For years, asset managers have navigated a sea of murky sustainability data – lack of transparency, fragmented data, and over focus on reporting past performance (lagging indicators like historical waste reduction rather than future-oriented metrics that show a commitment to long-term sustainability goals). Inconsistent sustainability reporting has been making it difficult to separate genuine green giants from clever greenwashers.
The European Sustainability Reporting Standards (ESRS) can be a game-changer that revolutionizes the market. The ESRS are specific standards that companies must use to comply with the Corporate Sustainability Reporting Directive (CSRD). On July 31, 2023, The European Commission adopted the initial ESRS for companies complying with CSRD. The CSRD standardizes how companies report on environmental and social impact, aiming for greater transparency and investment in sustainable practices. Both the ESRS and CSRD work together to achieve the EU's Sustainable Action Plan goals and make sustainability reporting more transparent and comparable across companies.
ESRS has been designed for compatibility with reporting standards and hence aligns with the international sustainability reporting standards such as ISSB standards and TCFD. ESRS is expected to be a boon for fund managers meeting their disclosure requirements under the Sustainable Finance Disclosure Regulation (SFDR). This is particularly true for funds invested in companies impacted by the Corporate Sustainability Reporting Directive (CSRD). The CSRD significantly expands the pool of companies reporting sustainability data, from around 11,000 to over 50,000. Additionally, the ESRS establishes a common reporting format, improving the quality and consistency of the data. This translates to more and better information for fund managers, allowing them to fulfill their SFDR disclosure obligations more effectively.
Understanding ESRS
Scope
Large companies (with >500 employees) (including some non-EU)
Report for year 2024
Publish in 2025
Other Large companies (including some non-EU)
Report for year 2025
Publish in 2026
Listed SMEs (including some non-EU)
Report for year 2026 (or until 2028)
Publish in 2027 (or 2029)
Large non-EU companies with big EU presence (EU turnover of €150m+ for last two consecutive financial years)
Report for year 2028
Publish in 2029
Categories of ESRS standards
- Cross-cutting standards (sector-agnostic): The cross-cutting ESRS standards, ESRS 1 and ESRS 2, provide the framework for sustainability reporting.
- ESRS 1 outlines the overall structure of ESRS standards. It explains the drafting conventions used throughout and establishes the core principles for companies to prepare and present sustainability information in their reports.
- ESRS 2 clarifies the disclosure obligations on sustainability topics. The disclosure must detail how the company integrates sustainability considerations into its governance structure, strategy, and risk management processes.
- Topical standards (sector-agnostic): Topical ESRS delve into specific ESG areas; provide a detailed breakdown by topic, sub-topic, and sub-sub-topic; and include additional disclosure requirements that build on the general level disclosure requirements of ESRS 2.
- Sector-specific standards: Sector-specific standards tailor sustainability reporting for sectors, and focus on impacts, risks, and opportunities that are material to that sector but have not been fully addressed by topical standards to promote comparability within each industry.
Further, companies can disclose additional entity-specific information beyond ESRS categories, if they deem a material impact, risk, or opportunity inadequately covered by the standards.
Reporting areas and disclosure requirements
The ESRS reporting framework focuses on four key areas
- Governance: Details the processes, controls, and procedures used to oversee a company's sustainability-related impacts, risks, and opportunities
- Strategy: Companies explain how their strategy and business model consider material sustainability impacts, risks, and opportunities, including how they address them
- Impact, risk, and opportunity management: Outlines the processes for identifying and assessing the materiality of sustainability impacts, risks, and opportunities; it is followed by an explanation of how a company manages these through policies and actions
- Metrics and targets: Details a company's performance on sustainability metrics, including targets set and progress made towards achieving them
ESRS mandates double materiality assessment which is shaping comprehensive sustainability reporting
ESRS mandates companies to conduct a double materiality assessment. This process requires companies to report on how sustainability issues can affect financial performance such as costs associated with higher carbon emissions or reputational risks from poor labor practices and how the company’s actual or potential impacts can impact people and the environment throughout the value chain.
Boundaries for sustainability reporting in ESRS
- Sustainability reports must match the scope of financial statements and cover an entire group in case of consolidated companies.
- Companies must expand their sustainability reporting to include material environmental and social impact, risks, and opportunities throughout their value chain (upstream and downstream); these have to be identified through due diligence and aligned with specific ESRS requirements
Upstream Value Chain (Only Material Information)
Downstream Value Chain (Only Material Information)
- Companies must disclose material value chain impacts to ensure users grasp their sustainability-related risks and opportunities.
- For joint ventures and associates in the supply chain (equity or proportionally consolidated), sustainability reporting should reflect the full impact associated with a company’s business, not just its ownership stake.
- When a company cannot gather its upstream and downstream information despite reasonable efforts, it can estimate its sustainability impact using industry averages and other reliable proxies.
Time horizons in ESRS
Companies must match the timeframe (reporting period) of their sustainability statements to their financial statements. They must also connect historical data with future goals to provide a clear picture of progress and aspirations. The ESRS provides time horizons for sustainability reporting (short-term, medium-term, and long-term). Companies must compare current performance to a base year and include historical milestones to offer additional context.
Guidelines for preparation and presentation of sustainability information
- Clear comparisons and progress: Sustainability statements should include comparison to the previous years (numerical data and financial amounts). Narrative comparison is also encouraged, when relevant. Any revision to previously reported data must be accompanied by relevant reasoning. In some cases, adjusting past data might be impossible (e.g., due to lack of prior collection methods). When this happens, companies must disclose the reason for lack of comparability.
- Estimates and uncertainties in sustainability data: Companies must disclose uncertainties with regard to value chain information and explain any assumptions used. Consistency with financial data assumptions is also encouraged. When considering potential future events (e.g., climate risks), companies should assess their materiality based on financial impact, environmental / social severity, and likelihood of occurrence.
- Addressing events after reporting: New information may emerge even after a sustainability report is finalized. If the new information significantly impacts the reported conditions, companies should update their estimates and disclosures. Additionally, reports should acknowledge important events occurring after a reporting period and highlight potential consequences.
- Change in preparation or presentation of sustainability information: Sustainability metrics, including those used for target and progress tracking, should remain consistent over time. When changing how one measures sustainability, companies must provide restated historical data (if possible) to ensure consistent comparison over time.
- Reporting errors in previous reporting: Companies must fix significant errors in past sustainability reports by adjusting the reported data. Such errors can be due to mistakes in calculation, misinterpretation of guidelines, or unavailability of information. Unlike estimates, which can be adjusted as new data comes in, errors in past reports need to be corrected, whenever possible.
- Consolidated sustainability reporting and subsidiary exemption: In consolidated reports, companies must consider the entire group's sustainability impact, even if subsidiaries operate differently. They must explain any major difference between group and individual subsidiaries to help users get a complete picture.
- Reporting on opportunities: Companies should describe sustainability-related opportunities that they are considering, with a focus on those integrated into their strategy.
Other reporting requirements
- No requirement to disclose confidential information, even if such information is important for sustainability reporting
- Organizing and presenting sustainability information in a clear and accessible way (in a format that is both human and machine-readable) within a company's management report
Connecting sustainability information with financial statements
Firms should connect sustainability reporting with other corporate reporting. They can incorporate information by reference from other reports, if it meets certain criteria (such as same publication time, language, level of assurance, etc.). It is also required that companies explain connections between different pieces of information in their reports, including how sustainability factors relate to financial statements; this is aimed at improving overall transparency and coherence of reporting.
Transitional provisions
- Companies can initially use existing entity-specific disclosures and best practices for sector-specific reporting.
- For the first three years, companies can limit value chain information to what's readily available and avoid disclosing metrics besides those mandated by EU legislation.
- There is no need for comparative information in the first year, and some disclosure requirements are phased in gradually.
ESRS requires sustainability information to meet certain quality characteristics
- Relevance: Information is relevant if it helps users to make decisions (considering both potential to predict outcomes and confirm past understanding)
- Faithful representation: Information is complete, neutral (unbiased), and accurate (with limitations explained)
- Comparability: Information can be compared to past reports of the same company and reports of similar companies
- Verifiability: Information can be checked for accuracy by independent reviewers
- Understandability: Information is clear, concise, and easy to comprehend
Implications for Asset Managers
ESRS as a strategic enabler for asset managers rather than just a compliance requirement
- Enhanced risk management: A deeper understanding of ESG risks and opportunities gained through ESRS data may help asset managers better manage portfolio risks.
- Attract ESG-focused investors: Rise of ESG-based investing creates an opportunity for asset managers to demonstrate strong ESG analysis through ESRS compliance and attract investors who prioritize sustainable practices. This could lead to new fee structures and revenue.
- Standardized benchmarking: ESRS will provide a common framework for the comparison of companies' sustainability performance, allowing asset managers to benchmark different companies within the same sector and make more informed investment decisions.
Challenges encountered by asset managers with respect to ESRS Implementation
In July 2023, asset managers voiced concern related to initial ESRS drafts by urging the European Commission for stricter mandatory reporting requirements to ensure high-quality data. Asset managers grappled with the disconnect between proposed ESRS standards and the high-quality sustainability data they require for informed investment decisions. They advocate for stricter mandatory reporting requirements to ensure companies disclose the information critical for effective ESG analysis.
ESRS implementation necessitates a significant increase in data collection, which in turn, raises potential challenges for asset managers in due course of time:
- Expanded data needs: ESRS will significantly increase the scope, volume, and detail of sustainability data asset managers need from their portfolio companies. Gathering and analyzing comprehensive data may require new collection processes, potentially leading to higher compliance costs.
- Creating consistent and comparable data for portfolio companies: As ESRS is an emerging regulation, there is a possibility of variation in how companies interpret and implement the standards; asset managers may need extra effort to ensure the accuracy, consistency, and comparability of ESG data across different portfolio companies.
- Greenwashing concerns: While ESRS aims to standardize sustainability reporting, the potential for greenwashing remains a concern for asset managers. The standardized format may unintentionally create opportunities for companies to manipulate data or present misleading information about their ESG performance.
- Alignment with existing SFDR requirements: While ESRS promises standardized sustainability reporting, asset managers will face the potential hurdle of lack of complete alignment with the existing SFDR (Sustainable Finance Disclosure Regulation) requirements. This disconnect creates confusion and additional work for asset managers who need to comply with both sets of regulations.
- Lack of complete standardization of ESG data: While ESRS establishes a common framework, complete data standardization remains a challenge for asset managers due to unique ESG metrics and reporting practices in different sectors. This can make comparisons across industries or even across companies within same industry less straightforward.
- Integrating ESG factors seamlessly with traditional investment strategies: While ESRS promotes transparency in ESG data, integrating these factors with traditional financial analysis presents challenges for asset managers in terms of risk-return analysis. Developing robust methodologies to assess both potential risks and opportunities linked to a company's ESG profile is crucial for asset managers to make informed investment decisions that consider both financial returns and sustainability.
The road ahead and how Evalueserve can help asset managers with ESRS reporting
Despite the challenges encountered during ESRS implementation, asset managers are now positioned to move forward and unlock the full potential of standardized sustainability reporting. Asset managers who embrace ESRS and develop new expertise can navigate the hurdles and unlock the full potential of sustainable investing. Evalueserve offers a comprehensive set of relevant solutions. Our AI-powered platform and deep domain expertise simplify complex ESG data requirements, ensure transparency, and enable informed decision-making.
Our key offerings
Domain expertise
- Proprietary framework for ESG assessment and controversy tracking
- Custom ESG assessment and due diligence
- Thematic research and exclusion screening
- Scoring models
- Competitive benchmarking of standardized and client specific ESG features
- Identifying ESG reporting improvement opportunities for portfolio companies
- ESG fund recommendations
- Identifying topics for strategic & thematic engagement with portfolio companies
Proprietary AI-driven platform (Insightsfirst)
- Identifies ESG risks and opportunities using AI / NLP-powered engines
- Provides real-time monitoring of global companies using client-specific taxonomy and criteria
- Includes GenAI chatbot
- Enables ESG and regulatory alignment
Benefits
- Efficiency gains through hybrid model
- Scalable ESG insights
- Customizable ESG taxonomy and criteria
- AI-powered ESG monitoring and opportunity tagging
- Access to in-house domain experts for actionable insights, additional intelligence, and noise reduction
