ESG: ESMAs response to EFRAG’s sustainability reporting consultation

On 10 August 2022, ESMA published its response to the European Financial Reporting Advisory Group’s (EFRAG) public consultation on its first set of draft European Sustainability Reporting Standards (ESRS), together with an annex containing technical remarks on the details of the draft standards.

The draft ESRS are a key element to achieve the Corporate Sustainability Reporting Directive’s (CSRD) ambition of ensuring sustainability reporting which is relevant, reliable, comparable and understandable.

ESMA’s response

• highlights its support for a strong materiality assessment but expresses its concern with the suggested ‘rebuttable presumption’ approach.
• encourages EFRAG to keep engaging with the International Sustainability Standards Board to ensure further alignment of the ESRS and the IFRS Sustainability Standards to benefit both users of sustainability reporting and the companies that prepare the reporting.

What happens next?

EFRAG is expected to deliver its final draft ESRS to the European Commission (the Commission) in November 2022.

In accordance with the CSRD, the three ESAs (ESMA, the EBA and EIOPA) will each deliver its Opinion to the Commission on the final draft ESRS which EFRAG publishes.

Background to ESMA’s response

While the Non-Financial Reporting Directive (NFRD) provides some common basis for sustainability reporting in the EU, the perceived need for increased transparency to combat greenwashing and to help detect ESG-related risks which may undermine financial stability led to the recent political agreement on the Corporate Sustainability Reporting Directive (CSRD).

The CSRD, which will replace the NFRD, establishes mandatory reporting standards and widens the range of in scope companies.

EFRAG is in the process of consulting on draft sustainability reporting standards which it has developed under the CSRD – the Directive requires each of the three ESAs to submit an opinion on EFRAG’s final advice before the European Commission adopts the ESRS in a delegated act.

What does the response say?

ESMA’s response takes into account the four main criteria which it intends to use in due course when preparing its Opinion. The criteria are intended to ensure that the ESRS:

• promote disclosure of material sustainability information of high quality
• are conducive to consistent application in terms of both content and format
• are consistent and interoperable with other EU legislation and
• promote, to the greatest extent possible and taking account of the EU sustainability requirements and objectives, interoperability with relevant international standards.

Looking at each of these in turn:

The ESRS should promote disclosure of material sustainability information of high quality

ESMA strongly supports basing the ESRS around the principle of double materiality, which implies that undertakings take a holistic view in assessing sustainability-related risks, opportunities and impacts.

A rigorous materiality assessment needs to be the basis for reporting information that is relevant for the decision-making of investors and other stakeholders. To this end, it is important that EFRAG provides adequate guidance to issuers on how to implement the materiality process and how to distinguish between impact materiality and financial or enterprise value creation materiality.

It is particularly important that EFRAG carefully assesses whether some of the proposed topical requirements are relevant mainly for certain sectors.

The draft ESRS envisage that while all mandatory disclosure requirements would be presumed material, this presumption is rebuttable if undertakings have reasonable and supportable evidence. Where an undertaking decides to rebut this presumption and avoid providing certain disclosures, it would have to produce ad hoc explanations to back up this decision.

ESMA does not support this approach for a number of reasons

• it is concerned that it may be conducive to a ‘checklist’ approach
• there is a risk that the approach may suggest a structured ‘non-disclosure route’, which might lead undertakings to see the ESRS as a ‘menu’ of disclosure requirements they can choose from through a form of ‘comply or explain’ mechanism.
• ESMA believes that combining a materiality assessment with cost-benefit or proportionality considerations may distract undertakings’ focus from preparing high-quality sustainability reporting for investors and other stakeholders.

Instead, ESMA recommends that EFRAG should

• remove the rebuttable presumption and avoid requiring explanations about the lack of materiality of certain disclosures
• emphasise the importance of the materiality assessment to ensure that only relevant information is reported
• make clear that the materiality assessment is not intended to pursue proportionality purposes and
• focus on pursuing proportionality objectives via other means – for example, by allowing the gradual phasing-in of certain requirements, reducing the complexity of the requirements and / or deferring some disclosure requirements to the later development of industry-specific standards.

The ESRS should be conducive to consistent application in terms of both content and format

In its response, ESMA

• notes that “the architecture of the requirements which distinguishes between cross-cutting and topical standards may result in implementation complexities” and recommends that EFRAG considers improving the interplay between these requirements
• recommends that the ESRS should remain focused on setting out requirements to provide for material information to fulfil the disclosure obligations set out in the CSRD and should avoid entering into the domain of conduct obligations, for example in the area of due diligence
• points out the importance of ensuring consistency in the way undertakings create connectivity between their sustainability reporting and the other parts of their annual financial report, recommending that EFRAG considers how to best set out the regime for incorporation by reference of material information in the sustainability statement
• calls on EFRAG to consider how best the ESRS can reflect the CSRD requirements on reporting on risks, opportunities and impacts relating to value chains – in particular, “ensuring proportionality of the relevant data collection efforts required from reporting undertakings as well as of any indirect reporting burden that may be imposed on entities in the value chains”.

The ESRS should be consistent and interoperable with other EU legislation

ESMA welcomes the fact that the ESRS largely take into account the disclosure requirements under the SFDR. It feels that consistency between standards will help financial market participants meet their obligation to disclose principal adverse impact indicators and contribute to reducing the risk of greenwashing across the sustainable investment value chain.

ESMA encourages EFRAG to ensure full consistency when it comes to terminology and definitions in other areas of EU legislation, such as the Taxonomy Regulation and SRD II.

The ESRS should, to the greatest extent possible and taking account of the EU sustainability requirements and objectives, promote interoperability with relevant international standards

CSRD requires the ESRS to take into account, as far as possible, the work of global standard-setting initiatives for sustainability reporting.

ESMA emphasises that global comparability of sustainability reporting requirements should be a key objective of the ESRS (though not to the extent of lowering the EU’s sustainability ambition).

The response identifies two areas where ESMA feels it would be beneficial to increase alignment between the ESRS and international reporting standards (most importantly the future IFRS Sustainability Standards of the ISSB and the GRI standards):

• EFRAG should engage in further discussion with the ISSB and GRI to achieve a better mutual alignment of the respective terminology and definitions
• there should be greater clarity as to how the assessment of the impacts that undertakings generate on the people and the planet (ie, the impact materiality perspective) should be filtered through the lens of the risks and opportunities for the entity (ie, the financial materiality perspective).

For more on sustainability reporting standards, see our articles:

• ESG: EFRAG sustainability reporting standards – SMSG’s advice to ESMA and
• ESG: ISSB Exposure drafts – ESMA submits its comments