Under the Corporate Sustainability Reporting Directive (CSRD), large and most listed companies in the EU – including companies outside the EU with listed securities on an EU-regulated market – will be required to start adopting European Sustainability Reporting Standards (ESRSs) in a matter of months.
The last step before finalising the first set of ESRSs – a four-week public consultation – closed on 7 July 2023.
The KPMG response to the proposals includes the following key points:
We acknowledge that significant changes have been made already; however, we retain concerns about the speed and extent of new disclosure requirements being introduced, particularly for the largest companies that are first to apply and have the least phase-in relief.
We welcome that the Commission works closely with the ISSB1 and GRI2 to achieve interoperability with international frameworks. However, we continue to have concerns about the practical interoperability between the IFRS® Sustainability Disclosure Standards as the global baseline and the draft ESRS.
As a fatal flaw, we observe that the definitions of financial materiality are still not aligned. We also highlight differences in requirements for explaining current and anticipated financial effects – such as explanations of when it is appropriate to provide this type of analysis. Aligning ESRS 1 requirements and application guidance for financial materiality and explanations of current and anticipated effects with the ISSB and eliminating any conflicting requirements in the topical standards should provide an easy interoperability win that would not undermine the additional requirements in ESRS to meet the needs of other stakeholders.
Further aspects that should be resolved for interoperability exist in relation to different reliefs and phase-ins, restrictive presentation requirements that may lead to duplication in reporting, and regarding differences in language. As both sets of standards will continue evolving in the future, we encourage the EC3 and EFRAG4 to continue to cooperate with the ISSB and ensure continuous alignment of topical standards that are to be applied under both frameworks. We would welcome the publication of an interoperability analysis to support stakeholders in understanding the two frameworks.
Need for guidance and clarifications
We welcome a principle-based approach to base reportable information on materiality. While this might not significantly reduce the reporting burden, it will lead to more targeted and more relevant disclosures. However, it puts more emphasis on a company's materiality assessment and the need for further guidance on how to perform the double materiality assessment and how to consider the value chain. The difficulties will mostly result from the impact materiality assessment. In absence of clear norms of when an impact on people or planet is to be considered material, the outcome of a company's assessment might differ significantly from expectations of stakeholders. Preparers and assurance providers face an open-ended expectation gap due to the diversity in size and type of stakeholder groups that might be relevant for the impact assessment. It is therefore crucial that inconsistencies in the specification of 'impact materiality' within ESRS 1 and between ESRS 1 and the topical standards are resolved. For example, ESRS 1.35 and ESRS 1.AR9 give the preparer discretion to determine what should be considered 'impact material' whereas ESRS 1.43 suggests that anything relating to the company's actual or potential impacts should be considered material. Additionally, terminology within the topical standards such as 'key', 'significant' can appear to override the materiality judgements described in ESRS 1.
Given the inconsistencies in the drafts, we stress that it is critical for any further guidance developed outside the standards to be demonstrably aligned to the standards themselves.
Entity-specific material matters vs voluntary disclosures
We also ask the EC's attention for the fact that there seems to be an inconsistency between the requirement in ESRS 1.30 to identify material entity-specific sustainability matters and the concept of voluntary disclosure requirements. Material matters that get identified as entity-specific, regardless of whether the matter is included in a topical standard or not, need be included based on ESRS 1.30, whilst they could be left out based on the voluntary reporting concept. Clarity needs be provided on how this inconsistency should be resolved in practice both by reporting companies as well as assurance providers. In the absence of sector-specific standards, entity-specific disclosures will play an important role and additional guidance on how to apply this requirement is essential.
Interplay between ESRS and other European laws and regulations
Clarification is also sought on the interplay between ESRS and other European laws and regulations (such as SFDR5) as financial market participants have to rely on data to be provided by companies reporting under the ESRS. In the current draft ESRS for example, it could still be assumed that SFDR datapoints are always mandatory given that Appendix B is still an integral part of ESRS 2, which is always mandatory based on ESRS 1.29. Alternatively, SFDR datapoints might be considered always material where there is an investor present that has to report under SFDR. In order to avoid inconsistent application, the interplay between ESRS and other European laws and regulations should be clarified.
We observe that phase-in measures are mostly available to the smaller companies, e.g. those with less than 750 employees. We welcome the introduction of further phase-in measures to reduce the initial reporting burden for smaller preparers and the consequential relief for assurance providers. However, there is little phase-in relief for large companies that are the first ones to report, some of which having no experience with sustainability reporting under the NFRD6 (i.e. large non-EU companies with securities listed on EU-regulated markets with more than 500 employees). This raises concerns about the quality of disclosures and the assurance that can be provided over it. In order to ensure high quality assurance, sufficient assurance evidence needs to be available which requires governance oversight, robust processes and controls to collect, process and report relevant information. Larger companies have the most complex systems and processes which require time to be set up. We therefore see a significant risk that current phase-in measures fall short of providing sufficient time for the largest companies to meet disclosure requirements and be assurance-ready in time.
As stated in the introduction to this letter, there is a significant risk that assurance providers and oversight bodies will not be able to get sufficient and appropriate assurance evidence to support unqualified opinions. Clear communications from ESMA7 and member state regulators to the markets on the challenges of sustainability reporting may help alleviate market concerns if qualified assurance reports are issued. In addition, the EC could facilitate dialogue among stakeholders, preparers, assurance providers and enforcers to optimise efforts to improve implementation over the years.
We support the initiative to put in place an interpretation mechanism to provide formal interpretations of the standards. This will help preparers to better meet the reporting objectives of ESRS. We urge that this is installed as soon as possible. We especially welcome the additional guidance currently being developed by EFRAG addressing the materiality assessment process and value chain considerations, making sure that it continues to be aligned with the financial materiality guidance by the ISSB.
We highlight that ESRS have been developed with speed as a main priority. However, this should not come at the expense of due process. Consultation periods (both from EFRAG as well as the EC) have been and are too short given the number of standards, and changes made as a result have been extensive. For future consultations, we suggest considering a longer and/or appropriate comment period to support the quality of standards issued.
The EU is expected to adopt the final standards before the end of July. Subject to no objections being raised by the EU Parliament and Council, the new standards will become effective for the first companies to adopt from 1 January 2024.
1 International Sustainability Standards Board
2 Global Reporting Initiative
3 European Commission
4 European Financial Reporting Advisory Group
5 EU Sustainable Finance Disclosure Regulation
6 EU Non-Financial Reporting Directive
7 European Securities and Markets Authority
8 US Securities and Exchange Commission