15 Sep, 2023
EU Adopts Mandatory ESG Reporting Standards: A Game-Changer for Sustainability Reporting
The European Union (EU) has taken a significant step towards promoting sustainable business practices by adopting long-awaited mandatory Environmental, Social, and Governance (ESG) reporting standards. These new regulations require companies operating within the EU to file annual sustainability reports alongside their financial statements, providing transparency and accountability in their ESG practices.
The Corporate Sustainability Reporting Directive (CSRD) and European Sustainability Reporting Standards (ESRS)
In January 2023, the EU introduced the Corporate Sustainability Reporting Directive (CSRD), which laid the foundation for mandatory ESG reporting. The CSRD requires both EU and non-EU companies with activities in the EU to comply with European Sustainability Reporting Standards (ESRS) when preparing their sustainability reports.
On July 31, 2023, the European Commission adopted the first set of ESRS, marking a significant milestone in the implementation of the CSRD. These standards will become law and apply directly in all 27 EU member states. However, they will not apply in the UK. Companies will need to report in compliance with these new ESRS as early as the 2024 reporting period.
The ESRS are distinguished by their comprehensive nature, going beyond the reporting requirements of other ESG frameworks. They cover a wide range of topics and require companies to perform materiality assessments, report on impacts, risks, and opportunities, provide metrics and targets, and have their sustainability disclosures audited by an independent third-party auditor.
The Scope of ESRS and Reporting Requirements
The ESRS apply to EU companies, including EU subsidiaries of non-EU companies. The reporting requirements cover various aspects of sustainability, including environmental, social, and governance factors. Companies must assess the materiality of each sustainability topic based on the double materiality principle, which considers both financial and impact perspectives.
The ESRS include ten mandatory ESG topics that require disclosure, subject to materiality assessment. These topics are:
- Climate change: Disclosures related to climate change mitigation, adaptation, energy consumption, greenhouse gas emissions, and transition risks.
- Pollution: Disclosures on the pollution of air, water, soil, living organisms, and the use of substances of concern.
- Water and marine resources: Disclosures on water consumption, withdrawal, discharge, and the extraction and use of marine resources.
- Biodiversity and ecosystems: Disclosures on drivers of biodiversity loss, impacts on species, and dependencies on ecosystems.
- Circular economy: Disclosures on resource inflows, outflows, waste, resource optimization, and the risks of transitioning to a circular economy.
- Own workforce: Disclosures on working conditions, equal opportunities, and work-related rights.
- Workers in the value chain: Similar to Own workforce, but extended to workers in the company's value chain.
- Affected communities: Disclosures on the impact of company operations on indigenous rights, civil rights, social and economic rights, and other community-related aspects.
- Consumers and end-users: Disclosures related to the impact of products and services on consumers and end-users.
- Business conduct: Disclosures on business ethics, integrity, and anti-corruption measures.
These topics represent a comprehensive view of sustainability, requiring companies to report on a broad range of issues that go beyond traditional financial reporting. This holistic approach ensures that companies consider the social and environmental impacts of their operations.
Compliance with ESRS and the Impact on Companies
Complying with the new ESRS will require companies to adapt their reporting practices and enhance their ESG frameworks. The reporting process entails conducting materiality assessments, identifying and reporting on impacts, risks, and opportunities, setting metrics and targets, and engaging independent third-party auditors.
To comply with these requirements, companies will need to gather data from their entire value chain, including upstream and downstream partners. This comprehensive reporting approach will foster transparency and accountability throughout the supply chain and promote sustainable practices across industries.
The impact of these new reporting requirements will be felt most immediately by EU-based companies. However, non-EU companies may also be subject to the ESRS if they meet specific criteria, such as generating a net turnover of more than 150 million euros in the EU or having subsidiaries or branches within the EU.
Companies are advised to start preparing for the implementation of the ESRS as soon as possible. This includes conducting materiality assessments, establishing reporting frameworks, setting targets, and engaging with auditors to ensure compliance with the new standards.
The Global Impact of EU's Mandatory ESG Reporting Standards
The EU's adoption of mandatory ESG reporting standards has far-reaching implications beyond its borders. As the world's largest single market, the EU's actions often influence global standards and practices. Companies operating internationally will need to consider the ESRS when reporting their sustainability efforts, even if they are not based in the EU.
Moreover, the EU's move towards mandatory ESG reporting aligns with a global trend towards sustainability and responsible business practices. Many countries and organizations worldwide have already implemented or are considering similar reporting requirements. The EU's leadership in this area sets a precedent and encourages other jurisdictions to follow suit, creating a more consistent and harmonized approach to ESG reporting globally.
The adoption of mandatory ESG reporting standards by the EU represents a significant milestone in promoting sustainability and accountability in business practices. The ESRS provide a comprehensive framework for companies to report on their ESG efforts, covering a wide range of topics and requiring materiality assessments and independent audits.
Companies operating within the EU and beyond will need to adapt their reporting practices to comply with the ESRS. This will require a thorough understanding of the standards, conducting materiality assessments, setting targets, and engaging auditors to ensure compliance.
The EU's leadership in implementing mandatory ESG reporting standards sets a global precedent and encourages other jurisdictions to take similar actions. This move towards transparency and accountability in sustainability reporting will contribute to a more sustainable and responsible business environment worldwide.
As the world continues to grapple with the challenges of climate change and social inequality, the adoption of mandatory ESG reporting standards is a crucial step towards creating a more sustainable future. By holding companies accountable for their environmental and social impacts, these standards drive positive change and foster a culture of responsible business practices. With the EU at the forefront of this movement, we can expect to see increased transparency, improved sustainability practices, and a more sustainable global economy in the years to come.