In this series, we explore several under-the-radar EU Corporate Sustainability Reporting Directive (CSRD) resources published over the summer. U.S.-based multinationals will find these resources helpful as they prepare for CSRD compliance.
This first installment in the series discusses the European Securities and Markets Authority's (ESMA) July 2024 Public Statement on the first application of the European Sustainability Reporting Standards (ESRS) adopted pursuant to the CSRD.
ESMA is the EU's financial markets regulator and supervisor. Its mission is to enhance investor protection, promote orderly financial markets and safeguard financial stability. In addition to fostering supervisory convergence among EU member state national competent authorities with responsibility for securities and capital markets supervision, ESMA aims to do so across financial sectors by working closely with the other European Supervisory Authorities competent in the field of banking and insurance and occupational pensions. ESMA is an independent authority, but is accountable to the European Parliament, the Council and the European Commission.
The Public Statement is directed to large listed issuers. However, the CSRD compliance call-outs in the Public Statement are relevant to other subject undertakings.
Five key areas highlighted in the Public Statement
The Public Statement highlights five key areas of attention that, in ESMA's view, are of particular relevance when preparing sustainability statements under the ESRS. These are summarized below. In the Public Statement, ESMA calls on the boards and senior management of issuers (as well as on assurance providers) to ensure that the aspects highlighted in the Public Statement are carefully considered when complying with the CSRD.
1. Governance Arrangements and Internal Controls
- The CSRD learning and onboarding process should specifically target the information needs of the bodies in charge of an issuer's governance, including due diligence procedures and internal controls.
- Issuers are encouraged to carefully set up their data collection and analysis systems and internal controls to be able to run meaningful double materiality assessments and deliver the granular sustainability information needed to meet the qualitative characteristics required by ESRS 1 (General requirements) (the qualitative characteristics of reported information are further discussed in this Ropes & Gray post). Structuring and documenting the internal governance arrangements and controls also is crucial to the work of assurance providers.
- For undertakings with sustainability reporting experience under previous requirements, it is necessary to assess whether existing processes, systems and controls are still fit-for-purpose.
- Implementing and providing transparency on robust processes and internal controls contributes to the quality and credibility of the sustainability statement. As noted in the Public Statement, the mandatory governance disclosures in ESRS 2 (General disclosures) seek to foster transparency on the governance processes regarding sustainability matters.
2. The Double Materiality Assessment
- Issuers should take particular care in undertaking the different steps of the double materiality assessment, first for the determination of the material sustainability-related impacts, risks and opportunities (IROs) and related material sustainability matters they will report on, and then for the selection of the material information attached to the IROs.
- Issuers are encouraged to consider the process illustrated in EFRAG's Materiality Assessment Implementation Guidance (IG 1) in the design or update of their materiality process. EFRAG IG 1 is further discussed in this Ropes & Gray post.
- The qualitative characteristics of information need to be considered when fulfilling disclosure requirements under ESRS 2, IRO-1 and the related disclosure requirements in the topical ESRS (description of the processes to identify and assess material IROs). Properly applying these characteristics, most notably those of relevance and faithful representation, is critical in preventing greenwashing.
- Full transparency on the materiality assessment process is required irrespective of the materiality of specific topics, since the topical specifications of IRO-1 disclosures are mandatory. These disclosures will help users of information better understand the outcomes of the process since, except for climate change, issuers are not required to disclose the reasons justifying the non-materiality of a sustainability topic.
- Except for selected disclosures that must be provided irrespective of materiality (i.e., the cross-cutting disclosure requirements in ESRS 2), the materiality assessment process is central to the ESRS architecture for disclosures of policies, actions and targets and of metrics to be provided.
- Materiality judgments also are needed to determine the disaggregation level of information. Disaggregation at the country level or at significant sites or assets level is required when needed for a proper understanding of material IROs. Although some datapoints or application requirements specifically point to a disaggregated approach, in other instances, it is up to the issuer to identify whether disaggregation is needed. Disaggregation is further discussed in this Ropes & Gray post.
- For policies, actions and targets relating to material sustainability matters, all related disclosure requirements and datapoints are mandatory. These include both the minimum disclosure requirements and their datapoints in ESRS 2, as well as the associated disclosure requirements and datapoints in topical standards if applicable. If no policy, action or target has been defined for a given material sustainability matter, the issuer is required to state this. It also may disclose a timeframe in which it aims to have policies, actions and/or targets in place.
- The minimum disclosure requirements in ESRS 2 require reporting of actions that materially contribute to achieving the undertaking's objectives in addressing material IROs. The Public Statement indicates that it is important to carefully assess the materiality of the contribution made by an action to enable a distinction between the actions to be reported from those which are anecdotal.
- An undertaking must include the information prescribed by an ESRS disclosure requirement if it assesses the information to be material. The Public Statement indicates that the materiality assessment at information level is particularly important because the omission of disclosure requirements or datapoints relating to metrics is an implicit statement that the related information is not deemed material. Sector considerations may play a role in determining metrics that are not material at information level.
3. Use of Transitional Relief
- In the Public Statement, ESMA acknowledges that meeting the data availability and quality demands stemming from the ESRS requirements may be challenging upon first-time application. These demands will require the development or strengthening of an issuer's sustainability data collection and control infrastructure.
- As a general rule, transparency regarding uncertainties and data limitations, if any, and regarding applied methodologies and significant assumptions, is key to enabling users to evaluate possible comparability limitations. This transparency is required as part of the mandatory disclosures in ESRS 2 and also by some topical metric disclosure requirements and will be especially relevant for value chain information. The Public Statement encourages issuers to conduct gap assessments to enable continuous improvement, starting with organizational and governance considerations, and including the necessary resources.
- Lack of data generally does not justify omitting material
information. For value chain disclosures, issuers should carefully
assess the transitional provisions for the first three years of
reporting. Most notably, an issuer:
- Can explain why not all value chain information is available and how it plans to fill the gaps;
- Can limit information on value chain policies, actions and targets to information available in-house or from publicly available sources; and
- Is not required to consider value chain information in metrics disclosures, except for metrics derived from EU law (such as Scope 3 greenhouse gas emissions).
- The transitional provisions in ESRS 1 allow undertakings not exceeding 750 employees on average during the financial year to omit information required by certain ESRS for one or two years. For a further discussion of the transitional provisions in ESRS 1, see this Ropes & Gray post. If an eligible issuer uses these phase-in reliefs, it must still disclose for each material topic the information specified in ESRS 2 (Paragraph 17 (a)-(e)).
- Entity-specific disclosures must be provided when a material IRO is not sufficiently covered by the ESRS. Issuers need to consider whether their entity-specific disclosures pass the significance or decision usefulness tests of materiality at information level, as required by ESRS 1. Entity-specific disclosures are to be reported alongside the most relevant sector-agnostic ESRS disclosures. Entity-specific disclosures are discussed in this Ropes & Gray post.
- Entity-specific information is distinct from complementary information stemming from other legislation that requires disclosure of sustainability information or generally accepted sustainability reporting standards and frameworks. When issuers include complementary information in their CSRD sustainability statement, these disclosures are to be clearly identified with an appropriate reference to the related legislation, standard or framework and meet the requirements for qualitative characteristics of information. The complementary information must not obscure material information.
4. The Sustainability Statement
- ESRS 1 includes requirements relating to the structure of the sustainability statement. It also includes a non-binding illustration. This approach allows some discretion to issuers in how they organize information and enables them to use internal cross referencing. The structure of the sustainability statement is further discussed in this Ropes & Gray post.
- ESRS 1 allows issuers to incorporate by reference separate and clearly identifiable elements of information, subject to safeguards aiming at preserving the overall cohesiveness and readability of the sustainability statement. Incorporation by reference is further discussed in this Ropes & Gray post.
- It is important for issuers that have experience in sustainability reporting under different frameworks to carefully assess whether their historical approach to the presentation of sustainability information is consistent with the CSRD and ESRS and, if not, to make adjustments accordingly.
- Issuers must include in their sustainability statement the disclosures and related reporting templates required by the Taxonomy Regulation within the section on environmental information. Taxonomy Regulation reporting is further discussed in this Ropes & Gray post.
- From the first application of the ESRS, the reporting process should take into account digital tagging. Digital tagging is further discussed in this Ropes & Gray post.
5. Connectivity between Financial and Sustainability Information
- The Public Statement reiterates the importance of connectivity between the sustainability statement and the financial statements, as required by ESRS 1. Issuers should be able to report relevant connections and reconciliations within the sustainability statement as part of their disclosures on current or anticipated financial effects, as well as through other disclosures (e.g., those relating to significant CapEx or OpEx to implement specific actions). Connectivity between CSRD and financial statement disclosure is further discussed in this Ropes & Gray post.
- As indicated in Appendix C of ESRS 1, disclosures regarding anticipated financial effects may be omitted for the first year of sustainability reporting. In addition, in some circumstances, disclosure of anticipated financial effects may be limited to qualitative disclosures for the first three years.
ESMA Final Report on Guidelines on Enforcement of Sustainability Information
At the same time as the Public Statement, ESMA released its Final Report on Guidelines on Enforcement of Sustainability Information. The CSRD requires ESMA to issue guidelines on the supervision of sustainability reporting by EU member state national competent authorities. The Guidelines set out a converged approach to supervision of sustainability information by undertakings whose securities are admitted to trading on an EU regulated market. In addition to enforcement actions, the Guidelines envision the possibility for enforcement authorities to engage in dialogue with issuers and other relevant stakeholders, including assurance providers, to support continuous improvement of sustainability reporting quality. The Guidelines, which are not discussed in this post, are available here.
Next up, the findings of an EFRAG study.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.