European Commission adopts European Sustainability Reporting Standards – a new milestone for corporate sustainability reporting in the EU

The regulatory landscape establishing sustainability-related reporting and due diligence requirements is rapidly evolving.

This week has been significant for the regulatory landscape relating to sustainability reporting. On Monday, 31 July 2023, the European Commission adopted the European Sustainability Reporting Standards (ESRS), which are mandatory to use by all undertakings subject to the Corporate Sustainability Reporting Directive (CSRD).

According to CSRD, all large undertakings (a turnover of above €40 million, a balance sheet total of over €20 million, an average number of over 250 employees per financial year) and all listed undertakings (except listed micro-enterprises) must provide information that is important for the investors and other stakeholders to understand the sustainability-related impacts of the undertakings in which they invest in.

This requirement derives from CSRD (which became effective from 5 January 2023) and aims to enhance the existing ESG reporting framework within the EU introduced in 2014 by the Non-Financial Reporting Directive (NFRD). The provisions of CSRD are currently being transposed into each Member State’s national law, which will determine the full scope and extent of the sustainability reporting requirements in each Member State of the EU.

What are the ESRS?

The ESRS standards set the structure and disclosure requirements that CSRD-scoped undertakings must follow and align their sustainability reporting with. The ESRS is adopted by the EU Commission as a delegated act in accordance with CSRD. In short, the European Sustainability Reporting Standards (ESRS) dictate the reporting format required under the CSRD.

There are three categories of ESRS:

• Cross-cutting standards, which explain the fundamental concepts and general requirements for ESG reporting.
• Topical standards, which are structured into topics and sub-topics covering the full range of environmental, social and governance issues irrespective of the sector.
• Sector-specific standards, which are applicable to all undertakings within a sector and cover issues that are not (sufficiently) covered by the topical standards.

The Commission made several modifications compared to the draft ESRS standards developed by European Financial Reporting Advisory Group (EFRAG). For example, (1) adding additional phase-in provisions (mainly apply to companies with fewer than 750 employees), which give companies more time to prepare, (2) offering more flexibility to decide exactly what information is relevant in their particular circumstances, and (3) a limited number of reporting requirements became now voluntary instead of mandatory (i.e., reporting a biodiversity transition plan and certain indicators about self-employed people and agency workers in the undertaking’s own workforce).

Undertakings must report both on their impacts on the environment, social and governance-related topics. Companies must report only relevant information and may omit the information in question that is not relevant (“material”) for their business model and activity.

The CSRD and its delegated act ESRS (with the exeption of for ESRS 2) require undertakings to report only on ESG topics that are so-called’material’ to them (meaning subject to double materiality assessment results).

In short, materiality assessment is an analysis, that can provide insights for entiries allowijng them to undertstand material ESG topics for them (both from the financial and ESG impact point of views). The concept of materiliaty assessemt is essentially designed to help entities to prioritise sustainability-related issues in order to manage and mitigate (and also now to report on) on most material ESG topics for them (and to their stakeholders).

What about SMEs?

CSRD imposes no new reporting requirements on SMEs, except for listed SMEs. However, the reality is that numerous (if not all) non-listed SMEs, which are not subject to any sustainability reporting requirements under the CSRD, will still need to provide sustainability information to larger undertakings to whose value chain they belong to.

It is likely SMEs will also start receiving sustainability-related information requests from customers, banks, investors, and/or other stakeholders, as sustainability-related topics are increasingly moving into the mainstream. On that note, the EU is currently developing simpler standards for use by non-listed SMEs, the so-called voluntary sustainability reporting standards (VSRS). These voluntary standards should enable non-listed SMEs to respond to the requests for sustainability information in an efficient and proportionate manner, and so facilitate their participation in the transition towards a sustainable economy.

In addition, the CSRD states that the ESRS standards (which are currently still being developed by the EU) for listed SMEs will legally cap the information that ESRS can require large undertakings to obtain from SMEs in their value chains.

What happens next?

The ESRS delegated act adopted by the Commission will be formally transmitted in the second half of August to the European Parliament and to the Council for further scrutiny. The inspection period runs for two months, extendable by a further two months. The European Parliament or the Council may reject the delegated act, but they may not amend it.

At this moment in time, it is a good idea for the CSRD-scoped undertaking to get ready for the reporting requirements introduced by the CSRD and its delegated act ESRS.

The CSRD and ESRS rules will start applying between 2024 and 2029:

• From 1 January 2024 for large public-interest companies (with over 500 employees) already subject to the Non-Financial Reporting Directive (NFRD), with their reports due in 2025;
• From 1 January 2025 for large companies that are not presently subject to the NFRD (with more than 250 employees and/or €40 million in turnover and/or €20 million in total assets), with their reports due in 2026;
• From 1 January 2026 for listed SMEs and other undertakings, with their reports due in 2027. SMEs can opt-out until 2028.
• From 1 January 2028 for non-EU undertakings who do not have securities listed on an EU regulated market but which have (i) a turnover at group level of over €150 million in the EU and (ii) a subsidiary that is a large undertaking or a branch having a net turnover of at least €40 million in the EU, whith their reports due i 2029.

For additional information do not hesitate to contact our Head of ESG Mervet Kägu or Partner Kristel Raidla-Talur.