First announced in the CSRD Directive of December 2022, the European Commission published the first draft of a on June 9, 2023 delegated regulations on the first set of non-financial reporting standards at European level. These standards are the fruit of The work of EFRAGwhich was submitted to the Commission on 22 November 2023. After several material changes, the European Commission finally adopted these important ESG standards on July 31, 2023. The changes made by the European Commission are intended to ease reporting requirements for reporting companies, and also to ensure alignment with other existing standards, such as the ISBB standards.
Overview of the CSRD Directive and the associated ESRS standards
Companies covered by the EU regulation
The Directive (EU) 2022/2464 on the Corporate Sustainability Reporting Directive (CSRD) was adopted as an amendment to Directive 2014/34/EU on the publication of non-financial and diversity-related information by certain large undertakings and certain groups (NFRD). It requires listed large companies and small and medium-sized enterprises (SMEs), as well as the parent companies of large groups, to include in a specific section of their management reports the information necessary to understand the company’s impact on sustainability issues, and the information needed to understand how sustainability issues affect the company’s development, performance and position. It also modernizes and strengthens the rules for the publication of this information. It was published in the Official Journal of the European Union on December 16, 2022 and has been in force since January 5, 2023. It will be phased in until 2028, depending on the size and location of companies. The first reporting is planned for 2025 and focuses on large European and non-European companies currently subject to the NFRD regulations (2014), for the financial year 2024.
ESRS: a set of standards for managing and disclosing ESG data
The Non-Financial Reporting Directive still needs to be clarified Commission delegated acts. These delegated acts will define the criteria for the application of the reporting standards contained in the said Directive. The first On 31 July 2023, a Commission Delegated Regulation was adopted to supplement Directive 2013/34/EU as regards reporting standards. It will enter into force after its publication in the Official Journal of the EU. These delegated regulations and their annexes, as well as future delegated regulations, establish common standards (ESRS) that will help companies communicate and manage their sustainability performance more effectively, and therefore gain better access to sustainable finance. The European Sustainability Reporting Standards (ESRS) will become mandatory for companies that are required to disclose certain sustainability information under the Annual Accounts Directive. These common standards have been developed based on technical advice by EFRAG. In developing these common standards, EFRAG and the Commission have ensured some alignment of the CSRD technical reporting criteria with other European regulations, in particular the SFDR (Sustainable Financial Disclosure Regulation) regarding indicators related to “main adverse impacts” and “taxonomy” indicators.
ESRS-CSRD and ISSB-IFRS standards: do they complement or compete with each other?
As mentioned above, the ESRS are non-financial reporting standards developed by the European Commission in collaboration with EFRAG and other stakeholders representing the European non-financial reporting ecosystem. They are intended as a European benchmark for sustainability reporting. The ESRS are therefore a public initiative led by the European Commission. As for the International Sustainability Standards Board (ISSB), it was established in 2021 during COP 26 by the IFRS (International Financial Reporting Standards) Foundation. The ISSB was launched in response to strong demand for universal sustainability reporting standards. While ESRS-CSRD is a European public initiative, ISSB-IFRS is a private international initiative hosted under the umbrella of IFRS, headquartered in Delaware, USA (although formally headquartered in Germany to take advantage of a more global footprint). Until 2021, IFRS specialized in the development of international financial reporting standards, intended to standardize the presentation of internationally exchanged accounting data. Within IFRS, two committees now coexist to develop standards. On the one hand, there is the IASB (International Accounting Standards Board), which continues to develop accounting standards, and on the other hand, the ISSB (International Sustainability Standards Board), whose mission is to develop ESG standards. In June 2023, the ISSB published its first two IFRS standards on ESG information, which can be accessed here:
Other draft IFRS standards for ESG reporting are in preparation. These include in particular the following document:
Based on its legitimacy in terms of accounting standardization, IFRS has succeeded in establishing a credible international ecosystem for the standardization of ESG factors. Through this quest for legitimacy and influence in the global ESG reporting market, the ISSB undoubtedly aims to compete with the EU’s ESRS standards. ISSB and CSRD work according to two different philosophies:
At first glance, ISSB standards have a clear comparative advantage over ESRS standards. IFRS (ISSB) is widely known and recognized in the accounting world for its accounting standards, a reputation that facilitates the adoption of its ESG standards. ISSB is also more focused on investor stakeholder groups, with a clearer message that is digestible for real-world investors, with a continued focus on ensuring investors can make the most informed decisions. But this is a questionable assumption, as there are now real legal (greenwashing) and financial (application of investment mandates) issues at stake, calling for robustness in ESG analysis and informed decision-making. This dual pressure, both regulatory and expected by an exponential number of customers, puts the comparative advantage of the ISSB and ESRS standards into perspective. The concept of dual materiality, which we at Ksapa have been using extensively with our clients for years, sounds technical, but clearly offers much greater robustness in the analysis, especially when it comes to setting credible ESG targets and thresholds. We’ll have to wait and see what happens on the field.
Nevertheless, the two standards claim to be complementary in an effort to avoid unnecessary duplication of ESG reporting efforts. One of the most important changes made by the Commission to the EFRAG proposals was to align the ESRS with the IFRS standards, in particular the General Disclosures standard. When finalizing the ESRS standards, the European Commission sought to ensure greater interoperability with existing ESG reporting frameworks. This interoperability effort is reflected in the overall architecture of the ESRS standards, based on the TCFD (governance, strategy, risk management and measures and objectives), an architecture also adopted by the ISSB in its most recent guidelines.
Does it really make sense for companies and investors to conduct “dual” materiality assessments?
Yes. EFRAG’s ESRS are built around the fundamental principle of dual materiality. In fact, the EU has been consistently pushing for double materiality for years. One of the most important innovations of the CSRD Directive is that the principle of double materiality has been made mandatory. Double materiality is the combination of two materialities: financial materiality, which corresponds to the ‘Outside-In’ view, and impact materiality, which corresponds to the ‘Inside-Out’ view. According to the CSRD, the principle of double materiality requires companies to report on the positive and negative impact of the ESG environment on their development, performance and financial results. On the other hand, companies must report on the negative and/or positive impact of their activities on the environment and society. According to ESRS 1 (European Sustainability Reporting Standard) “General Requirements”is the assessment of the materiality of a negative impact based on the sustainability due diligence process defined in international instruments such as the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises.
With the delegated act published on July 31, 2023, the European Commission has made this materiality analysis mainstream. From now on, all disclosures will be subject to a materiality analysis, with the exception of the General Disclosures. In addition, the Commission has introduced a requirement to explain situations where an entity considers an item to be immaterial. The use of the dual materiality principle and its mainstreaming by ESRS is a key differentiator from the reporting framework provided by the ISSB standards. The ISSB reporting system is indeed more focused on financial materiality. In advocating simple financial materiality, the ISSBs only consider information regarding the positive and negative impacts that the economic and social environment has on a company’s financial performance. ESG has developed around this ISSB philosophy over the past thirty years, and this philosophy has never proven to encourage investments for the climate transition. Ksapa has been conducting materiality analyzes for years and is very well positioned to see the improvement in robustness provided by the dual materiality concept. This reinforces how investors should define thresholds and targets in how they make informed investment decisions based on a robust ESG assessment. . With the philosophy currently adopted by the ISSB and practiced for decades, there is no need to repeat that successive IPCC reports have not seen the slightest impact of this ‘simple materiality’ on global climate trajectories, despite the exponential trillions claiming to be invested under robust ESG systems. analysis!
Ksapa supports you with your ESG compliance process
Ksapa and his team have spent years developing ESG expertise and tools to facilitate compliance with the requirements of the new directive, especially with regard to the principle of dual materiality. Ksapa can even help you identify ESG issues according to various international reference frameworks, resulting in reporting that meets the requirements of both the CSRD and other reporting frameworks, especially the ISSB and SEC. In fact, the materiality analysis process developed by Ksapa consists of an integrated methodology that makes it possible to simultaneously identify:
- internal and external stakeholders are at risk
- sensitive operations
- value chain segments at risk
Furthermore, Ksapa’s methodology facilitates the construction of a materiality matrix based on data analysis, revealing the information required under both the CSRD Directive and the IFRS ISSB standards, as well as other reporting frameworks that exist in the universe of non-financial reporting. We’d love to hear from you!