Inside the EU’s Overhaul of Sustainability Disclosure Rules

Why is this happening? 

The reduction of sustainability disclosures is part of the deregulation agenda initiated by the EU Commission earlier this year through the Omnibus 1 Simplification Package, which introduces major changes to EU sustainability reporting and due diligence legislations, including a drastic reduction of companies subject to mandatory reporting.

Research into the first year of application demonstrates that the EU Corporate Sustainability Reporting Directive and the EU standards have led to significant improvements in the quality and comparability of sustainability disclosures, especially on climate risks, climate transition plans, social impacts and the integration of sustainability matters in business strategy. 

However, even before these first results were known, the Commission requested EFRAG to deliver a significant simplification of the standards. 

The revised ESRS were approved by EFRAG on 28th November, after an extremely intensive process and dialogue between preparers and users of sustainability information. This resulted in the deletion of many important disclosures and the introduction of reliefs that will allow companies to skip disclosures they deem too costly or burdensome. 

The push to carve-out the standards was particularly noticeable from industries such as oil and gas, who have a vested interest in reducing transparency and accountability of companies' decarbonisation efforts.

The simplified standards still provide a functional reporting framework. However, the reduction of over two-thirds of disclosure requirements inevitably leads to a loss of critical insights, and the flexibility granted to preparers leaves very limited safeguards against misapplication and the concealment of important information.

In response to this outcome, Filip Gregor, Head of Responsible Companies at Frank Bold and a member of EFRAG's Sustainability Reporting Board said; 

“We were tasked with the impossible: slash the ESRS by more than half without turning it into a greenwashing tool. Intense external pressure fixated on reductions, sidelining concerns about quality, comparability, and reliability. It speaks volumes that the dissenting big business associations reject the principle of fair presentation which gives companies flexibility rather than imposing tick-boxing compliance and prevents  misleading practices. This principle, alongside disclosure of anticipated financial effects, is also a cornerstone of the IFRS sustainability reporting standards developed by the ISSB.” 

What are the changes? 

Stakeholders represented in EFRAG agreed on many of the key changes, including finding consensus around the simplification and clarification of materiality assessments, as well as significantly streamlining data points for reporting on policies, actions and targets. 

More difficult debates revolved around changes that would damage the integrity and utility of the EU standards. As already noted, some of the compromises make the standards prone to misapplication. Most notably, these contentious changes include: 

1. Undermining alignment with international standards 

While certain business lobby groups and politicians have been repeatedly calling for alignment with the international IFRS Sustainability Disclosure Standards, the quantification of anticipated financial effects - one of the most important elements to retain such consistency - has been the target of pushback by the very same voices. The draft standards submitted to the EU Commission maintain such disclosures but incorporate a long list of exceptions for companies to omit such information, including a full relief for any company that “does not have the skills, capabilities or resources to provide that quantitative information”. On top of this, EFRAG included a full postponement  regarding quantitative information  anticipated financial effects until  reporting on financial year 2030 

Similarly, the IFRS standards are clear that their framework is based on fair presentation, requiring companies to provide a full, accurate and faithful picture of their sustainability risks. This gives companies flexibility to tell their story instead of being subject to a tick boxing exercise. Although the standards have been reduced down to the bare minimum of data points, there are still businesses requesting to take this away and reduce reporting to a paper tiger exercise. 

2. Creating an indefinite loophole for companies to omit sustainability data

EFRAG proposes a range of reliefs that can be applied to any disclosures, but these are not coupled with clear guardrails and limits. In essence, the ESRS rely on companies implementing them in good faith, leaving little firm ground for auditors to challenge the misuse of these provisions. 

The European supervisory authorities (ESMA and ECB) warned during the public consultation against the extensive reliefs unlimited in time if the company concludes that disclosures would involve too much costs, or effort,  - or if it does not have access to data. This has been left unaddressed, leaving the omission of material ESG data open-ended, with no time limit or clear requirement to address the issue over time. 

3. Opening key disclosures to risks of greenwashing or obscuring information

Across the topical standards, many important disclosures were removed or radically simplified, undermining comparability and reliability.

For climate this includes permitting climate transition plans even if they don’t meet basic quality standards, loosening requirements on the scenarios applied in their risk assessment, or providing different options to report key values of their assets connected to climate risk. In addition, financial institutions are exempted from disclosures of absolute values of their GHG emission reduction targets, and may rely only on intensity-based metrics in this regard.

For impacts on nature, the new ESRS explicitly permit aggregation, including at the regional level, instead of strict reporting on major sites. This approach can result in better information, if applied responsibly, but can be easily abused to obscure information on critical locations. With regard to the substances of concern, EFRAG proposed a full 4 year postponement for the chemical industry until 2030.

In social standards companies have a greater flexibility to omit reporting on basic metrics on their own workforce, while on the governance standard, EFRAG removed a metric on late payment of invoices to SMEs, because of the high effort and cost to large companies of  monitoring it. 

The bigger picture

The revised ESRS are now in the hands of the EU Commission, who will initiate the process to adopt them officially. The process is expected to take six to nine months, including internal and external consultations, engagement with Member States and approval process by co-legislators. Those business associations lobbying on behalf of interests that are fundamentally opposed to transparency on sustainability will attempt to utilise this political process to further weaken and alter the reporting standards. While the reduced standards maintain integrity, they can be easily turned into a greenwashing tool.

A decade of steady, evidence-based progress on sustainability reporting has been undone in a matter of months by frantic political decision-making that is being slammed by the EU watchdog as “maladministration” and in breach of the established EU democratic and rule-making principles.

Meanwhile, Chinese and other Asian markets continue to expand measures to increase large-scale sustainability corporate data, aiming to capture a significant share of the trillion-dollar market connected with the development and manufacturing of cleaner products and technologies. The EU can’t afford to fall further behind. It must remain strategic and firm in setting the boundaries that define sustainability standards and protect EU markets and citizens from greenwashing.

Transparency and clear management of climate risks, for example, are essential in the strategy to free the EU from its dependencies on foreign fossil fuels and key transition technologies. 

In a recent Financial Times article, Teresa Ribera, Executive vice-president of the European Commission for a Clean, Just and Competitive Transition, was very clear that “Europe must be a rulemaker, not a rule-taker”, where she stressed that “Reliable information, clear standards and credible transition plans are indispensable to building competitive value chains, strengthening resilience and ensuring that Europe remains an attractive destination for investment”. 

‍