As published on: forbes.com, Friday 4 August, 2023.
On July 31, the European Commission adopted the European Sustainability Reporting Standards. The ESRS will standardize how companies within the European Union report climate change and other ESG related actions. They are set to go into effect on January 1, 2024.
The standards stem from the European Green Deal, which required an assessment of sustainability performance by companies. The standards, drafted by the European Financial Reporting Advisory Group, are meant to meet reporting requirements of the EU’s Corporate Sustainability Reporting Directive and Sustainable Finance Disclosure Regulation. The draft standards were initially submitted to the commission in November 2022, but EFRAG has since made substantial changes to that draft based on feedback from stakeholders and the commission. The final standards adopted by the commission are less stringent and recategorized some areas from mandatory to voluntary.
The ESRS, while featuring the term sustainability in the title, are inclusive of the broader environmental, social, and governance reporting requirements. ESG is a type of investing where non-financial factors are considered. The rise of ESG has prompted the need for reporting standards.
There are 12 ESRS, divided into four reporting categories: general, environmental, social, and governance. General covers topics that cross over to multiple categories, like format and timelines. Two of the ESRS are general.
Environmental gets the most focus, with five standards. Those standards are ESRS E1 – Climate Change, ESRS E2 – Pollution, ESRS E3 – Water and marine resources, ESRS E4 – Biodiversity and ecosystems, and ESRS E5 – Resource use and circular economy. The commission announced that they have been working with the International Sustainability Standards Board in their development of the recently announced International Financial Reporting Standards Foundation Sustainability Disclosure Standards.
The ISSB drafted the IFRS Standards as the global standard for sustainability and climate change reporting. IFRS is not used in the United States, but is used in 132 jurisdictions including European Union member states. Now that the standards are available, it is incumbent on those individual jurisdictions to adopt all or part of the standards. The environmental ESRSs are designed to work alongside and incorporate the IFRS Sustainability Disclosure Standards. However, not all of the IFRS Standards will be applicable as the ESRS is not as comprehensive as the IFRS. This makes sense as model standards should be written to include every possibility, while the individual jurisdictions choose which standards to apply.
The social category includes four standards. ESRS S1 – Own workforce, ESRS S2 – Workers in the value chain, ESRS S3 – Affected communities, and ESRS S4 – Consumers and end-users. The categories reflect a comprehensive overview of the company’s actions. It also shows two major divergences between how ESG is handled in the EU versus the US.
Second, social in the EU does not mean the same thing as it does in the US. In the US, social has become the most controversial aspect of ESG. The focus on LGBTQ+ issues within the past year has sparked controversy and boycotts from conservatives, the most notable being Bud Light’s Dylan Mulvaney decision. Social in the EU is comparably mooted, focusing more on working conditions, hours, and equal pay. While the EU does include social as part of their ESG reporting standards, the pending sustainability reporting standards from the US Securities and Exchange Commission is solely focused on environmental reporting.
The final category of governance only includes one standard. Governance focuses on the ethics of a company in regard to their corporate practices. In ESG, governance is often forgotten as many of those standards are set by existing laws and regulations. There have been attempts to raise its profile, however the environmental issues maintain most of the focus.
Notably, the ESRS will apply to publicly traded companies and large privately held companies. The goal is to eventually apply the reporting standards to small to medium size enterprises as well. However, the timeline for that action has been delayed as they focus on the first round of standards. The forthcoming SEC standards in the US will only apply the publicly traded companies. Any ESG reporting for privately held companies will come from the state level, although there has not been any movement in that direction.