26 July 2022

SMEs and their advisors are in no way placed to deliver on the CSRD/ESRS

Salvador Marin and Paul Thompson, respectively president and director at EFAA for SMEs, as well as Luc Hendrickx, director at SMEunited, discuss the challenges SMEs face in complying with CSRD and ESRS

Salvador, you have said that ESRS are technically perfect, what is the issue then?

Salvador Marin: Our primary concern is the trickle-down effect for SMEs. We agree with the need for the new standards and we think it is necessary that the EU design its own standards because they have been working on these issues for a long time. But what is our concern? What is our problem? It is very difficult to understand proportionality and materiality. What do proportionality and materiality mean for SMEs?

The current standard is technically robust but it's very difficult to apply to SMEs so we need specific standards for SMEs. We can't use these.

The problem is that companies are going to ask SMEs in their value chains to provide information to comply so we need tools for SMEs so that they can provide this information without more cost and burden.

You said in your speech on Friday that it came from the shadows to the spotlight very quickly in the space of three years. But that's not entirely fair because some voluntary disclosures have existed for decades so there is a history and there is an example of best practice. Is that a fair statement?

Salvador MarinSalvador Marin: Yes it's true in a way but for years it was a very specific, specialized topic, which only a few people dealt with. We are now opening this up to a very wide range of stakeholders. You can compare, for example, with financial information, where discussions took decades to come up with standards. Now you are opening the discussion on sustainability disclosures for everybody very fast. Please, let's do it step by step. Of course, we support the idea that Europe becomes a green continent and it's possible but we must help SMEs, and the SMPs that support them, because they are the principle businesses in Europe.

Paul Thompson: The reality is that sustainability reporting has been quite well established for many years but, as Salvador Marin said, it's primarily been a large company or large practice endeavor. It's now gone from margin to mainstream. All of a sudden, practically overnight, we're in a situation where almost every SME will be impacted in some way or another, it would seem. The other thing that has changed significantly is that, practically overnight, we're going from a regime of leaving it to market forces to one of quite granular regulation. In the past, GRI has had to rely upon voluntary adoption of its standards, for example. Around two years from now, 50,000 companies are going to be producing reports which, to all intents and purposes, are going to be largely kind of GRI compliant, or equivalent. It's a significant shift in a very short space of time. You can understand why the politicians want to tackle a range of sustainability issues, not least of which is climate change because, as Salvador Marin says, the climate isn't going to wait for us and we're going to have to move very quickly to address climate change. The corporates are obviously going to be on the front line, they're going to have to take seismic steps to mitigate their CO2 emissions and so on.

Luc Hendrickx: I have to agree with Salvador when he says that it's something which is now coming quickly, even if the whole file, at European level, dates back to 2003. When the NFRD was drafted, we convinced the NGOs that SMEs should be left out of the scope and our main argument was 'who is going to read 21,000 reports? Nobody!'

And very importantly at the time, the EU Commission kept asking me if there was a trickle-down effect issue and they said, 'as soon as this issue arises let us know', so they were really concerned about it.

Now we have CSRD and a very different issue. We have always said, and please read the explanatory memorandum, the only reason for the CSRD is to help third parties to have information about companies because they are saying 'all the investors need information, the banks need information, academics needs information'. That is the main objective so there is no reason to have sustainability reporting as mandatory for SMEs. We agree on voluntary reporting, we believe it is a management tool so that the SME can see where it stands.

Now we face a number of challenges as SMEs, even if we are not in scope of the legislation. Considering how the standards are currently designed, the trickle-down effect means that, as an SME is often in the value chain of different large companies, it will probably be obliged to produce different reports or different information.

Also, although the CSRD calls for an SME specific voluntary standard, there are no guarantees that the big companies will accept that standard.

Now the real fear is that from the first day that large enterprise have to report, they will pass on that burden to SMEs when listed SMEs have a phase in period of two years.

And I disagree with you Salvador, I don't think they are good standards. Maybe they are for large enterprises, but not for SMEs.

Paul Thompson: I think what Salvador is saying is that they are technically robust and technically strong standards. This does not make them correct or appropriate for the circumstances and capacities of companies.

Salvador Marin: I have studied a lot of standards in my life. In my opinion, from a technical standpoint, they are robust and, for some large companies, about right. You can have different opinions on small details that need to be adjusted, but technically they are sound. Now, if you want to apply these current standards to SMEs, right now it is impossible.

Luc Hendrickx: Because everything is in it. Every stakeholder has its list of what should be in this standard so everything is in it. This is exactly the problem, you cannot satisfy everybody because there will be this trickle-down effect on SMEs.

And you hear the Commission say that this is an opportunity for SMEs to start their sustainable reporting journey - but it is not! SMEs won't have to do sustainability reports but what they will end up doing is responding to a long questionnaire. Even for the large companies, the disclosures where they have to search for information in their supply chain will be difficult, so I really think they need to put water in their wine.

Salvador Marin: In general, I agree with Luc Hendrickx but it's important to clarify our position. Our concerns are that we need to clarify what proportionality and materiality should look like for SMEs and it's very important to clarify what standard they should follow when the value chain request this information. And this should be clarified before SMEs are asked to prepare a sustainability report or otherwise supply this information.

Is that the way to address the trickle-down effect then, to better define materiality and proportionality?

Paul ThompsonPaul Thompson: We're just a few days away from seeing the very final approved text of the CSRD but we already know pretty much what's in it. It doesn't appear to mandate complex, comprehensive European sustainability reporting standards from day one of the effective date. It would seem to us that there is an opportunity for EFRAG, the standard setter in this case, to prioritize issues, to defer some issues and to phase in other issues. So, for example, if they wanted to tackle climate because it's the most time sensitive issue, they can perhaps pursue a deep dive on climate and then the other issues could have a more phased in approach and that phase in approach may lend itself to improved interoperability with whatever the ISSB has in mind.

As an example, if you take the value chain, this is clearly the problem area for the SMEs. I wonder whether, or not, the ESRS could defer, to some or large extent, the value chain impacts that need to get reported upon by the in-scope companies. For example, giving three years or whatever before they are obligated to dive into their value chain and to capture the data necessary for reporting.

Now, you mentioned proportionality and materiality, there is perhaps some of the answer to some of our concerns within that. Clearly, where we are today is that SMEs and their advisors are in no way placed to deliver on the expectations of the draft ESRS. It's such a huge leap into the unknown for many of them and so things really need to be dialed back a little or significantly.

Luc Hendrickx: Something I forgot concerning the trickle-down effect is that you'll have the direct link between large enterprises and SMEs. Of course, the large enterprise had his commercial power to say, 'you have to deliver this or you're out', and this is already happening in some cases. For the SMEs, they also have their suppliers and they do not have the commercial power to ask for this kind of information from their suppliers. If you talk with people who are already active in the field of sustainable reporting for SMEs, they all say that even if an SME is contacting suppliers, their suppliers do not have the information, do not want to give the information or are not able to give the information This is an additional problem: even if the SMEs would like to give the information, they cannot oblige their suppliers to give the information and this is an aspect that is completely forgotten.

On the standards and on the quite extensive requests that are in, when EFRAG developed this proposal for the draft standard in the last month, they were not yet aware of the final text of the trialogue. In the meetings, EFRAG has always asked the different groups working on the draft standards to take into account the trickle-down effect and problems for SMEs but they didn't do it.

In the last weeks of the trialogue, we have done our job and talked with the Commission again and with the Parliament. They, especially the Parliament, have shifted it to have some important sentences which in principle should help us and it's also exactly linked to proportionality. In the text of the CSRD, it's now clearly mentioned that, and I quote: "The standard should also take into account the difficulties that companies may face in collecting information from actors along their value chain, especially from those who are not obliged to report on sustainability." This means the SMEs so the standards should take this into account which supports our view.

The standards will also specify that the information on value chains is: "proportionate and relevant to the scale and complexity of activities and to the capacities and characteristics of companies in value chains, especially SMEs."

There we have an important argument: in order to tackle the trickle-down effect, we should not go too far in demanding information from the SMEs.

Paul Thompson: The critical issue right now for us is to what extent is EFRAG now going to modify its draft ESRS to accommodate this requirement to have proportionality built into the into the standards. It's just not clear to us. Obviously, this is early days and the ink is barely dry but this is clearly a very important issue for us as to how this is going to be put into effect.

Luc HendrickxLuc Hendrickx: That will be a cost benefit analysis. In the very short term, I don't know how they are going to do this as I think they need to give their first report by 15 September. I'm also very skeptical on how this can be done in an acceptable and scientific way in one month. Everyone's on holiday so they have to contact the different stakeholders. And where to find the information on the cost? For example, how much does a CO2 report cost? Some say you can find it on an app or a website, which is true, but it also depends on the quality and obviously it costs €4000 to have a CO2 calculation and that's only CO2.

Salvador Marin: I think is interesting because in the past it was difficult to introduce this debate in the European Commission. But now we are introducing it step by step. We agree with the Green Deal about the sustainability for the future but we need to provide real tools for SMEs. We know very well their challenges and concerns and we agree on the need to provide sustainability information but SMEs and SMPs need the right tools to do this without undue cost or effort.

Paul Thompson: Obviously a lot of the discussion is quite rightly focused on SMEs. In relation to SMPs, let's not forget that SMPs are SMEs themselves. We are constantly challenged with trying to ensure that there is a level playing field with respect to competition with larger practices. One of the big concerns that we have, in the case of sustainability reporting, is that the larger practices are already able to offer the advice to prepare the reports of and provide assurance on sustainability reports. The SMP part of the market has very limited awareness of what's coming down the pipeline and we fear that, as a result, a disproportionately large proportion of the additional work for the accountancy profession is going to land with the big players. In effect, what we fear is that we will have yet more concentration in the market for professional services.

The CSRD and the standards are two separate things and one of EFRAG's defenses is to say, 'we are level two, and we are following the level one guidelines', do you do you accept that? Or do you think that maybe EFRAG, in some respects, went beyond the level one requirements? Or do you think that they have more leeway than what they pretend on things like prioritization for example?

Salvador Marin: EFRAG is the advisor to the European Commission and in the end the Commission will decide but EFRAG has an opinion and EFRAG has submitted their opinion.

Paul Thompson: It's not like the sustainability issues other than climate can be avoided. They have to be tackled. The issue is that perhaps climate can be the initial deep dive issue that that is dealt with in the first instance and with greater rigor. The other issues can be on-boarded but phased in over time. Glancing at the draft ESRS EDs I fear that EFRAG has maybe gone too far too soon. I much prefer the idea of think small and simple first and then gradually building complexity and comprehensiveness into standards. What they've tried to do from day one with the cross-cutting standard is to come up with standards that are as perfect and comprehensive as they can make them – state of the art if you will - within the time constraints imposed by the CSRD. But let's not forget that perfection is often the enemy of progress.. My personal opinion is that things should be a lot simpler in the first instance.

Luc Hendrickx: In the end it is the Commission but I think that they gave too much leeway to EFRAG. And at EFRAG, sorry for the expression, but it's License to Kill: everybody can dump their demands and request information in it.

Once again, for the large enterprises, getting this kind of information will not be that difficult. Okay it will cost them but they can play the 'good boys'. I did not hear that many concerns from the large industries on the CSRD which is strange.

The Commission, as they are not able to do it themselves, have given too much leeway to EFRAG. Of course, this can be compensated or corrected when they have to approve the delegated act, but it will be very difficult.

During the Spanish outreach event you said that SME United estimated a cost for an SME as €10bn to €200bn which is a pretty broad bracket. Can you tell me how that was estimated?

Luc Hendrickx: I was in the expert group on the NFRD and I had contact with an SME here in Belgium who made a simplified GRI report. It was a small company of eight employees and I asked them how much it cost: it was between €15,000 and €25,000 Euros and take into account that was 10 years ago. That data is in an official document of the Commission, it is important to know this because the Commission said they had no clue at all about the cost for SMEs. It was in an official document of the Commission and I've simply multiplied it by €10m and then you come €200bn. For the smaller end of the bracket, I was told by an advisory firm for SMEs that a CO2 report costs €4,000 and the initial meeting to discuss what you want to do also costs €4,000 so a total of €8,000 rounded up to €10m.

Obviously, your organizations are EU focus, but there are international developments, are you following the work of the ISSB? Are you intending to reply to the consultation?

Secondly, some would like to see the ISSB standards as the benchmark in Europe, do you have any thoughts on that?

Paul Thompson: At EFAA, we are monitoring developments at the ISSB. We probably will not respond to the two exposure drafts that were published in March with a deadline of 29 July. If we do, it will be a very simple and short letter that might repeat some comments that we had when they first mooted the idea of the ISSB, which was 'don't forget about SMEs from the get-go'. Because they've made the same mistake in the past with the IFRS: they developed these standards for decades and the afterthought was, 'oh, this is a huge burden on SMEs, we need to come up with some light standard in response to that'. We don't want to go down the same road and repeat the same mistakes. So, can we please have the ISSB with sufficient SME representation from the start to ensure we factor in SMEs from the very start? It's unclear whether that is the case with their two exposure drafts that are published. I've not examined them closely enough.

We're in a in a global world where things are increasingly going cross border, whether we like it or not and with a brief pause due to the global pandemic. Interoperability between European ESRS and ISSB disclosure standards is important but of course, here in Europe, laws, policy priorities and deadlines differ from the rest of the world. Clearly some issues, such as climate change and workforce conditions, are more urgent and higher priority issues for the EU than elsewhere.

Having said all of that, if we were to simplify the standards at European level from the outset and gradually build in complexity and comprehensiveness over time, then maybe there is an opportunity for us to then start to move in concert with the developments of the ISSB.

Luc Hendrickx: We will not take part because we do not have the time. I will go further than Paul Thompson, we dealt with the IFRS for SMEs and this does not work, you cannot have something that is developed for the big ones and then start to cut it and try to apply it to the small ones. This does not work. And by the way, I've mentioned this in one of the first EFRAG meetings on the standards and everybody agreed that it should not be like this and indeed that we should think small first and start from something that is made by and for the SMEs and then eventually build up.

Paul Thompson: On the IFRS for SMEs, I couldn't agree more. In an ideal world, we start with a blank sheet of paper and we develop the standard that is very simple and is targeted very much at the smallest and simplest organizations in the first instance and then you build in layers or modules on top of that. That is an ideal approach. Unfortunately, we have this legacy of having started by catering to the most complex and largest organizations in the first instance and then trying to simplify it for the SMEs. This a very difficult.

Luc Hendrickx: In EFRAG, we are working on the very simplified standard for SMEs. I was the chair of the group, preparing standard for the SMEs and it's nearly ready now. The idea is to have a sustainability reporting standard which is feasible for the smallest enterprises and then, depending on sectors, we can eventually increase the demand for information if necessary, in order to ultimately come down to "standards for listed SMEs", but it should be used by non-listed SMEs as well.