What EFRAG got right and why there’s plenty still to play for

When the European Commission asked the European Financial Advisory Group (EFRAG) to simplify the European Sustainability Reporting Standards (ESRS), its twin objectives were to make reporting less burdensome for companies, while retaining the ambition reflected in the European Green Deal.

EFRAG published its proposed revisions at the end of July after reviewing feedback from more than 800 organisations across the globe, including Kōan. In sharing our views on how the ESRS could be simplified and improved, we drew on our experience of helping several clients produce their first ESRS-compliant Sustainability Statements.

Below, we provide our initial analysis of the revised ‘Exposure Drafts’ and the extent to which they reflect our key recommendations. 

A step in the right direction

Overall, we think the Exposure Drafts are heading in the right direction, even if the proposed changes are something of a mixed bag. Given the volume of feedback EFRAG had to process, the divergent views of the hundreds of stakeholders that took part in the consultation, and the geopolitical pressure for deregulation in Europe and North America, that is hardly surprising. 

The burden on reporting companies has clearly been reduced when it comes to scale. EFRAG says the overall length of the standards has been cut by 55%, while the number of datapoints that must be reported has been cut by 57%. 

In other respects, however, the drafts remain overly complex or have taken a step backwards. EFRAG has missed an opportunity to make it easier for stakeholders to understand the link between sustainability efforts and a company’s core business and risk management. It has also introduced new reliefs that will allow companies to skip reporting that requires ‘undue cost or effort’.

Where we agree

1. Double materiality assessment (DMA) 

Streamlining the process for conducting DMAs — the heart of any ESRS-compliant sustainability statement — represents the biggest progress in this set of revisions. In our submission to EFRAG, we argued for a simpler approach, based on updating the current AR16 list of material topics, standardising rules for audit, and setting up a clear process for companies to follow. 

We didn’t get all we wanted — EFRAG is not providing clear guidance for auditors, saying that was beyond its EC mandate — but it has provided additional guidance for executing a DMA, including clarifying that the business model should be the starting point so that the most obvious topics can be identified. The AR 16 list was also simplified through the removal of sub-sub topics.

2. Minimum Disclosure Requirement (MDR) 

In our experience, companies were confused by the lack of clarity concerning disclosure. The general ESRS minimum requirement to disclose the impact of policies, actions and targets (PATs) on stakeholders and the business wasn’t consistently applied to topical standards. EFRAG has recognised the complexity, and according to the revised drafts, the MDR will not apply to topical standards (save for one or two exceptions.) In addition, EFRAG has improved guidance on PATs by allowing companies to describe a policy once, even if it covers multiple topics, and consolidating most PAT requirements under a principles-based standard in ESRS 2. 

3. Duplication, voluntary disclosure, user focus

Several of our recommendations focused on making sustainability statements easier to produce and to use. We called for similar data points to be merged, for voluntary disclosures to be scrapped to save companies wasting time and resource, and for the revised ESRS to focus on the issues that investors and other stakeholders find most useful.

We were happy to see that EFRAG has merged or deleted overlapping data points across all topical standards, and voluntary disclosures have been removed from the ESRS. Where appropriate, such voluntary disclosures have been moved to a separate document — Non-Mandatory Implementation Guidance — whose legal status has yet to be clarified by the EC. 

The deletion of many data points, and the removal of others to the non-binding guidance document also goes some way to meeting our call for greater user focus. EFRAG has also proposed a less granular approach to narrative disclosures. 

More work to be done

1. Policies, actions and targets

In our feedback, we asked EFRAG to provide better guidance on how companies should disclose the interaction between their PATs, by requiring a written narrative and ensuring better consistency across the ESRS. The new Exposure Drafts provide only limited additional guidance in this area. The tables that linked PATs to the business model and strategy have also been deleted, which could make it harder for stakeholders to understand how PATs are integrated into strategy. 

2. Risk management

As things stand, there is no clear requirement for reporting companies to demonstrate how the results of the DMA feed into their wider enterprise risk management. We suggested that Chief Risk Officers – or their equivalent – should be required to sign off on ESG risks and opportunities in sustainability statements to help bridge that gap.

Unfortunately, EFRAG appears to have widened the gap by removing the requirement for companies to disclose whether the process of identifying, assessing and managing impacts and risks is integrated into their overall risk management process.  

3. Cost and effort

In line with standards developed by the International Sustainability Standards Board (ISSB), EFRAG has introduced an ‘undue cost and effort’ principle to all ESRS metrics. We are concerned that this could be interpreted by some companies as a ‘get-out clause’, creating a loophole that could leading to material information not being reported and reducing the comparability of disclosures.