EFRAG’s proposed simplifications to the EU climate reporting standard (ESRS E1), issued for consultation with the other draft revised standards last month, would reduce the number of mandatory datapoints by 53%, while consciously furthering alignment with the language used in IFRS S2.
One of the specific levers used in the process of revising the ESRS is to enhance interoperability with global reporting standards, in particular the ISSB standards, and EFRAG believes its proposed updates to E1 fulfil this objective thanks to the use a more aligned terminology on transition plans, scenario analysis, resilience, internal carbon pricing, Scope 3 measurement and anticipated financial effects.
Transition plans
Out of these 419 stakeholders who provided feedback on E1 through EFRAG’s call for evidence earlier this year, 71% highlighted issues with the transition plan disclosure requirement (E1-1). EFRAG notes that most of these respondents “raised challenges with clarity, interactions within the standards or redundancies”.
The draft revised climate standard would require entities to describe the key features of their transition plans for climate mitigation in one clear concise narrative, whereas the current standard requires separate disclosures on the features of the transition plans.
Another key change is that E1-1 will now require information about the dependencies on which the transition plans rely, including a qualitative assessment of the risks that potential locked-in GHG emissions pose to the achievement of the plan.
This would further align with IFRS S2 which states that preparers should disclose any transition plans they have, as well as any related underlying assumptions and dependencies.
EFRAG has also proposed deleting the disclosure requirements on EU Taxonomy alignment in E1-1, whilst maintaining the reporting requirements on CapeX in fossil fuels.
While stakeholders raised concerns over what it means to align a business model with the Paris agreement goal of limited global warming to 1.5 °C, the European Commission has instructed EFRAG not to address this point as it is being discussed in the context of the level one regulation.
Scenario analysis
A new disclosure requirement in the draft EU climate standard (E1-2) would focus specifically on climate-related risks and scenario analysis – transposing the requirements on identifying climate-related Impact, Risk and Opportunities (IROs) that are currently set out in ESRS 2.
Whereas IFRS S2 states that preparers “shall use” a climate scenario analysis to assess climate resilience, companies reporting under E1 are not required to conduct a scenario analysis to identify climate risks, however if such an analysis is used, companies are obliged to clarify the methodologies they have used under E1-2.
Notably, the proposed revisions to E1 would better align with IFRS S2 by requiring entities to disclose whether each identified climate risk is classified as a physical or transitional risk
As with its international counterpart, the draft revised EU standard specifies that companies that have used a scenario analysis should disclose the scope of the analysis, the methodologies and tools that were used, the time period it was carried out and how the findings of the analysis have been used.
However, one difference that remains is that the ISSB standard explicitly requires companies to identify and report on the assumptions they have made when conducting the analysis. E1-2 does not require these disclosures refers more broadly to the “key elements of the methodology”.
EFRAG noted in its basis for conclusions, that this difference “could affect interoperability” with the ISSB standard.
Resilience
Similarly, a new disclosure requirement on climate resilience (E1-3) would be introduced under EFRAG’s proposal, reformulating the reporting requirements on how IROs interact with business strategy which are currently in ESRS 2 (under SBM 3).
E1-3 specifies that entities should disclose information on the resilience of their strategies and business models to respond to the climate-related risks they have identified. This includes information on: the results and implications of a climate resilience analysis; how mitigation efforts and transition plans support climate resilience; significant areas of uncertainty; and the company’s capacity to adapt to climate change.
Each of these disclosures is also required in section 22 of IFRS S2, and the alignment with the language on climate resilience in the ISSB standard has been improved in the proposed new EU standard, particularly on disclosures of uncertainty.
Climate metrics
Disclosures on GHG emissions in E1 have also been brought more into line with IFRS S2 through the draft amendments. Namely, E1-8 would require companies to disaggregate their Scope 3 emissions by categories and would no longer oblige preparers to disclose their total emissions.
E1-8 would also be updated to make remove the requirement to disclose GHG emissions intensity based on net revenue, which would be included instead as a voluntary disclosure in the non-mandatory guidance. Stakeholder feedback highlighted the challenges of producing revenue-based metrics as comparable KPI.
IFRS S2 does not require disclosures on GHG emissions intensity but does require entities to describe whether any of its climate-related targets are an absolute target or an intensity target.
In addition, the application requirements for E1-8 would be amended to align the definition of emissions reporting boundaries with the GHG Protocol guidance and IFRS S2. This would set the organisational reporting boundary at ‘financial control’, unless emissions disclosures based on the boundary of ‘operational control’ (as defined in the GHG Protocol guidance) are also required to “convey a fair presentation of emissions”.
EFRAG said this proposed change to reporting boundaries aims to “remove one of the main interoperability differences” between E1 and IFRS S2.
Disclosures on internal carbon pricing in E1-10 of the draft revised standard would also be streamlined, with datapoints on the type of internal carbon pricing scheme, the scope of application and assumptions made to determine the prices deleted.
Under the revised standard, entities would be required to disclose an explanation of how they apply a carbon price in decision making and the price per metric tonne of GHG emissions, both of which are also required by IFRS S2.
One additional datapoint is included in the draft revised E1 standard, which would require companies to report on the consistency of the internal carbon prices used with the prices used in their financial statements for impairment tests.
Anticipated financial effects
The disclosure requirements and language on anticipated financial effects – contained in E1-11 of the exposure draft - would also be better aligned with IFRS S2, while many of the datapoints have been deleted or converted into voluntary disclosures in the non-mandatory guidance.
In the draft EU standard disaggregated disclosures are required on the anticipated financial effects from material physical risks and material transition risks, as well as a disclosure on the “amount and percentage of assets or revenue derived from its business activities aligned with climate-related opportunities”.
EFRAG is seeking feedback on two potential approaches to providing transitional reliefs on the disclosure of anticipated financial effects.
The first option would align with the provision in IFRS S2 and permit qualitative disclosures on financial effects when companies are unable to provide quantitative information. The second option would allow entities to provide qualitative information on all anticipate financial effects, with quantitative information made voluntary.
Other transitional reliefs
EFRAG has proposed adopting several of the transitional reliefs provided in the ISSB standards. This includes the provision allowing companies to only report information that is available “without undue cost or effort” and the provision permitting companies to disclose ranges of quantitative financial effects instead of exact figures.
However, unlike IFRS S2, EFRAG has not included a transitional relief to allow companies to omit Scope 3 emissions when impracticable or a relief allowing companies to omit commercially sensitive information on opportunities in the draft revised ESRS.
SASB standards
The reference to the ISSB’s industry-based guidance, included as a transitional provision in the original standards, has been made permanent as a voluntary element within the draft amended ESRS.
ESRS 1 states: “When developing its entity-specific disclosures, the undertaking shall consider comparability over time and with other undertakings that operate in the same sector(s). For this purpose, it may use available best practices and/or available frameworks or reporting standards, such as IFRS industry-based guidance and GRI Sector Standards.”
EFRAG says this decision reflects the decision to discontinue the development of EU sector-specific standards.
Areas of reduced interoperability
EFRAG notes that the introduction of new transitional reliefs not included in the ISSB standards “would result in new interoperability differences” and that the significant reduction in datapoints has “marginally negatively affected the high level of commonality” described in the interoperability guidance issued last year.
In particular, it highlighted the proposed removal of the disclosure requirement on gross GHG emissions intensity as the only deletion that would result in a new difference between ESRS E1 and IFRS S2. The other deletions are either covered by other reporting requirements or related to IFRS S1.