The adoption of the first set of European Sustainability Reporting Standards (ESRS) became official in the European Union on October 21, 2023. What changes do the new standards bring for businesses, particularly those operating in the fintech industry?
All global economies are concerned about the impact of human activities on the environment. EU efforts on the path to a sustainable future are versatile. One of the legal initiatives aimed at promoting eco-friendly business practices is the introduction of the European Sustainability Reporting Standards (ESRS).
ESRS at a Glance
New European Sustainability Reporting Standards define the rules for businesses when it comes to disclosing their sustainability efforts, as well as risks arising from their activities and affecting society and the environment.
ESRS apply to all companies subject to the Corporate Sustainability Reporting Directive (CSRD). That encompasses all large and listed companies, including listed SMEs (except micro-enterprises).
The standards cover various aspects of environmental, social, and governance (ESG) issues, including climate change, resource use, biodiversity, affected communities and human rights. They are also highly interoperable with global standards of ESG reporting.
ESRS List
Here are the categories of ESG issues EU businesses need to address in their reports:
- General disclosures – mandatory information for all companies under the CSRD scope.
- Climate, pollution, water and marine resources, biodiversity, ecosystems – the impact of corporate activities on the environment, as well as risks presented by environmental changes to the company itself.
- Circular economy, resource use – the company will report only relevant information.
- Own workers and workers in the value chain – reporting on diversity practices, countering discrimination, creating a favourable work environment, etc.
- Affected communities, consumers and end users – how corporate activity affects wider society.
- Business conduct – work ethics, corporate values and mission.
Regarding all these aspects, the ESRS introduce more exacting reporting obligations than previous legal frameworks. Thus, companies are expected to collect information on both upstream and downstream operations, formalising it in a digitalised and integrated report with specific formatting requirements.
What Is the Purpose of ESRS?
The new standards aim to expand the scope and improve the quality of corporate sustainability reporting. The enhanced transparency should promote sustainable development in all industries.
It is expected that unified sustainability reporting standards will enable all stakeholders, including investors, other companies and wider society to gain better insights into the business practices of all reporting companies. This will make funding environmentally friendly activities easier and more efficient.
The sustainability reporting as it is at the moment has many imperfections. EU regulators note that, without obligations, many companies omit information which stakeholders consider important in their reports. Moreover, the absence of common standards makes it difficult to compare different companies’ ESG performance.
European Sustainability Reporting Standards Timeline
On 31 July 2023, the European Commission (EC) adopted the final delegated act of the European Sustainability Reporting Standards (ESRS).
After a period of scrutiny, the adoption of European Sustainability Reporting Standards (ESRS) was finalised in the European Union on October 21, 2023. The initiative didn’t receive any objection from the co-legislators.
The ESRS will apply to companies within the scope of the CSRD in a phased approach. First-time application (as defined by the CSRD) varies for different types of companies, starting from FY 2024 (reporting in 2025) for all companies already subject to the NFRD.
At the same time, the European Commission proposed a two-year delay to the adoption deadline for ESRS. The proposal is currently open for feedback.
After thorough consideration, the EC concluded that it should ensure that sustainability reporting objectives are reached at minimum cost. However, for many smaller companies introducing ESRS in a rush means significant investments.
Therefore, the regulator proposes giving EU companies substantially more time before being required to provide sector-specific sustainability disclosures. At the same time, non-EU entities might fully comply with the CSRD two years later than initially proposed.
Thus, the application of the standards to large companies that are not currently subject to the Non-Financial Reporting Directive is expected to start on Jan. 1, 2025, while large companies from third-world countries will have time till 2028.
European Sustainability Reporting Standards and Fintech
ESRS directly affect thousands of businesses operating in the EU. The first set of the new sustainability reporting standards applies to the following categories:
- Companies subject to the Non-Financial Reporting Directive (NFRD), i.e. listed companies, banks, insurance companies, and other entities with over 500 employees designated by the national authorities as public-interest ones.
- Large non-EU listed companies with more than 500 employees;
- Listed SMEs based in both the EU and outside the union;
- Non-EU companies generating over €150 million in annual revenue in the EU. Those should also have a branch in the EU with €40+ million revenue or a subsidiary that is a large company or a listed SME.
Apparently, many fintech companies and traditional financial institutions belong to the given list. Therefore, they should consider the effects of ESRS on their business practices.
Impact of ESRS on Businesses and Investing in EU
Corporate actions have a significant impact on products and services, employment, economic opportunities, working conditions, human rights, health, the environment, innovation, technology, education and training in the EU.
It works the opposite way too. All the given ESG factors directly influence the functioning of all types of European and non-EU-based businesses.
Under the European Green Deal, funding economic activities that support environmental, social and governance-related objectives is the main prerequisite to fostering sustainable growth. Therefore, ESG-focused fintech startups and long-established businesses have more chances to find investors for their activities.
However, proving your sustainability-related efforts is not that easy in the absence of unified reporting norms. This is especially true for transition finance initiatives which aim to reform the heavy-carbon industries but lack instruments to measure or quantify an organisation’s progress in climate strategy or products as it doesn’t bring quick results.
ESRS may become the first piece of the puzzle when it comes to the transparency of ESG reporting. It may help sustainable investing firms and individuals overcome the lack of data, clarity and transparency over what constitutes a sustainable corporate policy as well as the practical results of a company’s ESG strategy.
At the same time, so far, different reporting standards across jurisdictions have not been fully harmonised. Therefore, many stakeholders have been struggling to identify common disclosures for ESRS and the International Sustainability Standards Board (ISSB) standards (IRFS 1 and IRFS 2), to reduce the reporting burden on companies. Another challenge is to define those points which are unique to each reporting regime so as not to miss the important requirements.
What Changes Should Fintech Organisations Mind
Stricter ESG reporting rules increase companies’ accountability on social and environmental issues.
At present, around 11,700 of the largest EU-listed companies, banks, credit institutions, and insurance companies are required to disclose non-financial information under the NFRD. Along with other companies subject to the CSRD, they will now have to report their non-financial activity results according to European Sustainability Reporting Standards (ESRS).
Unlike popular belief, all the ESRS disclosures are not voluntary in common sense. Companies do have a lot of flexibility to decide exactly what information is relevant (“material”) in their circumstances, but only to a certain extent.
If an entity decides that some of the reporting points are not “material” meaning they don’t apply to its particular activities, it should provide a detailed explanation of why it reached such a conclusion. For some directives, like reporting on the climate change agenda, it would be hard since the issue is global-scale and impacts almost every aspect of the economy.
Financial market players, as well as other companies, will have to explicitly state that the data point in question is “not material” instead of just reporting no information. In addition, legal entities will have to provide a table with all such data points, indicating where they are to be found in their sustainability statement or stating “not material” as appropriate.
Financial market participants and financial advisers may assume that indicators reported as non-material by an investee company don’t contribute to principal adverse impacts in the given field.
Although the EU regulators are still considering deadline delays for the adoption of ESRS, fintechs and other businesses that fall under their scope should not waste time. For starters, they must exercise due diligence on current sustainability measures and existing reporting practices. Start or continue gathering data from suppliers, operators, and company partners on each ESRS framework to understand which of them are “material” to your operations.
Moreover, while companies, especially smaller ones, now have more time to implement data collection and reporting procedures, it is estimated that ESRS compliance introduction may cost around EUR100,000 to firms that previously weren’t obliged to report on ESG aspects. All those concerned should mind that in their firm’s annual budget.
