Investors are wary that overhauling sector-based sustainability reporting rules could increase complexity, Michael Hurley writes
A few years ago, it had been expected that investors would benefit from standardised corporate reporting by EU companies in line with mandatory sector-specific sustainability reporting standards.
But investors who asked for such standards to help them compare potential investments were denied these by cuts to the EU's Corporate Sustainability Reporting Directive (CSRD) last year, via its Omnibus package to 'simplify' sustainability reporting.
The Omnibus removed a mandate for the European Financial Reporting Advisory Group (EFRAG) to devise the standards – halting work the European Commission's advisors had already started on priority sectors including oil & gas and financial institutions.
The Commission instead suggested voluntary guidance could be developed that would inform company reporting in line with the CSRD sector-agnostic standards – but it has not yet confirmed whether it will ask EFRAG to do so.
It comes as the International Sustainability Standards Board (ISSB) is in the midst of a sprawling project to 'enhance' the Sustainability Accounting Standards Board (SASB) standards.
The standards, which cover 77 industries, are voluntarily used by about 4,000 organisations internationally but were last updated in 2018.
Updates to the SASB industry-specific standards were necessary to provide voluntary 'implementation guidance' for reporting in line with the ISSB standards in jurisdictions where these have been adopted, it said. These would not add any additional reporting requirements.
Just months after it seemed the EU's Omnibus had brought the CSRD and ISSB standards closer to achieving their years-long mission for 'interoperability', investors are concerned that the work could again muddy the waters of corporate sustainability reporting.
At the heart of these worries is the fact that the regimes apply fundamentally different measures of 'materiality' of data and thereby demand different types of reporting; whereas the ISSB's 'financial materiality' approach demands firms report the ways in which sustainability concerns could impact their business, in the EU, 'double materiality' also requires companies to report their impact on people and the planet.
Environmental Finance examines what investors want from sector-specific reporting and where standard-setting may or may not help.
Why sector standards matter to investors
Institutional investors have repeatedly called for sector-specific standards, which they argue will improve comparability of companies with their peers.
EU advisory body EFRAG noted this last year, when it said "the need to prepare sector guidance is often emphasised in the input gathered" in responses to its consultation, but it said it did not have time to do so as it rushed to meet a tight deadline to simplify the sector-agnostic standards.
Liad Ortar, a senior technical manager at EFRAG, said in December that it saw "huge" demand from institutions for sector-specific guidance, but it had not yet been asked by the Commission to devise it.
There is "huge" demand for sector-specific guidance from market participants – Liad Ortar, EFRAG
"From an investor perspective, I would say that a sector-specific focus is important to provide a roadmap to understand the different sectors – if you don't have that roadmap, you are kind of driving blind," Rikke Berg Jacobsen, head of ESG at DKK155 billion ($24 billion) pension fund AkademikerPension, tells Environmental Finance.
"Financial materiality of sustainability issues varies by industry, making sector-specific disclosures decision-useful to us as investors," says a spokeswoman for Norges Bank Investment Management (NBIM) – manager of Norway's $2.1 trillion 'oil fund'.
Camilla de Nardis, a manager for ESG compliance at consultancy BearingPoint, which has assisted companies in preparing CSRD reports, tells Environmental Finance: "One of the main challenges with the Omnibus package is the removal of sector-specific requirements.
"For high-impact industries, company-specific key performance indicators are essential to meaningfully assess performance and enable comparability. Without them, it becomes difficult to distinguish leaders from laggards within the same sector.
"Sectors such as automotive and utilities still have significant room to improve in terms of comparable, decision-useful disclosures. Marine and agriculture are also sectors where harmonised sector-specific KPIs would be particularly important," de Nardis adds.
A sector-specific focus is important – if you don't have that roadmap, you are driving blind" – Rikke Berg Jacobsen, AkademikerPension
Akademiker's Berg Jacobsen agrees that such standards are particularly important for companies in "the hard-to-abate sectors, the transition-critical sectors such as mining, transport – road or sea – and the sectors with high dependencies on raw materials, or high dependencies on labour, such as consumer discretionary companies".
They could also help companies improve their sustainability practices by easing comparison with peers to identify business opportunities, she says, and could improve the structuring of climate-related transition plans.
Sector-specific standards are also important for regulators, as the European Central Bank (ECB) repeatedly warned the Commission amid negotiations on the Omnibus.
"The benefits of sector-specific guidance would be particularly relevant for financial institutions, as aggregators of information from multiple economic sectors," it told the Commission this year, noting that "the need for additional guidance, including sector-specific guidance, was a recurring theme at EFRAG outreach events" last year.
As well as helping financial institutions compare performance of their investment and lending, sector-specific standards would help them meet their own reporting obligations, the ECB said.
"The sector-agnostic ESRS standards are, by construction, not tailored to disclosures by the financial sector, and ECB staff recommend clarifying the application of the standards by the financial sector," particularly for reporting on risks and impacts in their value chain.
"Parts of the existing ESRS are not well tailored to the financial sector... a more sector-specific approach would have improved both relevance and clarity," – Gjermund Grimsby, KLP
"Our experience is that parts of the existing ESRS are not well tailored to the financial sector," Gjermund Grimsby, chief advisor on climate change at Norway's largest pension company KLP, tells Environmental Finance.
"In that sense, a more sector-specific approach would have improved both relevance and clarity. We have managed to adapt our processes and report according to the ESRS, but targeted guidance would certainly have strengthened the overall quality of disclosures."
An early warning from the ISSB
As one observer said last year, the EU's decision to abandon sector-specific standards for the CSRD "gives away power" to the ISSB to determine what data it wants from high-risk industries.
Without a mandate for EFRAG, the emphasis on sector-specific standard setting has shifted to the ISSB and its project to 'enhance' SASB standards.
This is important partly because the ESRS indicate that, in preparing its CSRD-compliant report, a company "may use available best practices, frameworks or reporting standards", such as IFRS industry-based guidance.
"Many stakeholders who argued that the requirement for the Commission to adopt sector-specific reporting standards should be deleted from the CSRD also highlighted that existing sustainability disclosure frameworks, such as SASB, provide guidance for sector-specific issues," EFRAG noted.
"The benefits of sector-specific guidance would be particularly relevant for financial institutions" – European Central Bank
The SASB overhaul began last year with changes to nine 'priority' sectors including metals & mining, iron & steel producers, and oil & gas. Last month, it launched a consultation on proposed changes to three more sets, covering 'agricultural products', 'meat, poultry & dairy' and 'electric utilities & power generators'.
Investors hoping that ISSB-EU cooperation could contribute to simplifying the international sustainability reporting landscape may be disappointed.
ISSB members last month warned that the complexity of the work meant "trade-offs" were inevitable in its mission to ensure 'interoperability' of its standards and the SASB guidance with the EU's, and other frameworks including that by the Global Reporting Initiative (GRI).
It responded to concerns raised during the consultation on changes to the first nine SASB standards, by investors who argued the work threatened to break the ISSB's focus on financial materiality by forcing it to include impacts on environment and society.
While the respondents failed to identify specific elements which led them to this view, EFRAG members said they found instances where this could be true.
Julian Mueller, sustainability reporting technical manager at EFRAG, said the latest SASB proposals covering social elements, including due diligence for impacts of business operations on people, "appear to be impact oriented", rather than uniquely focused on financial materiality.
Elsa Savourey, an independent advisor to EFRAG on human rights and social issues, said this raised questions about how the ISSB sees "how the due diligence types that are described in SASB standards serve the purpose of financial materiality or impact materiality".
"This would be very helpful for preparers, because [otherwise] it might lead to confusion between those reporting under ESRS and double materiality and companies that would report just on SASB".
EFRAG says other areas that needed addressing in the SASB changes include that the standard for electric utilities "sets out a new precedent" by requiring the disclosure of the 'Scope 3 Category 3' greenhouse gas (GHG) emissions, such as those from extracting, producing, and transporting fuels consumed by the company.
This goes against the ISSB's stated intention not to add metrics on Scope 1, Scope 2 and Scope 3 GHG emissions to all SASB standards to avoid duplication with requirements in IFRS S2, its climate-focused standard, it says.
Reporting on labour conditions in a company's own operations is only included in the standards for agriculture but should be extended across all three SASB standards, it suggests – as should reporting on community relations and rights of Indigenous Peoples, and 'social supply chain management'.
The suggestions came in EFRAG's initial analysis of the ISSB proposals.
Looking for guidance?
Asked whether she was worried about the potential for sectoral standard-setting to increase complexity, AkademikerPension's Berg Jacobsen says it is "too early to be very concerned", citing the ongoing negotiations.
However, it is important to avoid a "mismatch" between international standards that could contribute to a situation where "we end up with a more pluralized way of working with this, instead of having a uniform way of doing it", she says.
While the Omnibus change to remove EU sector-specific requirements was lamented by some observers, others were optimistic that it could leave the EU better placed to benefit if it avoids unnecessary effort by standard-setters and reporting entities.
NBIM says it is an opportunity for the EU to adopt the SASB standards wholesale, while adding an 'impact materiality' lens to suit the CSRD's double materiality approach.
There is opportunity for the EU to adopt the SASB standards wholesale, while adding an 'impact materiality' lens to suit the CSRD's double materiality approach – NBIM
"The simplifications proposed in the CSRD adjustment process [via the Omnibus] could make reporting more manageable, and reducing unnecessary complexity is in principle welcome," KLP's Grimsby says.
"This could also reduce the need for sector guidance. As we do not yet know the full extent of the changes [to the ESRS, which are due by September], it is difficult to assess whether the simplifications may ultimately go too far, or whether we see the same need for sector specific guidance after the Omnibus simplification process," Grimsby adds.
One observer representing an asset management group agrees, telling Environmental Finance: "For us, EFRAG's initial work on sector-specific standards at the end of 2024 indicated a more complex and burdensome reporting framework for companies, with little added value for users."
While the Commission could still ask EFRAG to provide voluntary guidance, "the risk is that any potential guidance will be overly prescriptive, resulting in additional burden during the assurance check," says the commentator, who asked not to be identified.
"Our understanding is that financial market participants, including asset managers, and reporting entities do not see these as necessary, but I would rather suggest that we should first see reports from the first one or two years of implementation to assess the need for sector-specific guidance and the sectors that are of more interest."
ISSB plans for nature raise importance of sector-based work
The ISSB's plans to establish nature-related standards to complement its existing work are set to raise the importance of the SASB standards.
Last month, the ISSB presented papers that propose it adopt a simplified approach to standard setting for the topical standard expected to be developed in the Nature ISSB project.
Instead of issuing a separate standard – such as a previously mooted IFRS S3 to add to its S1 sustainability and S2 climate standards – it proposed:
- a new mandatory application guidance appendix to IFRS S1 where key definitions and concepts for the topic would be introduced;
- no cross-industry (i.e. sector-agnostic) metrics, but a reference to the SASB metrics.
The ISSB says its research found that "investors need industry-specific information on nature-related risks and opportunities, including metrics ... Investors primarily engage with nature-related information from an industry or sector-specific perspective".
By comparison, research on the need for cross-industry metrics "was inconclusive" and does not think it should work on cross-industry nature-related metrics, except in specific cases such as to clarify what type of location-specific information was required.
"If this direction is confirmed, the role of SASB standards for future interoperability for topics other than climate is even more important," EFRAG notes.
Chiara Del Prete, chair of EFRAG's sustainability reporting TEG, says the proposal does not mean reporting on nature in line IFRS S1 will be voluntary, as companies will be required to report nature-related risks and opportunities where financially material.
"I wouldn't dispute too much whether it is in a new standard or in an appendix... what we need to understand, though, is the decision of the absence of future sector-agnostic metrics. In a situation where, it seems to me, that many of the SASB nature disclosures have a sector-agnostic nature... That is trickier [to resolve] than the location," Del Prete says.