This standard emphasises the importance of aligning corporate actions with global climate goals.
Read our guide on the ESRS E1 Climate Change Reporting Requirements.
Reporting on social factors involves disclosing information on a company's impact on its workforce and communities. This includes data on labour practices, human rights, diversity and inclusion, and community engagement. Companies must report on their policies and actions to address these issues, as well as their outcomes.
Governance reporting involves disclosing information on corporate governance structures, decision-making processes, and ethical practices. This includes details on board composition, executive compensation, risk management, and anti-corruption measures, ensuring transparency and accountability.
The ESRS framework is dynamic, with ongoing developments and updates expected. Staying informed about changes and new requirements is crucial for maintaining compliance and leveraging the benefits of ESRS reporting. Future trends may include increased integration with other reporting frameworks and enhanced focus on emerging ESG issues.
Integrating ESRS reporting with other sustainability frameworks can enhance the comprehensiveness and credibility of a company's sustainability reporting. Choosing an approach that aligns with other reporting frameworks, like the Global Reporting Initiative (GRI) and the International Sustainability Standards Board (ISSB), can make it easier to meet your ESRS reporting requirements. This way, you’ll reduce the manual work needed to comply with each framework separately.
It is important to note that ESRS has some natural alignment built into the framework - for example the Strategy disclosure requirements have been aligned with ISFRS-S1 exposure draft for financial materiality and effects & with GRI for impact materiality.
Practical Steps for Implementing ESRS Reporting
Implementing ESRS reporting involves several practical steps: understanding the standards, conducting a materiality assessment, engaging stakeholders, gathering data, and preparing the report. Once a company is required to comply with the new regulation, it will become a yearly reporting requirement aligned with the financial year. Therefore, we advise that companies establish internal processes and systems to support ongoing compliance.