In this fifth report of Teneo’s ‘23 & ESG Series, we take a look at reporting trends through a European lens.
Other reports in the series highlight the top 10 takeaways and key statistics of 2023 sustainability reports, DE&I data, Australian sustainability reports and sustainability report design considerations.
The goal of sustainability disclosure is to give stakeholders a means to assess a company’s sustainability performance. Yet the rapid proliferation of different ESG disclosure frameworks over the years has created a proverbial “alphabet soup” that confused even the most experienced sustainability professionals. This year, the European Union completed an important milestone in the large-scale overhaul of its legal regime by completing the first stage of the European Sustainability Reporting Standards (ESRS), developed in partnership with the Global Reporting Initiative. It coincides with the finalisation of the International Financial Reporting Standards (IFRS) and their global ambitions. Both aim to provide transparent, comparable and reliable sustainability data to the market. But each follows different areas of focus, methodologies and reporting requirements.
While the IFRS disclosure standards are voluntary, the ESRS are mandatory for both European and non-European companies who are listed in Europe (including thousands of U.S. companies).
The clock is ticking for boards to make the right reporting decisions. The first wave of companies will already have to report under the ESRS in 2025 on their performance for the 2024 financial year. To help companies better understand and prepare for this evolving ESG disclosure landscape, we provide our perspective on the state of European sustainability disclosure and how it compares against other major frameworks (Appendix).
The EU is Just Getting Started
While the United States SEC climate disclosure rules are delayed, the first set of disclosure standards is about to become law in Europe under the ESRS. These disclosure standards are sector-agnostic and cover data points in 12 categories, including decarbonisation, circular economy, biodiversity and workers’ rights. The rules require companies to conduct a materiality assessment based on both the impact on financial value as well as the impact on society and the environment (i.e., double materiality). Where the assessment shows a topic to be non-material, it may be omitted from the reporting. The only two exceptions: Companies must always disclose the methodology (so-called
“General disclosures”), as well as the outcomes of the “climate change assessment” (i.e. even when considered immaterial, a justification must be delivered). The European Commission will add further sector-specific requirements and data points, which reflect the particular impact of individual industries. These are expected over the next few years. In what might be good news for some companies, the EU is also considering delaying the implementation of certain standards for non-EU companies, though those details still need unveiling. The EU’s goal is to focus on more immediate priorities, including implementation, guidance and standards for small and medium-sized businesses that may ultimately receive relief from the more burdensome requirements of the ESRS.
CSDDD: Further reporting requirements will capture the value chains of companies. In a new Corporate Sustainability Due Diligence Directive (CSDDD), companies will need to vet their suppliers for a catalogue of dozens of environmental and human rights standards. The granularity of the reporting will likely dwarf existing due diligence standards established under the Organisation for Economic Cooperation and Development (OECD) guidelines. Part of the required materiality assessment will be many first-time concepts without clear-cut definitions or methodologies. Further sector-specific due diligence laws banning products “contaminated” with deforestation and forced labour complete the picture and could force companies aiming to do business in Europe to downsize or even abandon sourcing operations in problematic non-EU countries (if violations cannot be remediated).
European Countries Outside the EU are Advancing, Too
Meanwhile, the UK is going to introduce rules mandating company sustainability disclosures in line with the International Sustainability Standards Board (ISSB) in 2024. The ISSB aims to consolidate and enhance existing sustainability reporting initiatives, such as the Sustainability Accounting Standards Board (SASB) Standards, the Task Force for Climate-related Financial Disclosures (TCFD) recommendations, the Integrated Reporting Framework and the Climate Disclosure Standards Board (CDSB) Framework. The ISSB has developed the IFRS Sustainability Disclosure Standards, which are understood as a global minimum standard and are being used as the basis for national frameworks by some countries, such as the UK.
Switzerland is equally revamping its sustainability reporting framework, lowering the current reporting thresholds for employee count and turnover in line with the EU scope. Swiss companies will in the future be able to choose whether to report according to the ESRS or an equivalent international framework.
Standards Interoperability is the Goal – But is it Likely?
The various sustainability reporting standards are not mutually exclusive and can be complementary. The EU, ISSB and GRI are continuously working on improving the interoperability. The Corporate Sustainability Reporting Directive (CSRD) also requires the EU to collaborate in good faith towards the convergence of global standards, to reduce the risk of inconsistent reporting requirements for companies with a global footprint.
But while interoperability is the aspiration, it may not be likely in the near future. Impact definitions, key terminologies, the delineation of industry sectors and calculation methodologies remain far apart. For example, the concept of the “value chain,” which includes downstream operations, cannot be found in global frameworks, which focus entirely on the upstream (supply) chain.
What Does This Mean for European Companies?
Businesses operating in the EU will be required to make strategic choices about the “right” sustainability disclosure standard to follow: Which legal and compliance regimes are our company subject to? Regardless of legal requirements, which standards may best represent our investments and improvements? Which disclosure standards do our stakeholders want us to report to, including our major investors?
It would be easy to deride Europe for trying to build the plane while flying it. But there is a strong case to embrace sustainability reporting as a company asset. Political backlash and budget crises are causing European governments to withdraw money from the green transition that is desperately needed to meet planetary targets. Companies will need to make up for this shortfall and become crucial in mastering the ecological industrial transition. The rising cost of capital will force investors to think twice about where their money has the greatest impact, and sustainability disclosures may give high-performers a first-mover advantage in attracting the capital needed to meet their goals.
Appendix: Comparative Overview of the Three Major Global ESG Disclosure Standards