The European Central Bank (ECB) has warned that the first set of European Sustainability Reporting Standards (ESRS) need to be “more granular and clearer”, as European stakeholders continue to thrash out corporate reporting requirements on a broad range of environmental, social, and governance (ESG) issues.
The ECB in a staff opinion published January 30, 2023, also called for “urgent” creation of specific guidance for financial institutions and a “centralised process” to handle specific disclosure queries from organisations subject to the “challenging” disclosure rules, as well early delivery (“before January 2025”) by the European Commission of audit standards to ensure “secure consistent enforcement.”
What are the ESRS Set 1?
The ESRS’s are part of Europe’s Corporate Sustainability Reporting Directive (CSRD), which is expected to enter into force in 2024; with the first batch of – likely quite onerous for the unprepared – reporting submissions due* 2025.
The first set of ESRSs were delivered to the European Commission (EC) in November 2022. The EC is now considering opinions from various stakeholders, with the ECB and the European Securities and Markets Authority (ESMA) both submitting broadly supportive yet pointed opinions on the ESG standards in recent days.
The EC is aiming to approve the initial ESRS by 30 June 2023.
(For an overview of the ESRS, KPMG has one of the better explainers here.)
ECB on ESRS: “Further specification…”
The ECB said tactfully that the “first set of ESRS appear capable of substantially improving the quantity, quality, reliability and comparability of corporate sustainability disclosures” and that its staff particularly welcomed the “reliance on quantitative metrics, the requirement to disclose detailed transition plans in line with the 1.5°C goal of the Paris Agreement, the inclusion of Scope 1, 2 and 3 GHG emissions… [and] quantitative estimates of exposures to physical and transition risks.”
But it warned that the “general requirements for materiality assessment would benefit from more granular and clearer guidance on the process to be followed by compilers; the use of estimates and the calculation of GHG emissions would benefit from further specification; the difference between the scope of consolidation under the CSRD and prudential consolidation may create challenges for the incorporation by reference of Pillar III disclosures as well as inconsistencies in relation to Taxonomy disclosures; a Legal Entity Identifier (LEI) requirement should be included in ESRS 2; [and] sector-specific intensity-based GHG emission metrics should be included in the sectoral standards to ensure alignment with Pillar III requirements.”
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In short, there is an awful lot of refining still to do. (Maxfield Weiss, of sustainability disclosure non-profit CDP Europe, last month also noted that the “TCFD and ESRS structures are different, but compatible. However, the differences in the structure may pose challenges to practical implementation, may lead to confusion, and inevitably cause unnecessary costs to preparers and users alike. The ESRS structure can be easily improved to better correspond with the TCFD (and ISSB).”
ECB: Financial services guidance asap
The ESRS Set 1 are vertical-agnostic, with the entity that is developing them – EFRAG, or the “European Financial Reporting Advisory Group” – due to follow them with additional sectoral standards in separate sets of proposals for the EC.
The European Central Bank staff opinion warns that “the standard for financial institutions, including credit institutions, should be prioritised and ideally adopted before the first reporting cycle foreseen in the CSRD. Such prioritisation is justified… pragmatically by the need to bring clarity… [and] coherence across the multiple reporting obligations under EU sustainable finance legislation, including the interactions with prudential disclosure requirements [and the] urgent need to develop specific guidance for the definition of the value chain of financial institutions.”
“Given its novelty, reporting in accordance with the ESRS might be challenging for some preparers, especially in the first years of implementation and particularly for entities not previously subject to sustainability reporting” the ECB emphasised.
“In this context, the successful application of ESRS will benefit greatly from a centralised process to address interpretation questions from stakeholders.”
ESMA input on ESRS Set 1
ESMA in its January 26 opinion held that “ESRS Set 1 broadly meets the objective of being conducive to investor protection and of not undermining financial stability.”
But it also warned that there appears to be a large potential loophole in the standards.
“ESMA raises a note of caution in relation to the provisions in ESRS 1, paragraphs 108-110 which allow undertakings to omit information on intellectual property, know-how or the results of innovation corresponding to ‘trade secrets’. While the interplay between the Accounting Directive and the Trade Secrets Directive (Directive (EU) 2016/9438) must be duly taken into consideration in Set 1 to avoid any unintended consequences on undertakings, in ESMA’s view, it is important that the inclusion of any such provision is carefully assessed by the Commission for two reasons:
(a) Firstly, the draft provisions in paragraphs 108-110 constitute a blanket requirement which may lead undertakings to omit material information on the grounds of an alleged risk of disclosing trade secrets. (b) Secondly, there is a possible interaction between these draft provisions and Article 19a(3), fourth subparagraph of the Accounting Directive. This article permits Member States to allow for the omission in exceptional circumstances of commercially sensitive information, on impending developments and matters under negotiation, under specific conditions. It is unclear whether, in some cases, the trade secrets addressed in paragraphs 108-110 of ESRS 1 could also constitute “impending developments or mattersunder negot iation” under Article 19a(3), fourth subparagraph of the Accounting Directive,” ESMA warned on January 26.