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Deep-Dive | Behind the scenes of the new European Sustainability Reporting Standards

Jan-Klaas Somers and Annelies Deconinck

On our very first EU Sustainability Policy Day, The Shift and WWF Belgium welcomed Philippe Diaz and Antoine Pugliese, two experts who contributed to the development of the European Sustainability Reporting Standards (ESRS) within EFRAG. Afterwards we asked Jan-Klaas Somers, one of our very own Young Challengers and a sustainability consultant, to interview them with his most compelling questions.

Sustainability reporting is a hot topic. There’s now a myriad of reporting standards. Why should companies care about ESRS more than about the others?

Antoine: “CSRD (the Corporate Sustainability Reporting Directive) is mandatory legislation for all large European companies and those listed on the EU-regulated markets, including EU subsidiaries of non-EU parent companies. It’s about complying with the law.”

Philippe: “CSRD applies to +10.000 non-EU firms and hence may turn into the global baseline itself.”

“CSRD may well turn into the global sustainability reporting baseline standard”

Philippe Diaz
ESRS roundtable

How do you feel CSRD will impact the status quo? How will it raise the bar comparing to the current reporting modalities?

Antoine: “Significant changes are on the horizon with the introduction of CSRD. The Directive is set to replace the existing reporting framework and substantially expand its scope, reaching from 11,000 to an estimated 50,000 companies initially. One distinguishing factor is its commitment to a robust double materiality perspective, in contrast to the standards set by the International Sustainability Standards Board (ISSB) for example. It also covers more ESG topics than most other frameworks.

Another key differentiator is that CSRD highlights the importance of third-party assurance, encouraging companies to enlist auditors or other experts to verify the accuracy of their ESG data. This focus on data integrity is a notable feature.

Lastly, another key distinction lies in how the reporting information is disseminated. CSRD introduces specific digital formats through which the data must be shared, enhancing transparency and standardizing the reporting process. These shifts represent a significant progress forward in sustainability reporting, with CSRD paving the way for more comprehensive, reliable, and accessible ESG information. We hope that the digital platform will be ready as soon as possible.”

Philippe: “A key rule is that ESRS 1 actually bans netting positive with negative impacts, which is key in reducing the amount of greenwashing in sustainability reporting.”

Based on the CSRD & ESRS rules, will it in the future be possible to compare the sustainability performance of organizations in a more objective way?

Philippe: “Ideally yes. So far most companies were largely free to choose on how to report on their ESG performance. Most opted for GRI, but comparability remained an issue, as GRI lacks the legal obligation that the ESRS have. The materiality assessment, however, is still an issue, as it hampers comparability. There is no standardized way to conduct it, hence firms with the exact same negative or positive sustainability performance may come to very different conclusions. Another issue is that firms are free to ignore datapoints they consider not material. All in all, I would say that while the ESRS are a significant step towards standardized reporting and comparability, improvements are still necessary over time.”

The CSRD is a key for transparency in sustainability actions and performance but is only one step in the transition towards a more sustainable economy and society. Which next steps in legislation do you see necessary to accelerate this transition?

Antoine: “For me, we would require mandatory environmental targets and transition plans, which will be central to the Corporate Sustainability and Due Diligence Directive (CSDDD, article 15). A crucial aspect of our progress will involve defining clear transition paths and a financial framework for these transitions. Additionally, we should establish a system for supervision, monitoring, reporting, and enforcement, including legal penalties.

Perhaps most significantly, if we look beyond sustainable finance action plans, we might need an economic plan similar to what the United States implemented during World War II. During that time, American leaders realized that the wartime stakes were too high to rely on an unrestricted, hands-off approach to the economy. Manufacturers could not be trusted to shift from producing consumer goods to war materials on their own. To guarantee the production of vital goods for the war effort, the U.S. government established mobilization agencies during World War II. These agencies not only bought goods but also took an active role in guiding their production and influencing how private companies and entire industries operated. While I'm not suggesting that these historical circumstances are directly comparable to our current situation, I do believe that there are some relevant insights we can draw regarding economic organization. In this context, I think the European Union and its member states might need to consider adopting similar policies, albeit adapted to today's challenges, while also ensuring a just transition approach.

“A crucial aspect of our progress will involve defining clear transition paths and a financial framework for these transitions”

Antoine Pugliese

Unfortunately, this approach might involve leaving some goods and economic activities aside to prioritize the most important ones. It's unlikely that a government with such a program will be elected easily. That's why we should also focus on crafting a convincing ecological narrative to gain support from the citizens.”

Philippe: “I fully agree. Leaving it up to the market won’t get us to where we want and that is an economy that operates within shrinking planetary boundaries.”

Eu policy day

Climate & Biodiversity standards

Climate change is probably one of the most well-known issues the ESRS is aiming to address. However, companies measuring their GHG emissions or having Science Based Targets, are still a minority. What do you think will be the biggest surprise or change for these companies in scope of CSRD but not yet taking climate action. What would you recommend to them?

Antoine: “Initially, companies may require external consulting support to navigate these challenges. However, I would recommend investing in developing in-house expertise over time. Building the right competencies within their workforce is essential for sustainable, long-term success in handling these new challenges. Effective governance is also a crucial component for success, and sustainability matters should be integrated into the highest governance body. Last but not least, bridging the gap between financial considerations and sustainability is pivotal for a successful approach in the company in my opinion.”

“I would recommend investing in developing in-house expertise over time. Building the right competencies within their workforce is essential for sustainable, long-term success in handling these new challenges around sustainability reporting.”

Climate change is the only topic that should always be included in their sustainability reporting, except if an organization argues it is not material for them. Do you expect this to be the case for many companies (to not include climate change)? Which ones?

Antoine: “I do not expect a significant majority of companies arguing against the materiality of climate. Even for already green and enabling activities, climate change will have an impact on their business model. My key message here would be that companies should consider reporting against all ESRS in the short term, say around after 2 or 3 years of the first CSRD reporting round.”

“My key message here would be that companies should consider reporting against all ESRS in the short term, say around after 2 or 3 years of the first CSRD reporting round.”

Which link do you see between ESRS and SBTi? What would you recommend to companies in scope of ESRS who have not yet committed to or set SBTi targets?

Philippe: “CSRD specifically asks for transparency on whether environmental targets are based on conclusive scientific evidence. This is implemented in the ESRS via the reference to emission budgets and ecological thresholds.”

Antoine: “In the previous iteration of the EFRAG (European Financial Reporting Advisory Group) draft, the Science-Based Targets Initiative (SBTi) was notably highlighted as an appealing methodology for climate reduction targets. However, in the latest guidance, SBTi's mention seems to have diminished, yet it still appears as a reference in the context of sector-specific pathways. Our current focus is on mapping the compatibility between SBTi and the ESRS E1 climate standards, and we anticipate releasing a report on very soon. So far we've identified a significantly high level of alignment between the two, which is quite promising.

Philippe: “SBTn (Science-Based Targets for Nature) is still referenced in ESRS E2, E3 and E5. The European Commission removed all mention of private initiatives and possibly just forgot to eliminate SBTn in the remaining standards (removed from ESRS E4).”

The latest changes to the CSRD significantly watered down the requirements of the ESRS E4 biodiversity standard. Additionally, many phase-ins were added. What’s the reasoning behind this and to which extent do you support those changes?

Philippe: “No, I do not support these changes, but it was apparently the only way for DG FISMA and the European Commission to save ESRS E4 from being cut entirely. The pressure from the business world was enormous. Less granularity is not necessarily good, as companies are left on their own when having to decide what and how to report against ESRS E4. This also leads to less comparability and more greenwashing. Granularity in itself is a useful guidance and must not be demonized as is the case currently. Besides I personally believe we should accept that sustainability is complex and it is not adequate to just select a few KPIs and be done with it.”

The ESRS E4 biodiversity standard refers to the LEAP-approach (Locate, Evaluate, Assess and Prepare) quite often, without making it obligatory. Why should organizations use this approach?

Philippe: “In my opinion the LEAP approach provides very useful guidance for the materiality assessment. Since the ESRS could not mandate or prescribe behaviour, LEAP could not be mandatory. Thus, the current reference with the wording “may” is as strong as it could be. Plus, LEAP and TNFD (Taskforce on Nature-Related Financial Disclosures) will likely play a key role in the potentially upcoming ISSB standard on nature. Since there are so many calls for alignment, it would have been sensible to align before the ISSB forges ahead.”

“The pressure from the business world to water down the standards and decrease granularity was enormous. I personally believe we should accept sustainability is complex and it is not adequate to just select a few KPIs and be done with it.”

Which tools would you recommend to our audience to use when preparing the reporting for your ESRS?

Philippe: “Anything that provides you with information that is as objective as possible. For nature this can be ENCORE or WWF Risk Filter Suite for example. TNFD has a good overview of tools that can be used.”

Concerns & criticism

We hear two main voices in the public debate about CSRD: On the one hand we have organizations claiming that the rules imply too much administration and do not lead to accelerated sustainability action. Other voices say that this Directive creates transparency that can lead to effective action and makes it possible to make sustainable choices for investors and consumers. How can we make sure that the second scenario will further develop in the upcoming years?

Antoine: “Firstly, I think it should be said that financial reporting is much more of a burden than sustainability reporting is today.”

Philippe: “Resource-wise it is likely that there is a 5 to 10-fold difference in favour of financial reporting. We need studies on this. My superficial survey on LinkedIn showed 51% of votes said 5-10 times more resources are going to financial reporting, 21% indicated more resources are going to financial reporting, 14% mentioned equal resources and a final 14% found more resources going to sustainability reporting than to financial reporting. Plus, sustainability has many sub-topics, like biodiversity, climate, governance, human rights. They could in themselves be regarded as requiring an equal amount of attention to financial reporting.

I believe that companies cannot succeed in their sustainability journey with the resources of yesterday. I cringe when I hear corporate representatives argue that the five people previously working on implementing sustainability measure now have to work on reporting.”

Antoine: “I believe that the European Single Access Point is the key platform to enhance transparency. For me its establishment needs to happen fast.”

The trickledown effect of the CSRD & CSDDD will impact smaller organizations as well. There are many concerned voices that fear that those smaller organizations will not be able to deliver the necessary data. This has recently also led to Ursula Von Der Leyen announcing in her state of the Union an EU SME envoy that will listen to the challenges of the SMEs and will propose legislation that will reducing reporting obligations for them. What’s your take on this? How could organizations tackle the data challenge across their supply chains?

Philippe: “EFRAG is finalizing its work on two SME standards. One for Listed SMEs that will be mandatory and includes a cap on what SMEs have to report, as well as a Voluntary SME standard. Important remark here: it is value chain and not supply chain, hence the CSRD also covers the use-phase of products.”

CSRD & third-party verification

Let’s talk about assurance. The CSRD obliges third part assurance of the sustainability report so many audit firms are currently in the process of upskilling their teams. The obligation also implies that auditors will have to assess if some of the targets are aligned with science-based targets or not. A sensitive issue. What’s your take on this?

Antoine: “Third party assurance is key to ensuring relevant and credible information. It is not clear yet if auditors will assess the targets’ alignment but they will need to ensure that the information corresponds to the disclosure requirements. Throughout the review, the auditor exercises professional judgement and professional scepticism. In particular, the exercise of professional judgement requires the auditors to take the necessary distance from the sustainability information reported. We expect auditors to exercise the same rigor as for financial information and to deep dive on critical disclosure such as target and transition plans. At WWF and together with other organisations, we aim to provide as much assessment guidance as possible.”

Philippe: “A big issue will be the capacity and competency level available at audit firms. It is worth following the debate on competence-greenwashing unfold in the next years. ”

Similarly, many companies feel that due to the complexity of the issue they are forced to learn from and rely on consulting firms. Do you feel this is true? How can companies build their own knowledge and pragmatically approach the CSRD without major consulting budgets?

Philippe: “This is correct and unfortunate. Both the public and private sector have become used to outsourcing knowledge and competency at a high cost. Often with questionable results. There are ways to address this, for example by using objective data instead of stakeholder engagement, as apparently sold by many consulting firms. That the materiality assessment plays such a significant role in the ESRS is a gift to consultants that businesses have pushed for. A classic own goal.”

“A big issue will be the capacity and competency level available at audit firms. It is worth following the debate on competence-greenwashing unfold in the next years. ”

Transposition of the CSRD and local sanctions

The CSRD still needs to be transposed locally by the different EU member states such as Belgium. How much room is there to water down the requirements locally? Do you expect any significant changes between member states?

Antoine: “I do not have a view on this for all member states. At least in France it seems that ambition levels won’t be scaled down. On the contrary, as we may have the adoption of new organisations performing sustainability audits to better integrate this paradigm change.”

Philippe: “The CSRD provides the bottom-level of ambition. Some member states, like Germany, are likely to interpret whatever appears to give some room for flexibility as the least ambitious possible. So there won’t be downscaling but rather malicious forms of interpretation.”

How do you expect countries will enforce the rules? Which sanctions would be needed to make this reporting effort effective?

Antoine: “Again I do not know for all member states but I do think that France will follow the current approach. In the absence of a DPEF (“Déclaration de Performance Extra-Financière”, the former French sustainability disclosure requirement), sanctions could include the criminal and civil liability of the company and its directors. More practically, the sanctions could lead to a reporting obligation or not very substantial financial penalties.

Philippe: “I believe it’s unlikely that sanctions will be levelled at reporting entities. This is also what happened with the NFRD (Non-Financial Reporting Director, the precursor of the CSRD). Frank Bold did a study on this comparing the consequences of non-compliance with NFRD in a few European countries. Hence, civil society will have to pick up the slack and possibly take individual firms for some particularly bad reports to court.”

Future outlook

In an ideal scenario: how would you like to see sustainability reporting evolve in the future?

Philippe: “Any sustainability report needs to include the social and ecological context. If not, it is just ESG information and there is a significant difference between random non-contextual ESG data and sustainability data. See here for an example that I have analysed."

“Sustainability is complex. Don’t be fooled by easy solutions to complex issues.”

Is there an end to how much sustainability reporting companies should be doing from your perspective? How could reporting and actual action be better aligned?

Philippe: “The materiality threshold should progressively fall with increasing maturity of firms on preparing their reports. Other pieces of legislation, i.e. CSDDD (Corporate Sustainability Due Diligence Directive), will require firms to act upon their material negative impacts. Voluntary actions or frameworks are not enough. And reporting should not be considered as a trade-off with action. It is not ‘either-or’, it is both. Think of financial reporting. Firms also don’t argue that we either report financial data or we act on financial figures.”

The Young Challenger perspective

As a Young Challenger at the Shift I can imagine that for some people like me, who are working on sustainability on a daily basis, being the head expert of an ESRS is quite a goal to achieve. How does one become part of EFRAG? For anyone who would like to pursue this path which advice would you give them?

Antoine: “Well to be very honest, I just raised my hand and contact Patrick de Cambourg, the chair of the EFRAG Sustainability Reporting Board. I do think they need more and more people so if your organisation thinks it is a key topic, you should definitely contact EFRAG.”

Philippe: “Yes, just show enthusiasm for what you want to change and go for it. There are competency and capacity gaps all around. Just beware to not get yourself consumed by organisational priorities and settle for too many compromises that have nothing to do with sustainability. The focus should be on a serious transformation towards an economy that operates within the planetary boundaries rather than but much more with fake solutions that help maintain the status quo.”

What were the biggest challenges during the standard setting process, for you personally and in general?

Antoine: “To find the right balance in the amount of information to be provided, in order to try and gain support from companies rather than receiving mostly negative reactions.”

Philippe: “To dispel myths surrounding sustainability reporting. For example: are 1.000 datapoints too much? Is it too costly? Too resource intensive? Compared to what? Compared to financial reporting not really, as firms spend 5 to 10 times more on financial than sustainability reporting (hearsay from a standard setter, large Austrian SME and a large German insurance firm).

“The biggest challenge during the standard setting process was to dispel some of the myths surrounding sustainability reporting. Too resource intensive? Compared to what? Compared to financial reporting not really as companies arguably spend 5 to 10 times more on financial than on sustainability reporting.”

Which final thought do you want to share with our audience?

Philippe: “Sustainability is complex. Don’t be fooled by easy solutions to complex issues. And let’s be honest, taking the transition towards an economy operating within the planetary boundaries serious might end up hurting some businesses, especially those who do not think ahead and hold on to the status quo.”

Who's who

Jan-Klaas Somers is a The Shift Young Challenger 2022 – 2023 and works as a sustainability consultant for BDO.

Philippe Diaz is a Technical Expert Group member at EFRAG leading the ESRS E4 Biodiversity standards. He’s also a Senior Manager at the Sustainable Finance Unit at the WWF Germany.

Antoine Pugliese is a contributor to the EFRAG, specifically working on the ESRS E1 Climate standards. He is the Head of Sustainable Finance at WWF France.