EU Sustainability Reporting Standards Replacing Mandatory Disclosures With Voluntary Disclosures - A Step Forward Or A Step Backward?
Author: House of Eden
- The European Commission has updated the European standards for sustainability reporting
- Companies should assess for themselves which sustainable, ethical and social obligations are "material" and therefore to be disclosed
- Does the Decree undermine a positive development through the lack of general regulation and a level playing field?
The European Commission recently revised the requirements for the ESG Reporting updated by companies. And it sparked a heated debate. Can discretionary information instead of mandatory information from companies really bring about the urgently needed progress in climate protection?
European Commission updates sustainability reporting standards
At the end of July, the executive body of the European Union published updated standards for sustainability reporting (ESRS), i.e. the disclosure of environmental, social and corporate governance (ESG) data by companies. These reporting obligations affect companies that have committed themselves to the guidelines of the Corporate Sustainability Reporting Directive (CSRD) and are to be introduced in stages. According to the Commission, this is a further step on the way to a sustainable EU economy.
The standards cover the full spectrum of environmental, social and governance issues. Including climate change, biodiversity and human rights. In doing so, they provide information for investors to understand the sustainability impacts of companies in which they invest. In parallel, they also take into account discussions with the International Sustainability Standards Board (ISSB) and the Global Reporting Initiative (GRI) to ensure a high degree of interoperability between the EU standards as well as the global standards. Obsolete double reporting should be avoided in this way.
Officially, the updated requirements are seen as not only an ambitious but also an important tool in support of the EU's sustainable finance agenda. "They strike the right balance between limiting the burden on reporting companies, while allowing companies to demonstrate their efforts to meet the Green Deal agenda and thus access sustainable finance," commented Mairead McGuinness, Commissioner for Financial Services, Financial Stability and Capital Markets Union
These are the main changes of the ESRS
Despite the confidence of the European Commission, the publication was not only perceived as ambitious or target-oriented. The legal act contains changes that significantly differentiate the standards from some points of EFRAG's draft, which was presented in November 2022. The main changes relate to:
- Companies can subject a larger number of reporting obligations to materiality. This means that the EU allows companies to omit information if it is not relevant in their particular circumstances. With one exception though: ESRS 2, which are reporting requirements for environmental pollution, specifically air, water and soil pollution and Substances of Concern.
- Added a new requirement in the event that a policy data point is determined to be non-essential. If this happens, companies must explicitly mark it as "non-essential". All data points derived from EU legislation must be disclosed in a table.
- Updated terminology related to financial materiality. The goal: Better alignment with the definition in the ISSB Sustainability Disclosure Standards.
- Changing disclosure requirements and data points related to certain topics from mandatory to voluntary
- Introducing additional transitional provisions for some of the reporting requirements (including on biodiversity). These apply mainly to companies with fewer than 750 employees.
Selective disclosure jeopardizes universal regulation and a level playing field
Many sides criticize the changes, especially points 1 and 4, as a step backwards in reporting requirements. The directive waters down the requirements for mandatory and therefore universal disclosure. At the same time, it replaces this with discretionary disclosure under the definition of materiality. The European Commission counters this assessment by saying that the change can help the reporting companies to achieve more flexibility and cost savings. But what do the new standards ultimately mean for brands in the free economy - far removed from theoretical discussions in the state framework?
In fact, the new draft significantly weakens the previously adopted guidelines. What this means unmistakably is that it is up to each company to decide what they should report on. The shift towards selective, voluntary disclosures undermines hopes for universal regulation and a level playing field between sustainable and unsustainable companies. Rather, the likelihood remains that organizations are still willing to circumvent rules and pay penalties if necessary.
Update on sustainability reporting could lead to greenwashing
In this scenario, brands ultimately decide for themselves whether key humanitarian areas such as collective bargaining, biodiversity, or observable progress in the supply chain are "material". But also what is supposedly "insignificant". It would not be surprising, then, that brands are tempted to disclose business activities in which they are making the most relevant advances, while keeping quiet about their construction sites. This means that they judge individually how their external impact should be. And construct a certain image only on the basis of skillful communication and strategic consideration of which positive effects are communicated and which negative effects are concealed. keyword Greenwashing.
So without collective action, there is a lack of systemic accountability and comparability. Due to the individual discretion of each player, neither official bodies, nor investors or consumers can directly compare the sustainable, ethical or social commitments of brands. And differentiate them from each other to make informed decisions.
This creates a dilemma: should brands focus on the areas that are most important and visible to them, or should they focus on holistic transparency? After all, critical voices and long-term plans indicate that the requirements will always become more stringent in the direction of obligations and standardization.
EU Commission positions free discretion as an incentive for more transparency
However, these concerns can also be countered with arguments in favor of the change. On the one hand, industry experts rightly address the fact that many brands cannot do justice to universal disclosure in the given period of time. The gap between current transparency and mandatory disclosure in all areas of business activity could weaken a significant number of brands and underpin their competitiveness. The weakened version of the legal act can therefore help to motivate and mobilize more companies and reduce the administrative burden in non-applicable areas.
On the other hand, the European Commission justifies its changes by invoking the International Sustainability Standards Board. This recently adopted global standards based on materiality: compliance with the ISSB should make it easier for companies to adhere to standardized guidelines and avoid double reporting.
Can cautious policies meet the urgent need for action?
With the publication of the final standards on July 31, 2023, the legislative process for the ESRS is now in its final phase. The delegated act on the ESRS will be sent to both the European Parliament and the Council for consideration in the second half of August. In the course of the examination, which lasts between two and a maximum of four months, the legal act can be rejected but not changed.
Considering the pros and cons of the draft amendments, the Commission's approach seems overly cautious. The urgent need for action in climate protection requires an acceleration of sustainable and ethical obligations - not stagnation or even a slowdown. Given the reluctance of many companies in these areas, it seems like the updated standards give them too much freedom. A freedom that allows them to communicate what is beneficial and therefore may be misleading. On the other hand, standardization could have a positive effect. And not only to promote sustainable development, but also to promote decent industry and fair competitive conditions.
One key challenge is Corporate sustainability reporting Directive (CSRD) came into force on January 5, 2023. It creates detailed sustainability reporting requirements and expands the number of EU and non-EU companies that are subject to the EU sustainability reporting framework. The European Sustainability Reporting Standards (ESRS) form the basis for the implementation of the sustainability information described in the CSRD. The requirement for companies to report against the ESRS is being phased in. The first reports from certain companies are due in 2025.