The release by the European Commission (EC) of the first European Sustainability Reporting Standards (ESRS) on 31 July has prompted concern that while efforts have been made to align these with International Sustainability Standards Board (ISSB) models, there are still important contrasts.
‘The definitions of financial materiality and other key definitions differ between ESRSs and ISSB standards’
According to Mark Vaessen, a partner at KPMG in the Netherlands, these will increase reporting work for companies and their accountants. ‘One of the main areas of concern flagged by many respondents to the EC’s recent consultation is that the definitions of financial materiality and other key definitions differ between ESRSs and ISSB standards,’ he says.
‘While improvements have been made in the final text, companies applying ESRSs will not automatically meet all the requirements in the ISSB standards and will need to check carefully to identify any gaps between the two frameworks.’
Alignment efforts
Efforts have been made to minimise these potential problems. An ISSB statement noted that the global body, which formally released its IFRS S1 (general sustainability reporting) and IFRS S2 (climate reporting) standards on 26 June, had worked with ESRS designer the European Financial Reporting Advisory Group (EFRAG) to boost ‘the interoperability of their respective climate-related disclosure requirements…’ It concluded: ‘This work has successfully led to a very high degree of alignment, reduced complexity and duplication for entities wishing to apply both the ISSB standards and ESRS.’
A similar claim was made by the Global Reporting Initiative (GRI), whose standards EFRAG claims were particularly influential in the development of ESRS. A GRI note added that it had supported EFRAG’s technical work and was ‘currently finalising plans for next steps to enhance cooperation in the future’.
Only general sustainability disclosures detailed in ESRS 2 will be compulsory under all circumstances
EFRAG and the GRI plan ‘to simplify reporting processes through a digital taxonomy and a multi-tagging system for their respective standards’, so that ‘companies can report in accordance with both the ESRS and GRI standards through one report’.
Double trouble
But how close are the ESRS to the ISSB standards? While the EC claims to have brought them closer, a key difference remains the EU’s ‘double materiality’ principle. This is where companies assess not just how sustainability and climate issues impact their income and profitability (the ISSB’s single materiality principle), but also their outside environmental and social impact.
In a briefing note, the EC explained how it had eased ESRS demands for such external impact reporting. Companies with fewer than 750 employees will now, for instance, have one or two more years to conduct certain reporting requirements on biodiversity and social issues. Non-listed small- and medium-sized companies were already exempt.
In addition, the EU executive has indicated that ESRS reporting should now be made only if companies think they are relevant to their operations. EFRAG had wanted mandatory external sustainability reporting on climate issues, workforce details, financial market data, capital and more. No longer; only general sustainability disclosures detailed in ESRS 2 will be compulsory under all circumstances.
And the EC has made some reporting voluntary even if these issues have a material impact on a company, affecting data points whose collection is ‘currently considered most challenging or costly for companies’. These include reporting on a biodiversity transition plan and indicators about self-employed people and agency workers.
As for ESRS single materiality assessments, the EC claimed that ‘intensive and constructive discussions’ between its officials, EFRAG and the ISSB ‘have ensured a very high degree of alignment where the two sets of standards overlap’. It added: ‘Companies that are required to report in accordance with ESRS on climate change will to a very large extent report the same information as companies that will use the ISSB standard on climate-related disclosures.’
‘The new ESRS might be challenging for the work of CFOs, corporations, and accountants’
EFRAG has also stressed its liaison work with the ISSB, saying that ‘it has progressively enhanced the level of alignment between ESRS 1, ESRS 2 and ESRS E1, from one hand, and IFRS S1 and S2 from the other’.
The closer, the better
Vania Franceschelli, chair of the European Federation of Financial Advisers and Financial Intermediaries (FECIF), says that regardless of the streamlining and dovetailing with other standards, ‘the new ESRS might be challenging for the work of CFOs, corporations, and accountants’.
She says: ‘This could mean extra hours on the job for the IT department, and increased tech spend on software and systems. New challenges are likely to include limited or poor data quality, the risk of producing sustainability data without actual relevance for business decisions, and the difficulty of identifying areas where investments can drive efficiency and innovation.’ Substantial changes in working methods, targets, and internal and external reporting may also follow.
‘For most small firms we’re talking about one person in charge of finance who is fully occupied just with day-to-day accounting’
Matthew Gamser, CEO of the SME Finance Forum, which is managed by the World Bank’s International Finance Corporation, says that the closer the requirements are, the better for listed medium-sized and smaller businesses. ‘In general, SMEs suffer more in any case where standards are not harmonised, as this means more time for the entrepreneur to understand how to deal with the differences’, whereas larger firms ‘can afford specialised staff to handle such matters, and thus it’s easier to cope.’
Medium-sized firms may have financial directors and staff capable of handling detailed sustainability reporting standards, but ‘for most small firms we’re talking about one person in charge of finance who is fully occupied just with day-to-day accounting, cash management and so on,’ Gamser says.
Impact on global baseline
So, how do all these moves impact the extent to which the ISSB will become a global baseline standard? The EC says it has contributed towards this goal: ‘With the adoption of the ESRS, the EU goes further than any other major jurisdiction to date in terms of integrating the ISSB standards into its own legal framework,’ it said.
Meanwhile, the UK government announced on 2 August that it had been consulting with national financial regulators on adopting ISSB as an official guideline. The Japanese government will issue draft sustainability disclosure standards based on the ISSB standards by March 2024, and finalise them by March 2025.
Also, on 25 July, the International Organization of Securities Commissions endorsed ISSB, calling on members, which include the US Securities and Exchange Commission, ‘to consider ways in which they might adopt, apply or otherwise be informed by the ISSB Standard’.
Franceschelli notes the efforts to ensure a ‘high degree of interoperability between EU and global standards and to avoid unnecessary double reporting by companies’ and says that FECIF ‘would like to stress the importance of the alignment with those standards’.
