Society responds to Proposed European Sustainability Reporting Standards

The IR Society response to the Proposed European Sustainability Reporting Standards issued by EFRAG.

European Financial Reporting Advisory Group (EFRAG)

35 Square de Meeûs

1000 Brussels (fifth floor)

Belgium

By email: info@efrag.org

8 August 2022

Dear Sir, Madam,

European Sustainability Reporting Standards - UK Investor Relations Society comment letter

Thank you for giving us the opportunity to comment on EFRAG’s Exposure Drafts for the European Sustainability Reporting Standards (ESRSs) available here. This response is made on behalf of the UK’s Investor Relations Society (‘the IR Society’).

The IR Society represents IR professionals working for publicly listed companies and consultancies to assist them in the development of effective two-way communication with the markets and to create a level playing field for all investors. It has over 860 members, drawn mainly from the UK, including the majority of the UK FTSE 100 and many of the FTSE 250 constituents, but also including some from companies listed overseas.

The IR Society’s mission is to promote best practice in investor relations; to support the professional development of its members; to represent their views to regulatory bodies, the investment community and Government; and to act as a forum for issuers and the investment community.

We responded to the International Sustainability Standards Board’s Exposure Drafts IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2 Climate-related Disclosures, as well as the call for evidence from the UK Government’s Transition Plan Taskforce. However, we note that the Corporate Sustainability Reporting Directive (CSRD), under which the ESRSs will be introduced, will impact on UK companies if they are dual listed in the UK/EU, if they have large EU subsidiaries (with 250 employees and a €40M turnover, whether listed or not), and/or if they do business with EU counterparties as those counterparties will request data to fulfil their own due diligence and reporting obligations. Companies with EU subsidiaries and branches and that generate over €150 million turnover in the EU will also be required to follow equivalent EU sustainability reporting disclosure requirements that will be developed regarding their ESG impacts. We would like to make certain specific points of relevance to those groups which we believe should be taken into consideration by EFRAG.

Overall/general comments

Support for global baseline and international collaboration

In our response to the ISSB’s consultation, we welcomed the initiative to provide an international set of sustainability reporting standards. We believe that any global baseline for sustainability reporting requirements should apply as broadly as possible and that regulators should seek to create as much harmonisation and convergence with existing and emerging standards and frameworks in reporting as possible. We therefore supported the decision of the ISSB to base its draft Standards on those developed by the Task Force on Climate-Related Financial Disclosures (TCFD) and the Sustainability Accounting Standards Board (SASB).

In our view, the global baseline for sustainability reporting requirements established by the ISSB (i.e. disclosure of information relevant to the users of general purpose financial reporting in assessing the enterprise value of the reporting entity) should form the first building block for sustainability reporting. It would be the choice of individual jurisdictions such as the EU whether, in addition to mandating the ISSB standards, they also mandate any additional jurisdictionally-specific and/or wider stakeholder or “impact” reporting (for example, based on the GRI reporting framework) if they wish reporting entities to provide such wider reporting for investors and other stakeholders on corporate impacts on economies, society and the environment.

We believe that international collaboration in the development of that global baseline is essential for the creation of a disclosure system that can be implemented globally, with a consistent approach across markets, thereby optimising reporting efficiency for companies falling under multiple reporting regimes. It is also important to ensure that there is alignment between these various differing reporting regimes, including that only one set of underlying data is required that should not need to be re-cut in order to comply with different reporting regimes, to help corporates comply without disproportionate burden or cost. We are therefore supportive of the participation by the European Commission and EFRAG in the working group recently established by the ISSB involving jurisdictions actively engaged in developing sustainability disclosure standards, and are pleased to see the ongoing liaison between EFRAG and the ISSB.

Interoperability between ESRSs and international sustainability reporting frameworks

As stated above, it is important to ensure that there is alignment between these various differing reporting regimes to help corporates comply without disproportionate burden or cost. However, the proposed ESRSs adapt, combine and/or reorganise the other existing sustainability reporting frameworks and metrics, which could make alignment and compatibility with those existing frameworks much more challenging. For example, EFRAG’s current proposed draft ESRSs are not fully interoperable with the ISSB standards, and we therefore have concerns that this could drive a required separate level of disclosure.

We acknowledge that EFRAG has published a reconciliation table stating that all IFRS S2 disclosures are covered in ESRS E1 (but with additional disclosures required). However, this implies that the ‘building blocks’ approach has been adopted in relation to the ESRS climate disclosures. However, the ESRSs do not follow the ISSB’s principles-based approach, and are instead very prescriptive (for example, lengthy mandatory application guidance regarding metrics) with differences in the architecture, terminology, methodology and presentation. We believe this will prevent interoperability and will require entities to adopt duplicative reporting processes. In our view, mapping between the various standards does not present the best solution to achieve interoperability because of the level and magnitude of differences across these areas. We note that some of the prescriptive requirements in the ESRSs originate from the Corporate Sustainability Reporting Directive (CSRD), which itself would therefore need to be amended in order to achieve better alignment with international sustainability standards.

EFRAG also states that “ESRS will be mapped to SASB standards in later versions of the Standards”, though such “mapping” does not necessarily achieve interoperability. In our view, any ESRS sector-specific standards that are to be developed at a later stage should be based on the ISSB sector-specific guidance (i.e. “internationalised” SASB standards), so that they are interoperable rather than simply “mapped across”.

We also note that GRI published an analysis on the level of synergy/interoperability between the EU’s additional “impact materiality” requirements and the GRI Framework. GRI mention that they have "suggested improvements, to deepen integration with established reporting practices, enhance quality and usability and reduce reporting burden", confirming that the ESRS exposure drafts adapt, combine and/or reorganise the GRI Standards (along with the other existing sustainability reporting frameworks and metrics i.e., TCFD, SASB, SFDR, GHG protocol), which makes alignment and compatibility with those existing frameworks much more challenging.

Given the need to avoid duplicative sustainability reporting requirements, we support the building blocks approach with ISSB standards forming a baseline, meaning any additional EU requirements should be consistent/compatible/interoperable with the requirements of the ISSB standards, with any jurisdictionally-specific and/or impact materiality/additional stakeholder requirements built on top. This would enable, for example, large EU subsidiaries to prepare one set of financially material “outside in” disclosures regarding how sustainability matters affect the undertaking’s development, performance and position, which would be reported on under the ISSB standards as far as they affect the enterprise value of the reporting entity (for their EU reporting and also to feed into overseas consolidated accounts), with any EU-specific and/or stakeholder reporting/impact materiality addon. Similar reporting efficiency would be afforded to UK/EU dual listed companies.

Improving harmonisation of ESRSs with international standards

Improving the harmonisation of the ESRSs with existing and emerging standards and frameworks in reporting would maximise reporting efficiency for companies falling under the CSRD/ESRSs and other reporting regimes based on TCFD, ISSB, GRI etc. We note that, in addition to the points raised above and below, to improve the compatibility of the ESRSs with the ISSB ‘global baseline’ approach would also require:

ERSR application guidance to be non-mandatory, to reduce the level of prescription for reporting entities but also to ensure that the ESRSs do not need frequent updates (see ‘Balance between principles and prescription’ below);
Entities to be permitted to prepare sustainability statements under sustainability reporting pronouncements of other standard setting bodies/non-mandatory guidance including sector specific (e.g. ISSB standards) instead of (rather than in addition to) statements prepared in accordance with ESRS, at least in respect of the financially material “outside in” disclosures regarding how sustainability matters affect the undertaking’s development, performance and position, which would be reported on under the ISSB as far as they affect the enterprise value of the reporting entity (this would require amendment to ESRS 1 paras 130, 147 and 40);
More compatibility in boundaries/value chain definitions; and
Less prescription as to due diligence (although these requirements come from the EC Proposal for a Directive on Corporate Sustainability Due Diligence and so would require that Directive to be amended).

Balance between principles and prescription

We believe there is a balance to be struck between the need for disclosure requirements to be high level/principles-based and the benefit that many companies might perceive in being offered a clear template to follow.

The advantages of the high level/principles-based approach include that it would:

Allow continuity of approach among entities that are already identifying and reporting on their sustainability-related risks and opportunities; and
Ensure the ESRSs ‘stand the test of time’, especially in relation to metrics/targets that will constantly evolve.

There is a potential benefit in clear guidance to assist corporates that are beginning their sustainability reporting journey. However, it is also important to remember that, while methodologies and knowledge continue to develop, it could be counter-productive to set granular mandatory disclosure requirements, and it is important not to turn sustainability reporting into a box-ticking, compliance exercise.

In our view, the right balance can be struck with high level, principles-based sustainability-related financial disclosure requirements that are underpinned by more detailed non-mandatory guidance (including practical examples), to help corporates comply without disproportionate burden or cost.

In our view, the ERSR application guidance should therefore be non-mandatory, to reduce the level of prescription for reporting entities but also to ensure that the ESRSs do not need frequent updates.

We note that some of the prescription in the ESRSs originates from the Corporate Sustainability Reporting Directive (CSRD), which itself would need to be amended in order to achieve our preferred high level/principles-based approach and in order to achieve better alignment with international sustainability standards.

Location of disclosure

In our view, reporting entities should be given the flexibility to choose whether to include all their sustainability-related financial disclosure within the annual report and accounts, or also to publish it in a standalone document(s) provided the core information is still required to be included within the annual report and accounts, so that it remains the single source for all key disclosures. We are already aware of practical variations between large companies or those in particular sectors who wish to publish more detailed sustainability-related information, for example with their Sustainability reporting spread across the annual report and accounts, a Climate Report and a third separate broader Sustainability or ESG Report, compared with other companies, often smaller ones, where it is all in the Annual Report. Therefore, we supported the approach taken by the ISSB, and we oppose the level of prescription in the ESRSs as to the location of the information. We acknowledge this originates from the overarching CSRD, which in our view therefore needs to be amended to remove this requirement.

Answers to specific questions

Part 1A. Overall ESRS Exposure Drafts’ relevance – Architecture

Q1: in your opinion, to what extent do the structure and articulation of cross-cutting and topical standards adequately support the coverage of CSRD topics and reporting areas?

As we mention above, we believe there is a balance to be struck between the need for disclosure requirements to be high level/principles-based and the benefit that many companies might perceive in being offered a clear template to follow.

The advantages of the high level/principles-based approach include that it would:

Allow continuity of approach among entities that are already identifying and reporting on their sustainability-related risks and opportunities; and
Ensure the ESRSs ‘stand the test of time’, especially in relation to metrics/targets that will constantly evolve.

Alignment and interoperability with international standards and frameworks

Q3: in your opinion, to what extent does the approach taken to structure the reporting areas promote interoperability between the ESRS and the IFRS Sustainability Exposure Drafts?

As we mention above, the proposed ESRSs adapt, combine and/or reorganise the other existing sustainability reporting frameworks and metrics (TCFD, ISSB etc), which could make alignment and compatibility with those existing frameworks much more challenging. For example, EFRAG’s current proposed draft ESRSs are not fully interoperable with the ISSB standards, and we therefore have concerns that this could drive a required separate level of disclosure.

We acknowledge that EFRAG have published a reconciliation table stating that all IFRS S2 disclosures are covered in ESRS E1 (but with additional disclosures required). However, this implies that the ‘building blocks’ approach has been adopted in relation to the ESRS climate disclosures. However, the ESRSs do not follow the ISSB’s principles-based approach, and are instead very prescriptive (for example, lengthy mandatory application guidance regarding metrics) with differences in the architecture, terminology, methodology and presentation. We believe this will prevent interoperability and will require entities to adopt duplicative reporting processes. In our view, mapping between the various standards does not present the best solution to achieve interoperability because of the level and magnitude of differences across these areas. We note that some of the prescriptive requirements in the ESRSs originate from the Corporate Sustainability Reporting Directive (CSRD), which itself would therefore need to be amended in order to achieve better alignment with international sustainability standards.

EFRAG also states that “ESRS will be mapped to SASB standards in later versions of the Standards”, though such “mapping” does not necessarily achieve interoperability. In our view, any ESRS sector-specific standards that are to be developed at a later stage should be based on the ISSB sector-specific guidance (ie “internationalised” SASB standards), so that they are interoperable rather than simply “mapped across”.

Given the need to avoid duplicative sustainability reporting requirements, we support the building blocks approach with ISSB standards forming a baseline. Any additional EU requirements should be consistent/compatible/interoperable with the requirements of the ISSB standards, with any jurisdictionally-specific and/or impact materiality/additional stakeholder requirements built on top (for example, based on the GRI reporting framework) if they wish reporting entities to provide such wider reporting for investors and other stakeholders on corporate impacts on economies, society and the environment.

This would enable EU subsidiaries to prepare one set of financially material “outside in” disclosures regarding how sustainability matters affect the undertaking’s development, performance and position, which would be reported on under the ISSB standards as far as they affect the enterprise value of the reporting entity (for their EU reporting and also to feed into overseas consolidated accounts), with any EU-specific and/or stakeholder reporting/impact materiality add on.

ERSR application guidance to be non-mandatory, to reduce the level of prescription for reporting entities but also to ensure that the ESRSs do not need frequent updates; and
More compatibility in boundaries/value chain definitions.

Sustainability statements and the links with other parts of corporate reporting

For clarity and ease of use, standardised sustainability reporting shall be easily identifiable within the management report (MR). To that effect, ESRS 1 – General principles (paragraphs 145 to 152) prescribes how to organise the information required by ESRS. It offers three options (paragraphs 148 and 149) for undertakings to consider when preparing their sustainability reporting:

– a single separately identifiable section of the MR;

– four separately identifiable parts of the MR:

(i) General information;

(ii) Environment;

(iii) Social;

(iv) Governance

– one separately identifiable part per ESRS in the MR.

The first option is the preferred option. When applying the other two options the entity shall report a location table to identify where disclosures are presented in the MR.

In order to foster linkage throughout the undertaking’s corporate reporting, ESRS 1 also:

- prescribes that the undertaking adopts presentation practices that promote cohesiveness between its sustainability reporting and: (a) the information provided in the other parts of the management report, (b) its financial statements (FS), and (c) other sustainability-related regulated information (paragraphs 131 to 134)

- promotes the incorporation of information by reference to other parts of the corporate reporting in order to avoid redundancy (paragraphs 135 and 136)

- organises connectivity with the financial statements by prescribing how to include monetary amounts or other quantitative data points directly presented in the financial statements (paragraphs 137 to 143).

Q8: Do you agree with the proposed three options?

2/ No

Q9: would you recommend any other option(s)?

Yes.

If so, please describe the proposed alternative option(s)

As we mention above, in our view, reporting entities should be given the flexibility to choose whether to include all their sustainability-related financial disclosure within the annual report and accounts, or also to publish it in a standalone document(s) provided the core information is still required to be included within the annual report and accounts, so that it remains the single source for all key disclosures. We are already aware of practical variations between large companies or those in particular sectors who wish to publish more detailed sustainability-related information, for example with their Sustainability reporting spread across the annual report and accounts, a Climate Report and a third separate broader Sustainability or ESG Report, compared with other companies, often smaller ones, where it is all in the Annual Report. Therefore, we supported the approach taken by the ISSB, and we oppose the level of prescription in the ESRSs as to the location of the information. We acknowledge this originates from the overarching CSRD, which in our view therefore needs to be amended to remove this requirement.

Part 1B. Overall ESRS Exposure Drafts relevance – Implementation of CSRD principles

Q17: to what extent do you think that the principle of understandability of sustainability information is adequately defined and prescribed?

Please explain your reservations or your suggestions for improvement or any other comment you might have

As we mention above, in our view, entities should be permitted to prepare sustainability statements under sustainability reporting pronouncements of other standard setting bodies and following non-mandatory guidance including sector specific (e.g. ISSB standards) instead of (rather than in addition to) statements prepared in accordance with ESRS, at least in respect of the financially material “outside in” disclosures regarding how sustainability matters affect the undertaking’s development, performance and position, which would be reported on under the ISSB as far as they affect the enterprise value of the reporting entity (this would require amendment to ESRS 1 paras 130, 147 and 40).

We hope you find these comments useful. Please do not hesitate to make contact if you have any questions.

Your sincerely,

Liz Cole

Head of Policy and Communications

Secretariat to the Investor Relations Society’s Policy Committee

(Email: enquires@irsociety.org.uk, Tel: + 44 (0) 20 7379 1763)

Published 8 August, 2022