8 March 2021
Future EU sustainability standards: NGOs welcome the final recommendations of EFRAG’s Project Task Force for the European Commission
Following the presentation of the Green Deal, the European Commission confirmed the EU’s ambition to reform the EU Non-Financial Reporting (NFR) Directive and develop accompanying EU standards. EFRAG was subsequently mandated to set up a Project Task Force (PTF) to advise the European Commission on the ideal content and structure of such standards. Six months after the selection of its members, the PTF has published its final recommendations. The Alliance for Corporate Transparency welcomes and supports the PTF’s work and - at least in principle - its final advice to the European Commission.
The research and studies published by the Alliance highlight major gaps in current reporting practices as companies disclose general and vague information instead of qualitative, comparable and decision-useful data and insights.
Clarifying thematic reporting requirements, in particular on climate risks, targets and transition plans, human rights due diligence, and on impacts across the value chain, is the only way to ensure that companies and their boards focus on relevant data and that investors and banks have access to relevant and comparable information needed for their decision-making.
EU standards play a critical role in this regard. The recommendations of the Project Task Force can successfully guide the EU standard-setting process, and significantly advance the quality of corporate sustainability transparency.
Below, we provide an overview and reflections on the most important recommendations for the success of the work of the future EU Standard Setter (ESS).
1. Quality criteria to be followed by the ESS and reporting entities
The PTF outlines a set of characteristics that should guide the development of EU standards (1); both the ESS and individual entities should ensure that information is relevant, conveys a faithful representation of reality, is comparable, understandable and reliable (2).
Moreover, the PTF identifies a set of criteria against which the quality of selected indicators should be assessed (3). The ESS must ensure that indicators do not lead to unintended consequences with regards to company practices; truly reflect the likelihood that the company is reducing negative outcomes and maximising positive outcomes for people and the planet (indicative capability); when relevant and possible, are measurable; are reliable and provide insight in the absence of contextual information for its interpretation (4).
As found by the Alliance for Corporate Transparency, the quality of information currently reported by companies is not sufficient to ensure access to relevant information and lacks relevance, which is why adhering to the above recommendations in the development of the standards will be crucial to advance sustainability reporting.
2. Double-materiality application
Companies should assess the materiality of individual topics by analysing (a) severe impacts on people and the planet and (b) financial risks to the company. While these two perspectives interact (impact and financial risk perspectives), their assessment should be carried out in their own right, and individually for each topic (5). This is essential given the different nature of separate themes. For example, while for impacts on people and the environment, materiality is intrinsically based on the existence of adverse impacts or the risks of such impacts, and on assessing their severity through due diligence, for climate change, a company may face major financial risks and opportunities even if its impacts on climate change are not significant.
As recommended by the PTF, the ESS should define principles for double-materiality. These should guide the definition of sector-agnostic and sector-specific standards by the ESS, and the materiality determination of individual companies for the definition of entity specific disclosures (6).
With regard to impacts on people and the environment, materiality assessment should cover a company’s direct impacts as well as those across the value chain linked to the company’s operations, products or services, including by sourcing, energy use, form and types of employment. For Climate Change, the PTF specifies concrete information which is material, including GHG emissions Scope 1, 2, and 3, the level of alignment with planetary boundaries and international targets, transition plans, intermediary milestones; and climate-related risks relevant for the short, medium and long term financial position, performance and outlook of the company (7).
As highlighted in the PTF report, the European standards should also reflect the interconnected dynamic nature of materiality, in particular the pre-financial quality of the information on impacts. The standards should ensure that companies are attuned to the fact that a topic which is usually considered from an impact perspective, can quickly become financially material due to a range of social, regulatory and environmental forces.
3. Levels of reporting and standards setting
The PTF recommends adopting a three-level reporting approach (8), which in our view allows to strike a balance between relevance and comparability of disclosure:
- Sector agnostic disclosures: These should be based on guidance provided in the reformed EU NFR Directive, based on double-materiality;
- Sector-specific disclosures: For issues that do not apply cross-sectorally, the EU Standard-Setter should provide thematic clarifications for specific reporting requirements relevant for given sectors. These should be based on a recognised classification of sectors (e.g. NACE)(9);
- Guidance for entity-specific disclosures: The ESS should provide guidance for the definition of entity-specific disclosures, based on double-materiality.
4. Value chain
The PTF makes several important recommendations on how the standards should approach risks and impacts in value chains. Firstly, it recognises that a material topic may manifest at different levels in different entities’ scope of operations and/or value chain, and thus the standards need to ensure that disclosures reflect information that is sufficiently specific to the level at which the material matter arises (10). Secondly, to ensure relevance and granularity, it highlights the need for sector-specific standards to address certain widespread impacts in value chains, as they tend to be clearly linked with certain sectors and levels (11). Thirdly, it recommends that the sequence in which the ESS develops standards should reflect the urgent need to improve reporting on the most severe impacts and significant dependencies connected to a reporting entity’s operations and value chains, regardless of its level of control or influence over them (12).
5. Forward-looking information
Meeting the goals of the EU Green Deal will require additional investments of at least half a trillion euros per year. Access to information on forward-looking targets and company transition plans is critical to redirect capital flows towards sustainable investments. However, as shown by the Alliance for Corporate Transparency, such information is missing from company reports; only 13.9% of companies report on the alignment of their climate targets with a science-based methodology or public objectives, expressed in the Paris Agreement, to limit global warming to well below 2°C, and 6.6% report on climate-related scenarios as required by the TCFD recommendations.
In this regard, the PTF recommends that the European standards should encourage the disclosure of targets and progress towards their achievement in relation to all material sustainability matters, articulated in terms of their relevance to outcomes for affected stakeholders and/or the environment; and that such targets need to be specific, measurable, achievable, time-bound, and science-based wherever feasible (13).
Such information is essential to provide interested stakeholders with a true insight into a company’s performance and management of impacts and risks, able to soundly inform decision-making.
6. Priorities & Roadmap
In alignment with the Alliance for Corporate Transparency joint position, the PTF stresses the importance for the EU NFR Directive to provide guidance on priorities for the development of EU standards (14). Setting such priorities is a political decision, and as such should be a responsibility of EU policymakers, rather than the ESS. Level 1 legislation should define a set of core disclosures and priorities to focus on, which in turn should be specified by bespoke sector-sensitive reporting standards at Level 2.
Given the urgency of particular issues, there are themes which should be prioritised (15), especially for high-risk sectors; examples include climate change, human rights and environmental due diligence, and impacts on people and the environment of high-risk industries along the supply chain (e.g. for the Apparel and Textile sector). Importantly, within each theme, the selection of core mandatory standards (to be selected based on the quality criteria previously discussed) should be lean, to avoid excessively long lists of irrelevant indicators.
7. Complementary recommendations on areas for improvement
The current categorisation of topics is one of the PTF recommendations we believe might require a more nuanced approach. Categorising topics under the ESG nomenclature can be confusing; certain issues fall under different categories (e.g. often the case for human rights and environmental due diligence). As such, in the case of components E (environment) and S (social), we would advise a more nuanced definition of topics. This is for example already done in the case of “E”, as reflected in the PTF’s suggestion to distinguish between six environmental areas, in alignment with the EU Taxonomy: climate change, water & marine resources, biodiversity & ecosystems, circular economy, pollution.
Likewise, instead of “S”, standards could be developed by focusing on the categories of potentially affected stakeholders along the value chain (workforce, value chain workers, communities and consumers/end-users) and then focus on human rights matters in relation to each.
The PTF also identifies “G” (governance) as a reporting topic, including subtopics such as governance, business & ethics, management of the quality of relationships with stakeholders, etc. While we agree on their relevance, we view these as a natural extension of the cross-topical reporting area defined as ‘strategy’ in the report’s section “Three Reporting Areas”, rather than a reporting topic as such.
Overall, we understand the PTF’s focus on the ESG classification of topics, yet we would advise a more nuanced approach that more adequately reflects the nature and interconnectivity of relevant impacts and risks faced by companies; and which we believe would not contradict the PTF’s recommendations, but rather fits into the already robust system described in the report.
(1) PTF Report, Proposal #14, p.66.
(2) PTF Report, Section ‘Qualitative characteristics of sustainability information’, p.64..
(3) PTF Report, Proposal #15, p.67.
(4) PTF Report, Section ‘Focus on certain specificities of sustainability information’, p.66.
(5) PTF Report, Proposal #22, 76.
(6) PTF Report, Proposal #22, p.76
(7) PTF Report, Section ‘Additional focus on certain aspects of the entity-level double materiality assessment process’, p.80
(8) PTF Report, Proposal #24, p.79
(9) PTF Report, Proposal #12, p.59
(10) PTF Report, Proposal #20, p.73
(11) PTF Report, Section ‘Ensuring that disclosures are applied at the most relevant level(s) in the entity’s controlled operations and/or value chain’, pp.72-73; Proposal #20, p.73
(12) PTF Report, Proposal #21, p.74
(13) PTF Report, Proposal #18, p. 70
(14) PTF Report, Section ‘Sector-agnostic, sector-specific and entity-specific material disclosures’, pp.77-79
(15) PTF Report, Proposals #44 and #46, p.112 and p.114