PI comment about the European Sustainability Reporting Standards (ESRS) Draft of the European Financial Reporting Advisory Group (EFRAG)
We advice EFRAG to standardize sustainabilty performance and not its management!
- Define selected mandatory sustainability indicators, ideally on activity level, to be reported along the value chain based on their absolute impacts on society – irrespective of an entity’s materiality judgement, with clear thresholds like 50 g CO2e/1 € revenue. Entities should be furthermore required to report these in an aggregated way (cradle-to-gate scope). In addition, consider working towards monetization factors to quantify the related impacts on society in monetary terms. Such indicators can, however, be complemented with related optional KPIs to be used in integrated reporting that links financial and sustainability performance.
- Require the disclosure of the strategic intent and give the freedom to declare all other disclosure requirements (materiality, governance, strategy, risk, and opportunity management) as not applicable based on their imperative. This also means to delete the rebuttable mechanism.
- Prevent standard-driven “Only PR” approaches by making the materiality analysis voluntary based on the strategic intent with “single” or “double materiality” as optional definitions to ensure that it matches with the materiality philosophy of the management/strategy of the firm. If done according to the ESRS, materiality matrices should contain the main dimensions “impact on society” (y-axis) and “impact on business” (x-axis), and the sub-dimensions actual- vs. potential impact on business (z-axis). Methods of determination and cut-offs should not be standardized. Rename the dimensions accordingly as both terms and definitions (“impact materiality” and “financial materiality”) are misleading and incomplete (see our paper What’s material?!).
Reasoning: In essence, sustainability/ESG is about changing the way business is done and not about reporting; this should be the guiding principle for any sustainability standard. To date, strategies and management approaches are not standardized to ensure competition and provide organizations with a necessary level of freedom, including the decision of some organizations to comply only with legal regulations. Any standard that suggests an organization should be doing more risks producing standard-driven “Only-PR” approaches. Instead, it could be more efficient for governments to create incentives for the market to reach a sustainable development that maximizes Societal Value. A global standard that determines the principles and rules for accounting Societal Value KPIs would be a step forward for measuring and comparing an organization’s sustainability performance. Relatedly, the identification of material topics and KPIs should be coupled with the organization’s management strategy. The ESRS should define core metrics on activity level for sustainability performance and reporting, including the upstream value chain for selected indicators. This enhances transparency, as outsourcing a certain production step may be a feasible approach to fool the primary users of a report. You can find PI’s complete response here