Beth Sasfai is a Partner, and Michael Mencher and Emma Bichet are Special Counsels at Cooley LLP. This post is based on a Cooley memorandum by Ms. Sasfai, Mr. Mencher, Ms. Bichet, Steven Holm, and Jack Eastwood. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) by Lucian A. Bebchuk and Roberto Tallarita; For Whom Corporate Leaders Bargain (discussed on the Forum here) and Stakeholder Capitalism in the Time of COVID (discussed on the Forum here) both by Lucian Bebchuk, Kobi Kastiel, Roberto Tallarita; and Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock (discussed on the Forum here) by Leo E. Strine, Jr.
The ESRS
The ESRS set out detailed reporting requirements for EU companies in scope of the CSRD, including EU subsidiaries of non-EU companies. The ESRS cover:
- General reporting principles.
- A list of mandatory disclosure requirements for EU companies related to the identification and governance of sustainability matters.
- The 10 ESG topics where disclosure is required, subject to a materiality assessment.
While this is the first set of ESRS, further sets of standards also will be adopted in the near future for specific industry sectors, small and medium-sized enterprises (SMEs) and non-EU parent companies.
Together, the CSRD and ESRS require companies to:
- Perform materiality assessments on each sustainability topic applying the double materiality principle to work out which information should be reported. (In line with double materiality, companies must report if sustainability information is material from either a financial or an impact perspective, taking account of people and the environment.)
- Report on the material impacts, risks and opportunities (IROs) identified in the company’s own operations, those of its group and those of its upstream and downstream value chain.
- Provide metrics and targets for material sustainability topics and connect these to their financial reports.
- Have their sustainability disclosures audited by an independent third-party auditor before they are filed with the relevant authority.
General requirements
ESRS 1 on ‘General Requirements’ explains the process requirements that apply to all companies reporting under these standards. For example, it explains what is meant by double materiality and reporting boundaries, as well as the extent to which a company must report on its value chains, due diligence expectations, the required quality of quantitative and qualitative data (including the use of estimates), the need for consistency with the company’s financial statement disclosure, and the overall report structure.
General disclosures
ESRS 2 on ‘General Disclosures’ lists all the mandatory disclosures that all in-scope companies must report on, irrespective of materiality. This standard includes disclosures on how sustainability-related performance is integrated into the company’s incentive schemes, statements on its due diligence processes and descriptions of the processes used to identify and assess materiality. Disclosures on key performance indicators prescribed by the EU Taxonomy Regulation also are required.
Topical ESRS
Materiality assessments: For the topical ESRS that cover the 10 ESG topics set out in more detail below, a materiality assessment is the starting point for reporting. Companies are required to assess and report on ‘material’ sustainability-related IROs in their value chains under each of the 10 topical standards. If, following the materiality assessment, a given sustainability matter is material from either a financial or impact perspective, the company must disclose against the relevant topical ESRS. The European Commission has been keen to emphasize that reporting on material sustainability matters is not voluntary. The conduct of materiality assessments may require significant advanced planning, including gathering information related to value chain impacts. Companies still will be required to gather sustainability information from their value chains even if, once assessed, they ultimately conclude that the information is not material enough to require reporting.
Where a company has determined that a topical ESRS is not material, it is not required to report information under that standard. However, unlike the other topical ESRS, if a company judges climate-related disclosures (E1) to be immaterial, the company must provide a detailed justification.
Permitted exclusions are very limited, and where a company relies on an exemption, it must disclose this to be the case.
The table below provides an overview of the content for each adopted topical ESRS.
Environmental | |
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E1 Climate change |
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E2 Pollution |
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E3 Water and marine resources |
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E4 Biodiversity and ecosystems |
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E5 Circular economy |
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Social | |
S1 Own workforce |
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S2 Workers in the value chain |
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S3 Affected communities |
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S4 Consumers and end-users |
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Governance | |
G1 Business conduct |
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Sector-specific standards and additional forthcoming standards
The ESRS outlined above do not represent the entirety of potential disclosure obligations under the CSRD. Sector-specific standards which will apply in addition to the current ESRS are expected to cover sectors such as textiles, information technology, electronics, and pharmaceuticals and biotechnology. These standards would create additional disclosure requirements related to topics of particular materiality for specific industries. Drafts of these standards initially were scheduled for 2023 – 2024.
Other sets of sustainability standards will be adopted by the EU in the coming years for SMEs and non-EU parent companies.
Further application guidance also can be expected in the coming months. The European standards body – the European Financial Reporting Advisory Group – is currently developing additional guidance on how companies can perform the double materiality assessment and the extent of value chain information required under the ESRS.
Key elements for businesses
Companies in scope of the CSRD should start getting ready for ESRS reporting now, as it may take some time to perform materiality assessments and set up systems to gather the audit-ready data needed for their reports. Key elements for businesses are outlined below.
- Centrality of materiality assessments
Companies will need to front-load work in this area to determine the scope of their reporting requirements under each of the topical ESRS. Outside advisers likely will play a key role in helping companies design relevant processes, which must include an analysis of value chains and double materiality – and likely will differ substantively from companies’ existing sustainability reporting frameworks or risk management systems.
- Process cannot be neglected
The ESRS are very detailed on what companies should report on and how they should report. This means that most companies will need to assess whether their existing sustainability diligence and reporting practices comply with the CSRD, even if they already report on some or all of the areas covered by the topical ESRS. Similar to US Securities and Exchange Commission (SEC) cybersecurity and climate rules, as well as the widely used Task Force on Climate-Related Financial Disclosures (TCFD) and CDP climate disclosure frameworks, the ESRS has a significant focus on disclosures related to the governance of sustainability matters. Companies should be attentive to preparing for the mandatory process and governance disclosures in ESRS 2.
- Importance of climate materiality
Perhaps the most notable feature of the adopted ESRS is the move away from proposed mandatory reporting on climate change, including the disclosure of scopes 1, 2 and 3 greenhouse gas emissions. Nonetheless, in practice, we anticipate that most companies will need to report on climate change, given the breadth of the double materiality framework and the need to justify any decision to exclude climate reporting – and have that justification pass audit. At the same time, we are seeing increased investor and customer demands for climate data, meaning, in practice, many companies will be making these disclosures anyway.
- Greater consistency with other ESG reporting frameworks, but gaps remain
Although the SEC’s final climate rule is not expected until later this year, the ESRS differ from the SEC’s current and proposed rules in numerous substantive and methodological areas. Divergences include how the ESRS approach to value chain reporting, the need for impact materiality assessments and the need to report on a broader set of sustainability topics. The ESRS also are broader than just climate disclosures and extend well beyond the current limited SEC requirements related to human capital and governance matters. For US companies already aligning voluntarily with frameworks such as the Global Reporting Initiative, Sustainability Accounting Standards Board or TCFD, the ESRS also contains numerous significant differences in subject matter and methodology.
Similarly, while improvements have been made to better align the ESRS and International Sustainability Standards Board (ISSB) standards – IFRS S1 and IFRS S2, published June 2023 – companies should not assume that a CSRD-compliant report will automatically meet all the requirements under the ISSB standards, and vice versa. For UK and Singapore companies, this is particularly relevant. On 2 August 2023, the UK government confirmed that the incoming UK Sustainability Disclosure Standards will be based on the ISSB standards. These new UK sustainability reporting requirements may apply to companies as early as July 2024. A similar proposal has been made in Singapore, where certain companies may be required to comply as early as 2025. The publication of a summary comparing the ESRS to the ISSB standards is expected in the coming months. As a result, we recommend that companies conduct gap assessments of their current voluntary reporting or other regulated disclosures against the ESRS to identify areas where additional work will be required.