If the EU Commission asks the EFARG to square the circle

News from the AGN EMEA Accounting, Auditing & Education Committee (AAEC)

If the EU Commission asks the European Financial Advisory Reporting Group (EFARG) to square the circle, history will repeat itself, and Mr Eccles was unfortunately wrong! In this newsletter, we hear what Carsten Ernst, AGN’s expert in financial (IFRS) and sustainability (ESRS and GRI) reporting thinks of the situation. What is likely to happen? How will EFRAG deal with this?

I have a lot of respect for Robert Eccles (Visiting Professor of Management Saïd Business School, University of Oxford), and I believe he is right when reading his articles and posts on sustainability reporting. That is, until now. In his latest post, I think Robert could be subject to a misjudgement. Let me explain why.

The following is an extract from Robert Eccles’s post:

“The work of (…) EFRAG to develop European Financial Reporting Standards across a broad range of ESG topics means that companies will need to significantly upgrade the quality of their internal control and measurement systems for sustainability reporting.”

This sentence is correct in relation to the draft versions of the European Sustainability Reporting Standards (ESRS) developed by EFRAG and submitted to the EU Commission in November 2022. However, this sentence will most likely turn out to be wrong concerning the final ESRS.

Ursula von der Leyen (President of the European Commission) announced the following in her speech at the “European Parliament Plenary on the preparation of the European Council meeting of 23-24 March 2023” on 15 March 2023:

“My second point concerns an issue which you hear about time and again: red tape. It is Europe’s companies and employees that make the single market one of the world’s most attractive economic regions. Regardless of whether we’re talking about industrial giants, global market leaders, medium-sized enterprises or family firms – their success is Europe’s success. We are therefore doing everything we can to make their work easier.

We know that the quality of public administration and the legal framework is key to competitiveness. That is why, together, we also ensure thorough comprehensive impact assessments that EU laws do not burden EU businesses but support them. However, as we all know, often, it is not an individual obligation to provide proof; often, it is not an individual condition that makes life difficult for them. It is the huge sum of all such requirements.

We will therefore look beyond departmental boundaries to see what really makes Europe more competitive and what we can do without. By the autumn, we will put forward concrete proposals to simplify reporting requirements and reduce them by 25%. It won’t be easy, but it’s an effort we have to make.”

A few days later, Mairead McGuinness (European Commissioner for Financial Stability, Financial Services and the Capital Markets Union) added the following in her opening speech at the “2023 PwC CEO Report” event on 21 March 2023:

“We know that the EU sustainability reporting standards will be challenging for companies.
And that’s why we’re asking EFRAG, who developed the draft standards, if you like, to focus on providing additional guidance for companies to apply the first set of horizontal standards. And indeed, to free up resources for this very critical task, we have asked EFRAG to prioritise its efforts on that first set of horizontal standards over preparatory work for the sector standards.

At first, this only sounds like EFRAG should provide further guidance on the implementation of Set 1 of the ESRS. But then comes the following sentence:

“And we will soon publish the proposed final version of the first set of horizontal standards for a period of public comment.”

All in all, this could mean that there will soon be new drafts(!) of the ESRS with 25% less content.

If this is the case, it is a mystery to me how the CSRD timetable can be maintained. At least if EFRAG and the EU Commission adhere to the CSRD’s prescribed process of standard setting with the involvement of various stakeholders and the granting of a sufficiently large time window for public consultation.

As can be seen from EFRAG’s post, it looks like EFRAG itself was not informed directly by the EU Commission about these planned adjustments to the draft ESRS, but indirectly through the public speech of Ms McGuinness (“Commissioner McGuinness has publicly called on EFRAG… “).

Corporate communications have a golden principle: “internal before external”. This principle probably does not apply to decision-making processes in Brussels. But that is another story.

With technical expertise, EFRAG submitted drafts of the ESRS to the EU Commission in November 2022, considering the following requirements: Implementation of the CSRD requirements, close to the GRI-Standards, and close to the future standards of the ISSB.

EFRAG has thus done the job for which it is responsible under the CSRD. So far, all is well, and Robert Eccles is to be agreed.

What’s happening now?

At the moment, it looks like pressure is being exercised on EFRAG by politicians (presumably driven by strong lobby groups) to reduce the content of the draft ESRS (by 25%?). Unfortunately, if this happens, the final ESRS is washed clean and thoroughly green, and Mr Eccles’ statement will be proven false.

What does this mean?

We will have ESRS, which does not cover a “broad range of ESG topics”, and “companies will not need to significantly upgrade the quality of their internal control and measurement systems for sustainability reporting.”

EFRAG’s draft versions ESRS 11/22 contain a high number of disclosure requirements and data points – this is undeniable, but there is also the central principle of “mandatory only if material” (with some exceptions which are considered “always mandatory”).

Numerous data points only have to be reported on if certain conditions are met (for example, if a company has a production site in a “high-risk water area”, it must rightly report on this data point; if not, then not).

Has anyone actually bothered to find out what reporting obligations the average CSRD reporting company has to fulfil at the end of the day in compliance with draft ESRS 11/2022? Before announcing, “It must be xx% less”, shouldn’t this have already been done? At least I haven’t read anything about this yet.

If the disclosure requirements and data points of the draft ESRS 11/2022 are reduced significantly (by 25%?), then the CSRD’s goals of bringing sustainability reporting on par with financial reporting and providing investors, financial institutions, and other stakeholders (NGOs, employees, customers, suppliers…) with sufficient and reliable ESG information will then be missed by a long way.

Is it true that history will likely repeat itself?

The Platform on Sustainable Finance (PSF) has developed the EU Taxonomy Regulation on a scientific basis. Due to political pressure (presumably from France and Germany), a delegated act was added to this regulation, according to which nuclear energy and fossil energy based on gas can also be considered as green economic activities.

What was Greenpeace’s response?

Greenpeace’s response to the delegated act was clear, but unfortunately, it came too late!

(EU sustainable finance campaigner Ariadna Rodrigo; Taxonomy: Greenpeace takes legal action against the EU’s gas and nuclear greenwashing – Greenpeace European Unit):

“This fake green label is incompatible with EU environment and climate laws. Gas is a leading cause of climate and economic chaos. At the same time, there is still no solution to the problem of nuclear radioactive waste, and the risk of nuclear accidents is far too significant to ignore.”

What are my thoughts right now?

I suspect that no one is really aware of what is happening here at the moment. The idea of the CSRD to lead sustainability reporting in Europe into a new era might now be entirely illusory. The topic is probably too unsexy for climate activists, and the leverage mechanism that truly transparent sustainability reporting has in relation to ESG issues is very difficult to understand.

What are my main concerns?

I fear what happened with the EU Taxonomy Regulation could now happen with the ESRS. EFRAG’s technical experts have done a good job and answered the CSRD’s task with the Draft ESRS 11/2022. If the disclosure requirements or data points of the draft ESRS are now to be reduced significantly (by 25%?) at the request of the EU Commission, then the EU Commission must reformulate the task set for EFRAG by adapting/amending the CSRD.

Key question: How will EFRAG deal with this?

The EU Commission cannot order a car with equipment on the level of a Mercedes Maybach and then be surprised that the price is higher than that of a Fiat 500 (not to be misunderstood: I love the Fiat 500). So either the EU Commission adjusts its CSRD order (“a Fiat 500 is enough for us”), or it does not (but then it should accept the price).

Or (which I don’t know because I’m not familiar with political Brussels), maybe the EU Commission also has this power. The question is, how will EFRAG deal with this?

Should the EU Commission ask EFRAG to square the circle (“the CSRD requirements remain, but please delete 25% of the draft ESRS 11/2022 reporting requirements”), EFRAG should stand firm.

Should you ever lose track of the big picture, my colleagues and I from the AGN EMEA Accounting, Auditing & Education Committee (AAEC) will be happy to help and guide you safely through the IFRS and CSR jungle. As a member of AGN International, you can use the AGN AAEC Helpline at any time or contact me by email at carsten.ernst@wirtschaftstreuhand.de or by mobile phone at +49 173 8710322.

Happy accounting and stay sustainable,

Carsten

Carsten Ernst Managing Partner Wirtschafts Treuhand Group Stuttgart, Germany

– Expert in financial (IFRS) and sustainability (ESRS and GRI) reporting – Audit of financial and sustainability reports in accordance with ISAs – Member of the following AGN bodies: – EMEA Board of Directors (Chairman) – EMEA AAEC Accounting, Auditing and Education Committee (Member)