First announced in the CSRD directive of December 2022, the European Commission published on June 09, 2023 the first draft of a delegated regulation concerning the first series of non-financial reporting standards at European level. These standards are the fruit of EFRAG’s work, which was submitted to the Commission on November 22, 2023. After several material changes, the European Commission finally adopted these key ESG standards on July 31 2023. The changes made by the EU Commission are designed to lighten 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 its ESRS standards
Companies Targeted by the EU Regulation
The Directive (EU) 2022/2464 on the Corporate Sustainability Reporting Directive (CSRD) has been 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 needed 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 governing the publication of this information. Published in the European Union’s Official Journal on December 16, 2022 and in force since January 5, 2023, it will be phased in gradually up to 2028, depending on the size and location of companies. The first reporting is due in 2025, and targets large European and non-European companies currently subject to the NFRD regulation (2014), for the 2024 financial year.
ESRS: A Set of Standards to Manage and Disclose ESG Data
The Non-Financial Reporting Directive is still to be clarified by delegated acts of the Commission. These delegated acts will define the criteria for applying the reporting standards contained in the said directive. The first Commission Delegated Regulation supplementing Directive 2013/34/EU as regards reporting standards was adopted on July 31, 2023. It will enter into force following its publication in the EU Official Journal. This delegated regulation and its appendices, as well as future delegated regulations, establish common standards (ESRS) that will help companies to communicate and manage their sustainability performance more effectively, and consequently gain better access to sustainable finance. The European Sustainability Reporting Standards (ESRS) will be mandatory for companies that are required by the Accounting Directive to disclose certain sustainability information. These common standards have been developed on the basis of technical advice from EFRAG. In developing these common standards, EFRAG and the Commission have ensured a certain alignment of the technical reporting criteria of the CSRD with other European regulations, in particular the SFDR (Sustainable Financial Disclosure Regulation) with regard to indicators relating to “principal negative 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 partnership with EFRAG and other stakeholders representing the European non-financial reporting ecosystem. They are intended to serve as the 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 created in 2021 at COP 26 by the IFRS (International Financial Reporting Standards) Foundation. The ISSB was launched in response to the 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 IFRS umbrella headquartered in Delaware, USA (though formally headquartered in Germany to benefit from a more global footprint). Until 2021, IFRS specialized in the development of international financial reporting standards designed to standardize the presentation of accounting data exchanged internationally. From now on, two committees coexist within the IFRS 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 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 disclosure accessible here:
Other draft IFRS standards on ESG reporting are underway. These especially include the following document:
Based on its legitimacy in terms of accounting standardization, IFRS has been able to assemble a credible international ecosystem for the standardization of ESG factors. Through this quest for legitimacy and influence on the global ESG reporting market, the ISSB is undoubtedly aiming to compete with the EU ESRS set of standards. ISSB and CSRD operate according to two different philosophies:
- While the ISSB serves the investor making informed decision, the CSRD is intended to serve society shifting trillions to accelerate transition of economy to adapt to a climate constrained world.
- ESRS standards are said to be centred on the principle of double materiality, whereas IFRS ISSBs are based on the principle of financial materiality.
- Another important point of distinction between ESRS and ISSBs includes the target stakeholders. ISSB is primarily intended to inform investor decision-making and risk assessment, while ESRS pursues a more ambitious and socially transformative goal. Through ESRS, the European Commission, as announced in its sustainable finance plan, aims to ensure an influx of private investment to finance efforts to combat climate change meaning that ESG disclosure intends to reach a much greater number of stakeholders beyond investors.
At first sight, ISSB standards have a clear comparative advantage over ESRS standards. Indeed, IFRS (ISSB) is widely known and recognized in the accounting world through its accounting standards, a reputation that facilitates the adoption of its ESG standards. ISSB is also more targeted on the investor stakeholder groups with a clearer message that is digestable by investor practitioners staying focus on ensuring that investors can make best informed decisions. But this is a questionable presumption insofar 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. This double 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 double materiality, which we have been already extensively deployed at Ksapa for years with our clients, sounds technical yet clearly provides much greater robustness in analysis, when it especially comes to setting credible ESG targets and thresholds. We’ll have to wait and see what happens in the field.
Nevertheless, the two standards claim to complement each other, trying to avoid unnecessary duplication of ESG reporting efforts. Indeed, one of the major changes made by the Commission to EFRAG’s proposals was to align the ESRS with the IFRS standards, in particular the General Disclosures standard. In the final drafting of the ESRS standards, the European Commission endeavored to ensure greater interoperability with existing ESG reporting frameworks. This interoperability effort is reflected in the overall architecture of the ESRS standards, based upon the TCFD (governance, strategy, risk management and measures and objectives), an architecture also adopted by the ISSB in its most recent guidance.
Does it Really Make Sense for Companies and Investors to Conduct “Double” Materiality Assessments?
Yes. EFRAG’s ESRS are built around the fundamental principle of double materiality. In fact the EU has been consistently pushing for double materiality for years. One of the main innovations of the CSRD directive is that the principle of double materiality has been made mandatory. Double materiality is the marriage of two materialities: financial materiality, corresponding to the “Outside-In” vision, and impact materiality, corresponding to the “Inside-Out” vision. Under the CSRD, the principle of double materiality requires companies to report on the positive and negative impacts 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”, the assessment of the materiality of a negative impact is 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 mainstreamed this materiality analysis. From now on, all disclosures will be subject to a materiality analysis, with the exception of General Disclosures. In addition, the Commission has introduced a requirement to explain situations where an entity considers an item to be non-material. The use of the double materiality principle and its mainstreaming by ESRS is an important point of distinction from the reporting framework constituted by the ISSB standards. Indeed, the ISSB reporting system is more focused on financial materiality. The ISSBs, in advocating a simple financial materiality, only take into consideration information relating to the positive and negative impacts that the economic and social environment has on a company’s financial performance. ESG has been developing around this ISSB philosophy for the past 30 years, and this philosophy has never shown itself to encourage investment in the service of the climate transition. Ksapa has been conducting materiality analysis for years, and is very well positioned to see the improvement in robustness provided by the double materiality concept strengthening the way investors need to define thresholds and targets in the way they make informed decision on investments based on robust ESG assessment. With the philosophy currently adopted by ISSB, at play for decades, no need to conclude reiterating that the successive IPCC reports have not seen the smallest impact of this “simple materiality” in global climate trajectories despite the exponential trillions claiming to be invested under robust ESG analysis!
Ksapa supports you in your ESG compliance process
For years, Ksapa and its team has developed ESG expertise and tools to facilitate compliance with the requirements of the new directive, particularly in relation to the principle of double materiality. In fact, Ksapa can help you identify ESG issues according to different international reference frameworks, resulting in reporting that meets the requirements of both the CSRD and other reporting frameworks, notably the ISSB and SEC. In fact, the materiality analysis process developed by Ksapa consists of an integrated methodology making it possible to identify at the same time :
- internal and external stakeholders at risk
- sensitive operations
- value chain segments at risk
In addition, Ksapa’s methodology facilitates the construction of a materiality matrix based on data analysis, thus revealing the information required under both the CSRD directive and IFRS ISSB standards, as well as other reporting frameworks existing in the extra-financial reporting universe. We look forward to hearing from you!
François works at Ksapa as a consultant in sustainable development. He is also in charge of advocacy and legal support.
Having developed a keen interest in sustainable development at an early age, François completed a Master's degree in Human Rights and Multi-level Governance at the University of Padua. He also holds a Master's degree in International Economic Law from the University of Paris 1 Panthéon Sorbonne. Passionate about the theme of sustainable development, he aspires to work towards building an economy that is more respectful of human rights and the environment.
François is fluent in French, English, Gourmantché and Mooré.