European Financial Reporting Advisory Group (EFRAG) Finalizes ESG Standards
Posted on November 22, 2022 | in ESG
By Phil Molé, MPH
The evolution of ESG reporting standards has reached another milestone due to the European Financial Reporting Advisory Group (EFRAG) approving its first set of Environmental, Social, and Governance (ESG) standards.
EFRAG is a private association founded in 2001, with guidance provided by the European Commission. The Commission had requested the formation of an agency to provide technical expertise and guidance on financial and accounting matters. For over two decades, EFRAG has worked closely with other standards-setting bodies, including the International Financial Reporting Standards (IFRS ®) Foundation, which develops many globally used financial accounting standards. Major updates to EFRAG came in 2004 with changes to the governing structure and in 2009 with “EFRAG Plus” reforms to enable EFRAG to qualify for public funding by the European Commission.
In recent years, the financial and investment communities have expanded their focus to include ESG management, based on growing evidence that higher ESG performance leads to better business performance. In late 2021, the IFRS Foundation created the new subsidiary group, International Sustainability Standards Board (ISSB), to bring more reliability and consistency to the world of ESG disclosures, as we discussed in a previous blog post. This close working relationship between EFRAG and the IFRS Foundation over the years has helped shift ESG’s own priorities toward inclusion of ESG issues. But an even bigger push in that direction came in April 2021, with the European Commission’s acceptance of a proposal for a Corporate Sustainability Reporting Directive (CSRD) which would revise the Non-Financial Reporting Directive (NFRD)—the current EU sustainability reporting framework that sets disclosure requirements for non-financial and diversity information by certain large companies. The CSRD also set the stage for the development of specific sustainability reporting standards. In a letter dated May 12, 2021, EU Commissioner Mairead McGuinness formally requested that EFRAG develop ESG standards under the CSRD.
EFRAG made good on their designated responsibility by publishing their first exposure draft European Sustainability Reporting Standards (ESRSs) on April 27, 2022. These standards addressed many areas of ESG, including common aspects like greenhouse gas (GHG) emissions and general disclosure requirements, but also aspects of social sustainability, a term used to describe efforts to create and support healthy places inside and outside company environments, including relationships with communities and workers outside of the company’s own workforce. For example, EFRAG included a standard that addresses the management of workers in the value chain, such as suppliers and contractors, who might bear some of the impacts of the company’s operations and included a standard on “affected communities” that tasks companies with assessing how their business operations impact community equity in terms of access to clean air, clean water, and adequate housing. The standards also widen the lens of environmental sustainability to task companies with understanding and mitigating their impact on marine life and biodiversity. EFRAG accepted public comments on its draft standards until August 8, 2022.
Based on this author’s perusal of some of the commentary by EHS and ESG stakeholders on social media, many expected EFRAG to take a relatively long time to sort through stakeholder feedback and revise and finalize its standards. That’s not what happened. On November 15, 2022, EFRAG approved the final versions of its EFRS standards, which contain revisions based on incorporation of stakeholder feedback.
The final standards are quite similar in content to the original draft exposure standards, with some slight differences in organization – for example, the final versions consolidate corporate governance requirements into one standard on Business Conduct. EFRAG also revised the criteria for assessing material impacts, risks, and opportunities to better align with materiality assessment criteria used by the Global Reporting Initiative (GRI).
Perhaps the most significant revision compared to the draft standards concerns EFRAG’s reconsideration of the so-called “rebuttable presumptions” approach to materiality. While EFRAG had designed its standards on the assumption that the disclosures were material (i.e., relevant and important) to all companies covered by the standards, the draft standards proposed to allow companies to “rebut” this assumption by presenting evidence, which could potentially exempt them from reporting on that topic or sub-topic. EFRAG received stakeholder feedback expressing concerns about that provision, with commenters arguing that it was impractical and would create confusion that would undermine the value of the disclosures. The final version of the standard ESRS 1 simplifies matters by specifying that companies cannot omit data required under standards ESRS 1 and ESRS 2 and cannot omit data related to actions, targets, and policies. In other cases, companies that omit data can only do so on the condition that the information they do provide allows them to meet the objectives of the disclosure reporting (DR) requirements. The revised standards also include more guidance on conducting materiality assessments, again due to stakeholder request. EFRAG has published a cover note summarizing and explaining the revisions made to its standards.
In almost the same time frame that EFRAG was approving its final ESRSs, the European Parliament adopted the CSRD, and the EU Council may adopt them in the coming days or weeks. Putting all this together, it means the CSRD, including EFRAG’s approved ESRSs, is now set to go into effect in early 2024, starting with the largest companies. Altogether, the approved ESRSs will increase the number of EU companies required to prepare and submit ESG disclosures to approximately 50,000, which is a significant jump compared to the roughly 12,000 currently reporting.
The fast adoption of the EFRAG standards is yet more evidence that ESG is here to stay, and as it evolves, it’s going to be about much more than GHG and environmental management. EFRAG standards are based on a double materiality concept, meaning they consider issues important to companies from both a financial perspective and an impact perspective, including the company’s influence on community health and ecosystems. Companies pursuing ESG maturity will need flexible tools so they can easily create, deploy, and share materiality assessments to help them develop robust and effective ESG management strategies.
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