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EU’s ESG Reporting Standards Move Ahead While Global Rules Lag

Dec. 30, 2022

Multinational companies will face a growing burden of sustainability reporting over the next few years, largely from new European standards rather than the UN-backed rules announced with much fanfare a year ago.

“We’ve identified around 1,000 data points companies will need to report,” Patrick de Cambourg, chair of the EFRAG Sustainability Reporting Board, said in an interview.

The European Financial Reporting Advisory Group has drawn up comprehensive reporting rules covering all aspects of environmental, social and governance issues, which will be mandatory for big European companies beginning in the 2024 financial year. The standards have been sent to the European Commission for approval, De Cambourg said. They are expected to be finalized around the middle of 2023, and will then be made mandatory in all EU countries. That means many companies will have to comply with the EU rules ahead of global rules that are being drawn up by the International Sustainability Standards Board, or ISSB, which will cover far fewer topics.

“International companies must follow the rules if they operate in Europe,” Peter Paul van de Wijs, the Global Reporting Initiative’s chief policy officer, said in a recent phone interview. “That’s feeding global impetus towards impact reporting,” he said, drawing a contrast between the approach used by GRI and the EU, which emphasizes a company’s impact on the world, and the ISSB’s, which concentrates on how a company’s value could be damaged by ESG issues.

Worldwide Impact
GRI’s voluntary reporting rules, which underpin the EU standards, are aimed at making companies report their worldwide impacts. The coming ISSB rules, in contrast, aim more narrowly at financial investors, concentrating on the risks companies face from threats such as climate change. Based on ISSB guidelines, companies will themselves be the ones that judge what is “material”, or important enough to report. Critics say that’s a loophole that could undermine the quality of the ISSB data.

De Cambourg said there had been “lengthy discussions” within the EU over the reporting requirements, with complaints about imposing such a big new task on companies already battling the effects of recession and the pandemic. In the event, 12 detailed reporting standards have been sent to the European Commission; if they pass muster there, they’ll apply to all large companies. The standards cover a broad range of ESG issues—including climate, pollution, workforce and business conduct—that adds up to the 1,000 data points mentioned by De Cambourg.

In recognition of the additional burden that puts on companies, firms won’t have to report all 1,000 indicators. Rather, each enterprise will have to report about 300 of the ESG data points, with the rest required only if they are material, de Cambourg said. The reporting will be mandatory for all EU companies employing more than 250 people, including private firms and foreign subsidiaries, with the reporting requirements introduced in phases between 2024 and 2026, depending on company size.

More ESG Standards Coming
Still, the explosion in reporting requirements is just getting started. De Cambourg said requirements would “grow organically,” with EFRAG working on two additional sets, though no date has yet been set for their introduction. First, there will be detailed reporting rules for companies operating in certain industrial sectors, and then voluntary reporting rules for small companies falling outside of the mandatory requirements.

“The industry rules will be in addition to the first set of reporting requirements,” De Cambourg said.

Many companies headquartered outside of Europe will be caught up in the EU net. Van de Wijs noted that the adjustment won’t be as big as some fear, because more than 10,000 companies worldwide—including all of the 100 biggest global companies—are already required or encouraged to use GRI’s rules, which are quite similar.

“Globally, all of the top 10 countries by population, with the exception of Russia, have at least one policy instrument which references GRI, including the US, China and Japan,” Van de Wijs said. “As well as the biggest countries, southern Asia has seen particularly strong take-up, sometimes through stock exchange listing requirements and sometimes by being recommended by law, as in India.”

Tax Reporting as ESG?
GRI covers more ESG issues than the EU rules, but Van de Wijs said he expects Europe to add new categories over time.

“We require tax reporting, for example,” he said, “which is increasingly important given the drive for minimum tax rates globally. Europe might well follow us there.”

Most multinationals will therefore have to report on ESG impact to comply with EU standards soon, if they don’t do so already. Progress on financial reporting rules being set by the ISSB is relatively modest, in contrast, with little sign they will be required anytime soon.

The ISSB was launched with some fanfare at the United Nations Climate Change Conference in November 2021, tasked with writing financial reporting rules covering the full range of ESG issues. The following March it published drafts of the first two of these, covering general sustainability and climate disclosures, which it said it hoped to finalize by the end of 2022. It also said it would agree on the next set of topics it would cover by the same date. It has missed those deadlines.

The ISSB declined an interview request and did not respond to questions about the reasons for the delay, or how much of the work it has completed. In an emailed statement, however, it said that “the ISSB is looking to issue the final standards as early as possible in 2023.” The deadline for agreeing the next topics has also been pushed back to the first half of 2023, although it said in December that it would prioritize biodiversity, ecosystems, human capital and human rights, and connectivity in reporting with its sister body, the International Accounting Standards Board.

ISSB Rules Remain Far Away
Even after the first two standards have been written, Van de Wijs noted, the 140 countries that use the international accounting board’s standards will have to adopt them individually—a process that could drag on for a decade.

A few countries, including Australia, are starting to talk about using them, Carol Adams, a Durham University accounting professor specializing in sustainability said, but most haven’t said anything, because there aren’t yet any rules to adopt. Neither the US nor UK, nor any other large country, has set up a mechanism to adopt the ISSB rules.

“The IFRS Foundation Trustees and ISSB have put rather a gloss on the strength of support they have, have been dismissive about GRI, and haven’t come up with any meaningful statement,” Adams said. The ISSB likes to call its rules a “global baseline” for countries, and has set up a cooperation agreement with GRI so that countries can choose to use both.

The reality, Adams said, is that—of the two systems—GRI is already widely in use. And to have any effect, ESG reporting must emphasize companies’ impact on the wider world, not just the financial threats they face, she said.

“The ISSB Standards are conceptually not geared to address climate change or sustainable development,” she said. “Given their focus on what matters to investors and the large amount of judgment involved in applying them, they may do more harm than good.”

[Bloomberg Law]

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