The transformative power of the CSRD - Part 2: The expanded scope of disclosures
The CSRD’s European Sustainability Reporting Standards (ESRS)
The centerpiece of the Corporate Sustainability Reporting Directive (CSRD) is undoubtedly the European Sustainability Reporting Standards (ESRS), which specify the new reporting requirements that in-scope companies must satisfy.
The first batch of standards approved by the European Union contains 12 individual standards, two concerning general disclosures and 10 concerning specific topics in the environmental (5), social (4), or governance (1) categories.
ESRS 1 - General Requirements defines the core principles that apply to all sustainability reported content, such as drafting conventions, precise definitions of key concepts that define reporting scope (e.g., sustainability matters, stakeholders, double materiality, value chains, communities, etc.), the obligation of due diligence, reporting time horizons, and disclosure format.
ESRS 2 - General Disclosures provides the overarching structure applicable to all sustainability disclosures, very much aligned with the four pillars of the Task Force on Climate-related Financial Disclosures (TCFD), i.e., Governance, Strategy (and business model), Impact, risk and opportunity management, and Metrics and targets.
In total, the first batch of ESRS contains 100 Disclosure Requirements (DR) comprising 1,172 unique data points, i.e., specific quantitative or qualitative information that needs to be distinctly and digitally identified. You can access these ESRS and navigate through them by DR here.
Of course, companies do not need to comply with all Disclosure Requirements and disclose all data points. They are required to disclose only on the topics, the DRs, and the data points that they have determined are material to them. Appendix E of ESRS 1 contains a useful flowchart for determining disclosures.
What’s so complicated?
What makes the application of the ESRS a much bigger lift than any other prior or existing reporting frameworks is its scope. First and foremost, the ESRS require companies to report sustainability matters “based on the double materiality principle”. In other words, a sustainability matter is material if it meets the definition of impact materiality or financial materiality, or both.
- Impact materiality: a sustainability matter is material from an impact perspective when it pertains to the company’s material actual or potential, positive or negative impacts on people or the environment over the short-, medium- and long-term. This is commonly referred to as an “inside-out” materiality perspective. An example is the pollution of waterways for a chemical manufacturer.
- Financial materiality : a sustainability matter is material from a financial perspective if it generates risks or opportunities that affect or could reasonably be expected to affect the company’s financial position, financial performance, cash flows, access to finance or cost of capital over the short, medium or long term. This is commonly referred to as an “outside-in” materiality perspective. An example is the access to potable water for a beverage producer.
Of course, the key question is how to determine whether a particular topic or data point is material or not. To help companies in this process, the European Financial Reporting Advisory Group (EFRAG), which created the ESRS, has recently published non-authoritative Guidance for the Materiality Assessment and Implementation Guidance on Value Chain.
The ESRS don’t actually spell out how to conduct a materiality assessment; they refer instead to the ongoing process of due diligence defined in the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises, the outcomes of which inform a company’s assessment of its material impacts, risks, and opportunities.
However, the standards do identify engagement with stakeholders as a core element of the ongoing due diligence process and subsequent determination of material sustainability matters. ESRS 1 defines stakeholders as either (i) those whose interests are affected or could be affected by the company’s activities across its value chain or (ii) users of sustainability statements, including investors, creditors, insurers, but also business partners, trade unions, governments, or analysts.
The second reason for the greater complexity of the ESRS is the expanded scope of value chains and time horizons. Indeed, the materiality assessment exercise becomes exponentially more significant because companies must take a whole-of-value-chain approach. When conducting an impact materiality assessment, companies are required to consider those impacts connected with their own operations and their upstream and downstream value chain, including through their products and services, as well as through their direct and indirect business relationships. For example, a computer chip manufacturer that outsources its manufacturing may not consider access to water to be a material issue for its own operations, but it becomes material when taking into account its upstream supply chain. Furthermore, companies are required to consider impacts, throughout their value chain, over the short term (i.e., their reporting period), medium term (up to five years out), and long term (more than five years out). For example, most physical and transition risks related to climate change are not discernible in the near term, but become critically material when looking farther into the future.
The opportunity within
Properly framed and executed, a double materiality assessment that takes into consideration a company’s entire value chain over the short-, medium-, and long-term horizons builds the foundation for truly embedding sustainability to the business model and strategy, with clearly mapped and prioritized sustainability-related impacts, risks, and opportunities.
Companies should embrace the spirit of the law and consider compliance with the CSRD not as a mere compliance sprint, but as a transformational journey.
In Part 3 of The transformative power of the CSRD, we explore how this regulation will potentially pull into its orbit thousands of companies of all sizes across the globe.
The contents of this article are inspired by the Seizing the Corporate Sustainability Reporting Directive (CSRD) opportunity white paper, which provides companies with practical guidance on how to identify compliance gaps and build a roadmap to fill them and take control of their CSRD journey to achieve lasting sustainability leadership.