The question now arises as to whether these EU-Com.-ESRS violate the European Accounting Directive (hereinafter BilR), as amended by the Corporate Sustainability Reporting Directive (hereinafter CSRD), at least in two key points.
1. Provision of information central to allocating cash and capital flows to sustainable enterprises and business models.
According to the EFRAG ESRS, certain reporting requirements were classified as “always mandatory” according to Appendix C of ESRS 2.
“Always mandatory” means that all reporting entities must include this information in their sustainability report, regardless of whether it is considered material based on the entity-specific materiality analysis.
Sustainable Finance Disclosure Regulation:
These reporting requirements relate to information that financial market participants (especially banks) need to fulfill their own disclosure obligations based on the Sustainable Finance Disclosure Regulation (SFDR) – one of the central points of criticism of the previous practice of sustainability reporting.
The European Green Deal:
The objective of the European Green Deal is to channel money and capital flows into “green” companies and business models. With the SFDR, financial market participants were obliged to be more transparent in this respect. However, financial market participants have not been able to fulfil these obligations, as companies have not been required to disclose the necessary information – The CSRD should change this. Consequently, EFRAG has classified these reporting obligations as “always mandatory”.
However, this has not been adopted in the EU-Com. ESRS. According to EU-Com.-ESRS, this information – which is mandatory for financial market participants – is only to be disclosed if it has also been classified as material on the basis of the company-specific materiality analysis. This results from EU-Com.-ESRS 1.29, 1.33 as well as the deletion of the sentence “They are to be reported irrespective of the outcome of the materiality assessment” in EU-Com.-ESRS ESRS 1—Appendix B.
This means that companies would only have to include this information in their sustainability report if it was also classified as material on the basis of the materiality analysis (in which, as is well known, there is a great deal of scope for estimation and discretion).
EU Commission and Art. 29b (1) BilR:
The amendment made by the EU Commission is problematic, as, in my opinion, it is not in line with the following provision in Art. 29b (1) BilR: “In the (ESRS), the Commission shall (…) specify the information that companies (…) are required to report, which shall include at least the information that financial market participants subject to the disclosure requirements of the (SFDR) need in order to comply with these obligations”. The EU Commission did not observe this clear requirement of the BilR in the context of the EU Com. ESRS.
Irrespective of this potential legal violation on the part of the EU Commission against its own EU Accounting Directive, the achievement of one of the central objectives of the European Green Deal and the CSRD would not be achieved or would at least be significantly impeded: the allocation of money and capital flows to sustainable companies and business models.
2. Sustainability reporting and financial reporting at eye level versus “scattering” of sustainability information in various reports.
Sustainability and financial reporting:
The sustainability report has so far played a shadowy existence in the perception of report addressees compared to the financial report. Another objective of the CSRD is to change this in the future and to ensure that sustainability reporting is on an equal footing with financial reporting.
The new BilR:
According to the new BilR amended by the CSRD, the ESRS are to specify “what information entities (…) are required to report” (Art. 29b (1) BilR). With regard to the presentation of the sustainability report, the BilR’s requirements for the development of the ESRS are then clear: the sustainability report must be “clearly identifiable in the management report by means of a section provided for this purpose” (Art. 19a (1) or 29a (1)) – This could not be formulated any clearer.
EU Council and the EU Parliament:
Both the EU Council and the EU Parliament insisted on this clear provision in the CSRD legislative process with the following justification: “Provision is made for the disclosure of information in a clearly identifiable section in the management report, in order to facilitate the readability and identification of sustainability reporting.” This justification for the above-mentioned amendment to the BilR could not be more concise.
However, and completely surprisingly, the EU-Com. now plans that an integration or “scattering” of sustainability information in the financial report as well as in other reports should also be possible and permissible (cf. EU-Com.-ESRS 1.118).
The section “Sustainability Report” in the management report would then be degraded to a list in which only the respective passages in these reports (e.g. management report, annual financial statements, corporate governance report, remuneration report) are referenced (“incorporated by reference”).
This “incorporation by reference” would be exactly the opposite of “readability and identification of sustainability reporting” and “disclosure in a clearly identifiable section”. In my view, this would contradict the meaning and purpose of the clear requirements of the BilR – also against the background of the objective and history of the CSRD.
Irrespective of this legal approach, the final adoption of EU-Com.-ESRS 1.118 would once again have missed the great opportunity in the implementation of the CSRD with regard to the equivalence of sustainability reporting with financial reporting (as was already the case with the predecessor directive, Non-Financial Reporting Directive (NFRD).
In relation to the two points discussed here, the EU Commission has, in my opinion, not observed the requirements of the BilR amended by the CSRD for the adoption of delegated CSRD/ESRS acts and would thus be in breach of its own BilR. In the event of final adoption by the EU Commission, the EU Council and the EU Parliament would have to fulfil their role and, in my opinion, at least raise objections in this regard.
In implementation practice, both the preparers and the auditors of sustainability reports would be faced with the question of what should now apply: the clear requirements of the Accounting Directive or the regulations of the European Sustainability Reporting Standards that deviate from them. It does not take much imagination to see that this question will probably be answered inconsistently for now.
However, it is questionable whether the EU Council and the EU Parliament should wait until the EU Commission has adopted the final ESRS before reacting. Since the EU Commission quite obviously does not adhere to the clear requirements of the CSRD (or the BilR amended by the CSRD) in the current ESRS drafts, at least with regard to the above-mentioned points (and taking into account numerous other inconsistencies in the EU Commission’s ESRS).
The question arises as to whether the EU Council and the EU Parliament should not now immediately withdraw the authority granted to the EU Commission under the CSRD to issue delegated CSRD/ESRS legal acts.
And they should do so before a comprehensive “greenwashing” of the CSRD on the basis of delegated acts of the EU Commission takes place.
Unfortunately, this has already happened with the EU Environmental Taxonomy Regulation regarding the possibility of classifying certain nuclear power and natural gas activities as environmentally sustainable economic activities. In this regard, Greenpeace, BUND, WWF and other NGOs initiated legal action against the EU Commission at the European Court of Justice in Luxembourg in April 2023: “With the decision to classify fossil natural gas as climate-friendly, the EU Commission has put itself on very thin ice, both factually and legally” (BUND Chairman Olaf Bandt).
The ice on which the EU Commission has now set itself with the classification of the sustainability information required by financial market participants as “mandatory only if material” and the option to “scatter” the sustainability information in several reports is likely to be at least as thin.