In this quick chat, ESG Talk host Andie Wood provides an update on the European Sustainability Reporting Standards — new reporting rules companies will need to follow to comply with the CSRD — and explores their connection to the concept of double materiality.
Additional Resources:
- CSRD: What are the final European Sustainability Reporting Standards (ESRS)?
- What Is Double Materiality? Here's What You Need to Know
Transcript
Hello and welcome to the latest episode of ESG Talk, your go-to source for insights and advice from leaders in environmental, social and governance. I'm your host, Andie Wood. I am still Vice President of regulatory strategy at Workiva. I'm back today to build on an earlier chat that focused on the Corporate Sustainability Reporting Directive or CSRD. Since that episode, the European Commission has published the final version of the European Sustainability Reporting Standards or ESRS.
The first wave of companies in scope are going to be required to record against these standards in early 25 for their 2024 fiscal year. So one of the reasons I wanted to talk specifically about the European Sustainability Reporting Standards is that obviously everybody knows that they are a key piece of compliance with the CSRD. However, I think a lot of people are a little bit confused about what's in the CSRD, what's in the ESRS and also what basically are the key features of those standards to think about and how to get ready for them.
So the CSRD is the underlying directive. It's the law. So there are a number of core principles and requirements that are set out in the CSRD. So for example, that includes the fact that this information will be assured. It includes the idea that there will be double materiality applied, and so on and so on. The European sustainability reporting standards are the standards that CSRD says will be used by all companies to comply with the rule of the law. A number of key topics are mentioned in the base directive, but fundamentally, the standards are where we see the detail and where we see the requirements really building themselves out so that companies can understand exactly which topics they will need to report against and which metrics they will need to produce and how they are to put that report together.
So that means that because we're talking about a directive that is asking for full E, S and G reporting across all three topics. The standards themselves are very comprehensive. They've already been through a number of phases of drafts. They were initially prepared by a European organisation called FRAG that also works in financial reporting. And under a European standard setting board. And they've eventually been passed over to the European Commission, which is obviously one of the rule and law setting bodies in the European system, to check that they are working against that core directive, to check that they are proportionate, that is, that the amount of effort required to produce them produces the outcomes that are desired and also to make sure that those standards can now be written into law, so that they are applicable across the entirety of the CSRD companies. So that means that these standards have already been through a number of different phases. They've gone from very comprehensive standards covering a very, very broad range of disclosures. They have been reduced down a bit since then via this process, but we're still left with something where the aim is very much to cover that full scope of topic.
So that means we now have 12 standards overall within the ESRS. Two of those are cross-cutting standards. They provide general reporting concepts and background, for example, things like double materiality, which we'll get onto in a minute, and 10 topical standards, which cover disclosure requirements across topics in the environmental space, the social space, and the governance space. There's only one of those governance standards because a lot of that is covered by regulation elsewhere. Overall, and there are different ways to count this, but you'll see the most frequently quoted numbers, that makes for 84 disclosure requirements and somewhere over a thousand qualitative and quantitative data points or metrics. So that's quite a lot of information that a company might need to compile.
I think one of the other key points to note about the standards is that they're looking to achieve a number of things. So, they're looking to bring comparability to sustainability information disclosed by companies across the EU. Obviously, that's one of the core principles of the directive itself. They're also quite detailed. So they increase the level of detail beyond the scope that many companies are used to at the moment in a voluntary reporting environment. They also impact the value chain, which is another term that's often used for a slightly broader definition of the supply chain. For those who are mostly used to climate or carbon reporting, that's where we find scope three in carbon reporting. But the ESRS take that beyond just carbon, and they want to know information about the broader value chain across different topics for environment and society. So that's a very, very key point of these standards.
There is a little bit of relief there for the duration of time it takes companies to be able to build up to that because that's quite a lot of effort as we know. And finally, the ESRS provide a lot more detail about the structure of what these disclosures need to look like when they appear into an integrated annual report, what a sustainability statement looks like, and connectivity with the financial information. And there is actually a lot, just as a sort of top level note, in these standards where finance comes in.
So, for example, one of the things that's been done to try and alleviate the burden on companies as they get used to these broad standards is that certain disclosures are phased so that companies have a little bit more time to get to their final results and to get to the quality they're looking for. So that, for example, means that certain size companies below 750 employees may leave Scope 3GHG for a little while. There's some stuff related to own workforce that they get a bit of phasing time for.
Some of the value chain reporting can be phased in over a number of years. And a number of other standards for smaller companies can be basically phased in over a couple of years as well. And finally, one of those very, very key pieces of overlap with financial reporting is that in various places, the standards ask for information on anticipated financial effects. Now, that's a really, really important part of the disclosure here, because that's one of the things that's really bringing together the world of finance and sustainability information, bringing ESG and F into sustainability as a broad topic. And there's a bit of a delay on those as well, because as a lot of companies pointed out, actually that involves actually really calculating what that financial impact looks like. And I think the final sort of broad point to make about the ESRS, I think we've covered it many times on episodes, is that interoperability is key. We've talked a lot, we've got the ISSB. Everybody has been incredibly grateful to see interoperability being one of the targets with the standards consolidation. And I think a piece of good news about the ESRS is that they've worked to make the climate standard and the general cross-cutting standard interoperate with the ISSB standards. They have also, and I'll come on to this in a minute as well, done some work on materiality. And finally, of course, this whole effort, if you look through these standards, you'll find they're very, very heavily based on core concepts from TCFD that everybody is very, very familiar with. So that's looking at governance, looking at impact risk and opportunity, policies, targets, and actions, and metrics. So hopefully while there is very much a lot of work to do in these standards, there's also quite a bit in there that companies should at least feel is familiar and is something that isn't wholly new.
So having sort of introduced the standards a bit there, why do I keep mentioning double materiality and why is double materiality so key? Now, there are potentially a lot of things to cover on materiality, and I don't necessarily have the time in this episode, but I wanted to make sure that I cover how double materiality interacts with the standards and why it is so important for these final European sustainability reporting standards.
So there are a couple of key reasons it's so important. Firstly, many other standards so far have been thinking about and financial reporting thinks about materiality as what's called single or financial investor focused materiality. The European Sustainability Reporting Standards, in common with frameworks like GRI, ask companies to think about double materiality. So double materiality means two dimensions to an assessment of whether an item is a material impact. And that means a material financial impact on the business or in the case of double materiality, whether that something is an impact outside the business, whether it impacts society or the environment. And in the case of double materiality, if something is materiality on one side of that scale, it is material overall. And that's very, very important for the ESRS, because most of the disclosures in this final version of ESRS are dependent upon materiality. There are a few general disclosures that are mandatory, regardless of their status in an organization. But the majority of the rest of the topics, the company needs to perform this double materiality assessment to understand how the CSRD and sustainability impacts their strategy, where the risks and opportunities are, therefore, where the current gaps are in their reporting process. Often, you will find recommendations for an active data gap assessment. And therefore, what actually are their final required disclosures? So it's an incredibly important part of the process.
One of the good pieces of news again, interoperability, as I mentioned before, has been one of the key focuses during the final development work of the ESRS. So we now see that the financial materiality side of that double materiality assessment has been aligned with the ISSB's materiality assessment. Financial materiality, I think for many listening to this, if you want a little bit of help, your colleagues are very, very experienced in financial materiality assessments. But obviously there might be a bit of work here to have a think about how certain sustainability topics actually do or don't impact on the financial materiality, whether that's something that needs some calculation work and there's gonna be a bit of teamwork involved to get that sorted.
The impact materiality on the other hand, that side of the equation is something that many sustainability teams are already very familiar with, especially if they've been reporting under TRI. And obviously this is where we hear the word stakeholders mentioned very, very frequently.
And the European sustainability reporting standards, obviously stakeholder consultation and stakeholder impact is a very big part of the picture. There's a couple of really good lists of types of stakeholders to consider in the way I'm looking at different types of stakeholder and different types of impact. However, I think something that is often missed in the descriptions of the double materiality process is that the standards go further than that. They also talk about measuring the severity of actual impact and determining that by scale, scope, and whether or not it is an irredeemable character, whether or not the impact could ever be reversed. And there's also necessary to actually think about whether that, the likelihood of that severity or severe outcome actually occurring. So between those two, there's a lot of actual analysis to do that. There's judgment, of course. There is always judgment and materiality assessments. But for some areas of materiality people are going to need to have a think, have a bit of a look to see if there's also data that might indicate severity or help them understand the likely severity of impacts on the world. This is where things like scenario analysis come in. So this materiality process, there's quite a bit of detail in the standards.
Obviously, it's so important that EFRAC has also been working on and will be producing additional guidance. You can find the draft guidance hiding away on their website in their current draft documents for consideration by their standards board. But eventually there will also be some final guidance to go with this bit of the process.
So that leads me very nicely into how do companies get ready for ESRS compliance and how do they know where they are? So obviously that's where that process I started on right at the beginning of discussing materiality comes in. Materiality and the materiality assessment really helps companies assess their current position, where they are now compared with where the materiality assessment on the topics and the standards tells them they're going to need to be.
So they've been, obviously companies have been working their way through this over the last sort of few months or so. Many still have some work to do here. But we saw an example recently in some articles where Royal Phillips, which is a Dutch and a Dutch conglomerate that's already been working on sustainability reporting for quite some time now, 15 years they say, they did a double materiality assessment and they found that they'd have to report on quite a lot of the ESRS. But they also discovered, despite their long storied history in that reporting, their current reporting would still only cover 30% of those data points. Now, that I think is a really good indicator of what happens on the difference between voluntary reporting, maybe on topic against material topics that have been very, very actively demanded from the market. And what happens when maybe you're assessing against a more rigid and more detailed framework. So it's very, very worthwhile getting through the double materiality assessment early in preparation for working against the European sustainability reporting standards.
And I don't just say early because of the idea that obviously there's gonna be a lot of disclosure writing to do because we know that's where our mind goes. We go to the end report. How much stuff are we going to have to fit in that report? How much more data are we going to have to get into those sustainability statements? But of course we want to start early because whilst the report isn't due until 2025 for the companies in that first phase, obviously they're reporting on the financial year 2024, which means any of those data gaps, if it's not possible to collect that data for the reporting period at the time when we really get into reporting development. Then it's going to be very, very challenging to go and backfill that data from the beginning of the financial year. So many companies are looking to understand where their gaps are now so they can start collecting the correct data from the beginning of the year.
I think another thing that companies are doing is obviously, I already talked about how the European sustainability reporting standards are very heavily based on those TCFD core pillars. And that included impact, risk, opportunity, governance. And of course, a lot of this has to do with strategy and business model. So again, it really helps to have done the materiality assessment early and to really start to dive into the European sustainability reporting standards sooner rather than later, to help understand if there's going to be any impact at that level. So that when it comes down to it, actually pulling out and disclosing on risks and opportunities is all very, very nicely tied back into the full impact on the business and the strategy for the business. It makes for a much more coherent reporting process.
In general, companies are all obviously at very different points in the maturity of their reporting process, how long they've been working in sustainability, which topics have already been material for them, which voluntary frameworks they're using. But most will benefit from doing a double materiality assessment, maybe one or two, maybe phasing that assessment. I've had some excellent conversations with companies who are managing the burden a bit more by doing an initial assessment and a follow-up assessment and a detailed assessment, especially as we get closer and closer to the deadline. And really diving into the European sustainability reporting standards, doing that gap assessment, and then using all that information to tie directly into their sustainability program so that they can go forward and keep working on this iteratively over the next year. There is no one size fits all, but there's plenty in there that will benefit companies of all sizes. So really looking forward to seeing how companies pick that up and getting a lot more data from the European Sustainability Reporting Standards.
I hope you've enjoyed this episode of ESG Talk, brought to you by Workiva, the world's only unified platform for financial reporting, ESG audit and risk. You can find many more resources exploring CSRD and ESRS on our website. We also have an interactive guide on double materiality assessments. And we also have specific blog talking through what the final European sustainability reporting standards look like.
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