How to ensure sustainability reporting in Europe drives emissions cutsDr. Jane Thostrup Jagd, Deputy Director of Net Zero Finance at We Mean Business Coalition and Juliet Taylor, Manager of the CFO Network at World Business Council for Sustainable Development
The aim of the European Sustainability Reporting Standards (ESRS) is bold: to help achieve the EU Green Deal’s ambitions and turn Europe into the first climate neutral continent by 2050. While we couldn’t agree more with this overarching purpose, the current draft of the standards is at risk of derailing this goal.
We often hear from CFOs and CEOs of large companies at the forefront of climate action that the current drafts are too much, too soon. Why? It is not because they are against the ESRS’ aims. On the contrary, CFOs and CEOs consistently share with both of our organizations that clear, comprehensive and comparable sustainability reporting is one of the foundational building blocks of a well-functioning capital markets system.
Our view from the World Business Council for Sustainable Development, a member-driven organization made up of over 200 of the world’s leading companies, and the We Mean Business Coalition, which works with close to 9,000 companies – is that with a few, but fundamental, changes to the current draft, we can drive forward progress on the reporting standards.
We need better global convergence, better definitions –and then we need a more phased-approach. The risk with the current drafts –which require companies to disclose against data that’s too immature or new to measure–is that we flood the system with incomplete information. This could result in investors losing trust in the integrity of the reporting before it’s even begun.
Align with global standards
The current ESRS-drafts are not yet technically compatible with the International Sustainable Standards Board (ISSB) and Global Reporting Initiative (GRI). There are some similarities on disclosure requirements, but the different architecture, objectives of disclosure requirements, terminology, and definitions (e.g., enterprise value, reporting entity/boundaries, materiality, significance, quality of information) make it very difficult for the standards to be interoperable. This, in turn, makes it very difficult for companies to report correctly.
At present, the ESRS-drafts do not refer to the ISSB international standards. As these international standards will develop over time, just like the International Financial Reporting Standards (IFRS) have developed over time –a reference to said standards would make continued convergence and comparability across jurisdictions more likely. Comparability across jurisdictions will:
- Offer the most cost-efficient solution for companies committed to transparent and robust reporting and minimize the opportunities for greenwashing
- Provide the clearest possible picture to investors seeking the world’s most sustainable companies across markets and geographies.
- Deliver the greatest degree of accountability for corporate climate reporting, which is essential to secure a just transition to a sustainable future
In this regard, it’s great to see a clear mandate for convergence with the ISSB global standards in § 37 of the Preamble for the CSRD final agreement from June 2022. In our view, it is crucial that this mandate is fully incorporated into the next drafts of the ESRS standards, as the current drafts differ in terms of terminology and definition –creating unnecessary confusion for preparers.
Sixty-five organizations from across the business, investment and auditing communities are explicitly calling for this kind of alignment in an open letter to the Commissions’ leadership. Aligning the ESRS and ISSB to the greatest extent possible will facilitate comparability and analysis, improve transparency, and minimize reporting burden while accelerating the European Commission’s ambitions.
Be clear about what, exactly, is required
To ensure the most robust and appropriate disclosures, companies need clear guidance on what information should be reported.
The ESRS assumes all reporting requirements and KPIs to be material unless proven otherwise, also known as rebuttable presumptions. This is a new concept not used in any other standard, and it is intended to lighten the load for companies, while maintaining comparability. However, this rebuttable presumptions-concept has drawn much criticism from a wide variety of stakeholders. If companies are forced to provide detailed information about why a particular disclosure requirement is NOT material, it may actually be easier for a company to provide data for all of the requirements and KPIs requested. This could result in an overflow of information, making it very difficult for the investor to discern what’s important for decision-making and what’s not –and making it easier for bad actors to hide information.
Companies are broadly supportive of reporting in a way where impacts to people and the environment and enterprise value are interlinked–also known as the ‘double materiality approach’. In our view, the materiality principles in GRI and ISSB, accompanied by clear disclosure requirements on the materiality assessment process and documentation-requirements of this would serve the needs of preparers, users, and civil society stakeholders–and still provide comparable reporting.
Some of the reporting requirements and KPIs are related to the Green Taxonomy. This also is problematic, since the Taxonomy still suffers from imprecise definitions, such as what constitutes an “economic activity”. We suggest simplifying the definitions and think carefully about how they’re tied to the Taxonomy.
Combat greenwashing by focusing on the most mature metrics and KPIs
With the current CSRD, the ESRS will already apply to large companies from reporting year 2024 – with subsequent phase-in of other companies the following years – enlarging the pool of reporting companies from approximately 11,000 to 50,000, in an extremely short time. And as mentioned, if companies are required to disclose against data that’s too immature or new to measure, there’s a risk of flooding the system with incomplete information before investors are equipped to make sense of it all.
This could, at best, result in mistakes on the kinds of information disclosed and/or considered, and at worst, make it easier for companies to greenwash by hiding the needle of unsatisfactory performance in the proverbial sustainability information haystack.
To address this, companies are in favor of a phase-in period that would allow them the time to define and implement the technology and processes needed for robust reporting. A phase-in period would also give the auditing and investment communities time to prepare for the onslaught of new information as well.
However, research undertaken by the We Mean Business Coalition has uncovered how the 25 largest listed EU companies reported against the ESRS’ 61 suggested KPIs in their 2021-reports and it is clear that not all information across each ESRS standard is mature enough to be useful-yet.
For instance, all or most companies report on scope 1, 2 and 3 GHG emissions, whereas almost no companies report on marine resources related performance or biodiversity offsets.It’s important to note that this research is not necessarily indicating that the metrics not reported on currently are immaterial, but rather that they are unfamiliar.
It could, therefore, be helpful for the European Commission to encourage its member states to require initial disclosure against the more mature metrics and targets listed above, and phase in the rest over a period of one to three years –perhaps supported by better definitions. This would enable companies, auditors, and investors to take the time they need to ensure that all information issued and subsequently used, is as robust and accurate as possible.
This would also give European Financial Reporting Advisory Group (EFRAG) the time to fine-tune some of the standards and enable deeper dialogue with the users about which information is the most useful, and with companies and auditors about feasibility of collecting and validating such information.
Make it easy for the capital market to reward sustainable behavior
Done well, this process could streamline the way that investors and third parties access and assess sustainability information about companies.
Requiring companies to provide clear and verifiable information on sustainability performance allows investors, lenders, or even prospective employees-to assess whether they want to engage with a particular company, based on the full scope of sustainability risks and opportunities they face.
This will enable capital market actors to use sustainability information to create a race to the top. If the financial system has all the necessary information, it will be able to prioritize sustainable investments, redirecting the flow of financial capital towards productive investments, reducing risk and creating reliable markets.
Shifting the capital market system
Just last month ISSB Chair Emmanuel Faber wrote in the Financial Times,
“Markets are the self-generating sources of financing that shape business models and transform economies. Properly harnessed, they can deliver solutions at scale…But they can only play this pivotal role if they operate with high-quality, comparable sustainability information that can be relied upon to make investment decisions.”
Global leaders, standard setters, businesses and the public have an historic opportunity to shift the capital market system to hold companies accountable for their actions, empower and protect investors as well as shift attention and capital flows to the most sustainable companies and investments. But we can only get it right if we adopt a global baseline, avoid flooding the market with unreliable information, and make it easy for the capital market to reward sustainable behaviour.
We urge the standard setters and legislators to make this effort successful.