2022 witnessed a tremendous and massive movement towards sustainability. This movement is accompanied by the emergence of new regulations and standards. With these standards, ESG (Environment, Social, Governance) reporting becomes more and more regulated. Among these standards are the ESRS (European Sustainability Reporting Standards) and the IFRS S1 & S2.
What are ESRS and IFRS all about? Which organisations prepared these standards? We will be clearing it all out.
In 2015, the 2030 Agenda for Sustainable Development had been adopted by all member States of the United Nations. This means that all member states accepted and agreed to achieve the 17 Sustainable Development Goals, which are about the safety and impact on the environment and society.
A year before, in 2014, the European Commission adopted Directive 2014/95/EU also known as the NFRD (Non-Financial Reporting Directive). The NFRD regulated ESG disclosure or non-financial reporting, especially for large companies with more than 500 employees. For the other companies, non-financial reporting remained exclusively voluntary. The disclosed information was about the environment, social and governance criteria in general. While in Europe, ESG reporting was more or less regulated, it remained voluntary all around the world depending on each country’s regulations and laws. There are a lot of disclosure frameworks that helped companies and governments to prevent “greenwashing”, such as GRI (Global Reporting Initiative), CDP (Carbon Disclosure Project) and many more.
However, since the end of 2021 and the beginning of 2023, great advances have been developed in terms of standards and regulations. The European Commission has officially adopted in November 2022 a new directive "CSRD (Corporate Sustainability Reporting Directive)". The first talks about CSRD in 2021 led to the preparation of the new ESRS (European Sustainability Reporting Standard) by EFRAG (European Financial Reporting Advisory Group), which takes into account the EU Taxonomy Climate Act. And at the same time, and on an international level, the IFRS (International Financial Reporting Standards) established the ISSB (International Sustainability Standards Board) to work on the new IFRS sustainability standards related to ESG reporting, which are IFRS-S1 and IFRS-S2. Both IFRS sustainability standards and the ESRS drafts had been made public for feedback and comments before issuing the final versions by the end of 2022 or in early 2023.
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CSRD and the ESRS standards
The CSRD directive replaces the NFRD, and the first sustainability reports from companies are to be published in 2025 based on the performance of the previous year 2024. The CSRD directive extends the reporting requirements to all large companies and all companies listed on regulated markets including ones with more than 250 employees (before 500). The new CSRD directive widens the scope of action of the previous NFRD, by improving the quality, reliability and sincerity of the disclosed information (auditing of the reported information by a third party). It also introduces more detailed reporting requirements concerning ESG. The draft of the European sustainability reporting standards is developed by EFRAG and it led to the ESRS standards.
The new reporting requirements draft contains 13 standards related to ESG. According to EFRAG’s Appendix I draft, the 13 standards are classified into 4 categories:
- ESRS E1 Climate change
- ESRS E2 Pollution
- ESRS E3 Water and marine resources
- ESRS E4 Biodiversity
- ESRS E5 Resource use and circular economy
- ESRS S1 Own workforce
- ESRS S2 Workers in the value chain
- ESRS S3 Affected communities
- ESRS S4 Consumers and end-users
Therefore, companies that are concerned with the new CSRD must disclose how sustainability is integrated into their business strategy and how the ESG materiality impacts, risks and opportunities are identified and managed. This is the basis of EFRAG’s sustainability standards, which is the “double materiality” (financial materiality and impact materiality). This is one of the most important differences between the ESRS and the IFRS standards where only the “simple materiality” (financial materiality) is concerned with ISSB’s work on the sustainability standards and requirements. Therefore, companies concerned with EFRAG’s standards should take into consideration not only how the external threats, environment and other issues influence their business operations and activities but also how their activities impact the environment and communities. The ESRS standards will include major guidelines and much detailed information to help and guide companies on the adoption of the most appropriate ESG policy and reporting framework.
One should always remember that for now, the EFRAG’s sustainability standards are still a draft and subject to change. However, the major standards will remain the same. The final version will be issued towards the end of 2022.
We should mention that EFRAG’s work takes into consideration the already existing regulations and directives, such as the Sustainable Finance Disclosure Regulation (SFDR) (regarding the financial market), the EU Taxonomy, the Corporate Sustainability Due Diligence, and others. Moreover, EFRAG’s team took into account the existing international reporting standards and frameworks to align the requirements and include the best practices, among which we can mention the previous NFRD, GRI, TCFD (Task Force on Climate-Related Financial Disclosures) and many more.
Ongoing negotiations between the European Parliament and Council to finalise the legislative texts of the CSRD will determine the date of the adoption of the ESRS standards. The date seems to be towards the end of 2022 or early 2023, which will mean that the concerned companies have to comply with the sustainability reporting standards in 2023.
In parallel to EFRAG’s sustainability standards, other standards are being developed, such as the ISSB’s sustainability standards IFRS-S1 and IFRS-S2.
ISSB and the IFRS standards
The ISSB was founded by the IFRS to develop global sustainability reporting standards, which led to the creation of the IFRS Sustainability Disclosure Standards S1 and S2. These standards aim to connect both sustainability-related and financial reporting of a company.
The ISSB’s set of global ESG disclosure standards was developed to make sustainability-related risks and opportunities more comparable between companies. Same as EFRAG’s team, the ISSB working group collaborated and integrated other sustainability standards and reporting frameworks, among which the TCFD, the Climate Disclosure Standards Board from CPD, the Sustainability Accounting Standards Board and more recently the GRI.
This work led to the proposal of:
- IFRS S1: General Requirements for Disclosure of Sustainability-related Financial Information;
- IFRS S2: Climate-related Disclosure
IFRS S1 will require companies to report information about sustainability-related financial information. The data disclosure will be based on the core content of IFRS S1, which are the companies’ views of “governance, strategy, risk management, metrics and targets”. This will lead to the measurement, monitoring and management of sustainability-related risks and opportunities. IFRS S2 will include the same reporting strategy concerning the core content of IFRS S1, but with more climate-related physical and transition risks and opportunities.
Therefore, and as mentioned before, IFRS Sustainability Disclosure Standards are based on financial materiality only. This means that companies will report on how the environment and the community will affect their business operations, so it’s more of an “outside-in” strategy while the double materiality of EFRAG’s standards includes the impact materiality which we can call the “inside-out” strategy. Now, this is the major difference between both sets of standards, even if there are many similarities between the two sets, there were also other differences as pointed out in EFRAG’s Appendix V - IFRS Sustainability Standards and ESRS reconciliation table. However, the ISSB has put together a working group to enhance compatibility with the ESRS. Members of the working group include the Chinese Ministry of Finance, the European Commission, EFRAG, the Japanese Financial Services Authority, the Sustainability Standards Board of Japan Preparation Committee, the United Kingdom Financial Conduct Authority and the US Securities and Exchange Commission (SEC). This collaboration highlights the aim of the world's major states to accelerate the movement toward more sustainable actions and development.
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Will the application of ESRS and IFRS standards be mandatory?
Before we answer this question, it is important to mention that we might find ourselves with two competing standards around the world, especially since the European Commission will be adopting the ESRS standards. But as mentioned previously, the collaboration that was created between the ISSB and EFRAG will lead to two complete sets of standards rather than competitive, but only time will tell especially since the final versions are yet to be issued.
The EFRAG’s standards, the ESRS, will be adopted by the new CSRD directive. This will mean that in the European Union (EU), this set of standards will be mandatory and transposed afterwards in each member state after its final issuing. This will mean that companies present on EU soil will have to comply with the ESRS standards, even if their headquarters are outside the EU.
On the other hand, IFRS sustainability standards will not be mandatory, and each jurisdiction outside the EU will decide whether they require companies to apply these standards or not. However, 166 different jurisdictions apply the IFRS standards, and some of them are most likely to apply sustainability-related standards.
The United States and sustainability-related financial standards
In the US, the SEC adopts the US GAAP (Generally Accepted Accounting Principles) collection of accounting rules and standards for financial reporting rather than the IFRSs’. The US SEC allows the adoption of IFRS standards for financial reporting for only foreign-based companies. However, in terms of ESG disclosure rules and laws, the US SEC has proposed a rule to “Enhance and Standardize Climate-Related Disclosures”. This ESG disclosure rule and along with the US GAAP financial reporting standards will make ESG reporting in line with the financial reporting of US companies more and more regulated.
ESRS, IFRS and the challenge of data collection
The CSRD directive will “require companies to digitally tag the reported information, so it can feed the European single access point envisaged in the capital markets union action plan”. In other words, companies should collect and report their data in a digitally tagged form.
Therefore, companies should be at the forefront of collecting all the necessary information and complying with the formalities of the directive. It is the same when it comes to IFRS standards, data should be collected and reported to disclose the necessary information, and digital forms will greatly help all the stakeholders and investors to easily assess the ESG performance of a company.
Compiling all the necessary information, and data concerning the 3 ESG pillars can be tedious, and time-consuming. Digital tools exist to help collect all the data, indicators and statistical analysis, and automatically include them in predefined reporting forms.
In addition, a digital tool will significantly help the monitoring of the adopted objectives, targets and actions via KPIs and KRIs thanks to a real-time data feed. Such a tool can be the solution for the standardised formatting of a mandatory report and allows fast decision-making according to the data feed and the boards' strategy.
Finally, a digital tool can shed the light on the differences and similarities between both sets of standards, ESRS and IFRS. This feature allows every company to make the right decisions by choosing the most appropriate standards while dressing its ESG strategy.
All these talks about sustainability standards and applications will bring to light the real contribution and impact of many business operations on the environment and community. Two huge sets of standards that will be proposed at the end of 2022, will greatly help companies and many organisations to carefully choose their new ESG strategy and framework and to be the best-performing company on the market.
To go further:
> Discover our review of Successful ESG strategy with EHS on the BlueMarket.