Professionals in accounting and auditing are ideal for guiding clients toward financial and environmental responsibility to promote sustainable business practices. Despite some confusion surrounding regulatory changes, with clear guidelines, established laws, adequate support, and the right expertise, we are confident that Kreston member firms can effectively assist their clients.

Kreston is committed to sustainability and taking proactive steps to reduce its carbon footprint. The company has made great strides in improving its environmental impact. One of its latest efforts includes the formation of an ESG task force for member firms in December 2022.

An ESG Advisory Committee has been examining three essential areas: regulatory compliance, sustainability efforts, and client services, and will report back to the World Conference in Dubai in December 2023.

The advisory committee and task force members researched and created internal and external materials such as handbooks, glossaries, regulatory updates, and client solution tools. They also attended webinars on related topics.

Carmen Cojocaru, Kreston Romania’s managing partner, has been a member of the regulatory sub-group from the beginning, ensuring to provide relevant information related to any updates in the EU.

We want to share the extract from the last peace she presented at the September 26th webinar related to ESRS 1 and 2*

“The Accounting Directive from 2013 as amended by CSRD requires large companies and listed small and medium-sized companies (SMEs), as well as parent companies of large groups, to include in a dedicated section of their management report the information necessary to understand the company’s impacts on sustainability matters, and the required information to understand how sustainability matters affect the company’s development, performance and position.

This information must be reported per European Sustainability Reporting Standards (ESRS) adopted by the European Commission in July this year.

There are twelve standards, including two cross-cutting and ten topic-specific standards for Environment, Social, and Governance. Except for cross-cutting standards (ESRS 1 and 2 – general disclosures), all standards and disclosures will be subject to a materiality assessment.

Standards disclosure layers include sector-agnostic, sector-specific, and entity-specific. 

This first set of standards are sector-agnostic standards. Sector agnostic – meaning that they apply to all companies under the scope of the CSRD regardless of which sector or sectors the companies operate in. The Commission will monitor the implementation of the standards to ensure that they lead to the disclosure of relevant, reliable, and comparable sustainability information.

In future years, the Commission is expected to adopt additional delegated acts for additional standards. The CSRD requires the Commission to adopt by June 2024 sector-specific standards, proportionate standards for listed SMEs, and standards for non-EU companies.

ESRS 1 and ESRS 2 contain the general principles and disclosures for sustainability reports. ESRS 1 outlines content requirements, while ESRS 2 provides specific company disclosure requirements.

Here is the structure of ESRS 1, and I will go through each shortly, but I have to emphasize three new components:

• Double materiality
• Due diligence
• Value chain 

1. Categories of Standards and Disclosures under European Sustainability Reporting Standards:

In the case of which a company assesses a sustainability matter as material, but a topical standard does not cover it, it is conceptually intended that companies develop their entity-specific disclosure standards. In this respect, you can find information in detail in Appendix A.

2. Qualitative characteristics of information: The quality of reporting must be ensured by presenting relevant, credible, comparable, verifiable, and comprehensive input.
3. Double materiality as the basis for sustainability disclosures:

The principle of double materiality considers impact materiality on the one hand and financial materiality on the other, which are interlinked.

A sustainability aspect shows material impact if it relates to the company’s significant actual or potential positive or negative effects on people or the environment in the short, medium, or long term. Financial materiality is fulfilled if a sustainability aspect has or can have a material financial impact on the results of operations in the short, medium, or long term.

Companies must first conduct a materiality analysis to identify the significant effects, opportunities, and risks. If the materiality analysis shows that a sustainability aspect is material, the company must report on it. After conducting the materiality analysis, a justification must be provided if companies classify a sustainability aspect as immaterial. Regardless of the materiality analysis result, companies must disclose information.

4. Sustainability due diligence:

The purpose of conducting sustainability due diligence is to gather information that can be used to evaluate the impact, risks, and opportunities associated with a company’s operations. This process aims to identify, prevent, and minimize any adverse effects on the environment and people. The specific aspects of sustainability due diligence are further discussed in ESRS 2: General disclosures.

5. Value chain:

The company responsible for the annual financial statements is also responsible for reporting the sustainability statements. The reporting company must also include the material impacts, risks, and opportunities of the company’s upstream and downstream value chain in the reporting. If the data on the value chain is unavailable or insufficient, the company must make necessary estimations using appropriate data to ensure accurate reporting.

6. Time horizons:

The reporting period for sustainability must align with financial reporting and consider short-, medium-, and long-term time horizons.

7. Preparation and presentation of sustainability information:

Companies must provide comparative data for the previous year’s critical figures and sustainability disclosures when reporting on the current period. If there are any differences, they must explain them and provide detailed descriptions and explanations for any estimates or assumptions made, especially in the value chain.

8. Structure of sustainability statements:

Companies should select a structure that is easily understandable and readable by humans and machines. Apart from ESRS, companies may also have to comply with other standards from local laws or international regulations. The reader should be able to distinguish between the information to be disclosed per ESRS and other disclosures in the management report.

9. Linkages with other parts of corporate reporting and connected information:

Unless reference is allowed, the company must present all disclosures in one section of the management report. Suppose sustainability disclosures have the same level of assurance as annual financial statements and meet technical digitization requirements. In that case, they may be referenced in the management report or other documents published simultaneously.

10. Transitional provisions:

Suppose a company is unable to obtain specific information regarding the value chain. In that case, they may explain the lack of information in the first three years, along with a plan for obtaining it. If small and medium-sized enterprises (SMEs) are part of a reporting company’s value chain, there is a simplified process for reporting information in the first three years reports.

 

As for ESRS 2, it is divided into the following five sections:

1. Basis for Preparation:

The disclosure requirements of BP-1 and BP-2 explain the procedures and principles companies should follow when reporting. If a company’s reporting is consolidated, it must disclose the scope of consolidation, primarily when specific data cannot be published due to sensitivity or estimation uncertainty.

2. Governance:

The governance chapter aims to understand the governance processes, controls, and procedures to monitor and manage sustainability issues, such as the composition of the administrative, management, and supervisory bodies, their tasks and responsibilities, incentive schemes, the company’s risk management, and internal control processes related to sustainability reporting.

3. Strategy:

Companies must disclose their market position, sustainability strategy, business models, and key value chains. Ensure that stakeholder’s interests and views are considered and aligned with the corporate sustainable strategy.

4. Impact, risk, and opportunity management:

Companies must reveal the methods they use to identify impacts, risks, and opportunities, along with the processes they use to assess them. They must also disclose topics classified as non-material based on their materiality assessment, the reasons for this classification, and the action plans and resources they plan to use for implementation.

5. Metrics and targets:

To provide transparency about the effectiveness of their actions and progress towards set targets, companies must reveal the metrics they use to evaluate the material impact of a risk or opportunity (IRO). This includes disclosing whether external parties, besides the sustainability reporting auditor, have validated the ESRS metrics.

The annexes are an integral part of the standard and illustrate data points derived from other EU legislation.

As we can see, in the ESRS, the materiality assessment plays a crucial role in categorizing the topics to be reported. A well-structured and understandable implementation of this assessment is essential for the sustainability report and its contents.

Various transitional provisions have been established to allow for a phased introduction of disclosure requirements. These provisions typically allow for a phasing-in period of 1 to 3 years. However, companies with no more than 750 employees may temporarily be exempt from some disclosure requirements. Appendix C contains a list of phased-in Disclosure Requirements of ESRS 2.

It is recommended to address necessary disclosures early, as they will eventually become mandatory for all companies.

The European Commission confirmed that the ESRS takes account of discussions with the International Sustainability Standards Board (ISSB) and the Global Reporting Initiative (GRI) to ensure a very high degree of interoperability between EU and global standards and to prevent unnecessary double reporting by companies.”

 

*Material is prepared based on Annex 1 to the Commission Delegated Regulation supplementing Directive 2013/34/EU regarding sustainability reporting standards (not in force until published in the Official Journal).

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