EFRAG and the EU's new ESG reporting standards

The ESG criteria of environmental, social and responsible corporate governance need to be fleshed out in order to obtain clear contours. So far, the criteria used for this purpose, on which ESG reports in the EU were based, varied depending on the rating agency. There were different assessment criteria and assessment systems that were neither comparable nor transparent (see https://www.allenovery.com/en-gb/germany/blogs/countdown-to-cop/sustainability_esg-ratings). One and the same company could be rated quite differently by different rating agencies. This situation was disadvantageous for potential investors as well as for the companies themselves, as the lack of transparency led to uncertainty on both sides.

The CSR Directive (Corporate Sustainability Reporting Directive – CSRD), which is expected to come into force soon and is intended to lead to a harmonisation of reporting standards in the EU, is of central importance in this respect. To this end, the Commission worked closely with EFRAG. EFRAG stands for European Financial Reporting Advisory Group. On 15 November 2022, the EFRAG Sustainability Reporting Board adopted the draft European Sustainability Reporting Standards (ESRS), which will be submitted to the Commission shortly.

The role of EFRAG

EFRAG plays an important role in the practical implementation of the Corporate Sustainability Reporting Directive (CSRD). EFRAG is a (non-profit) association based in Brussels, established in 2001 under Belgian law. The two tasks or pillars of the organisation are Financial Reporting and Sustainability Reporting, with the Sustainability Reporting pillar added in 2021/22 for the preparation of the new guidelines. Already in June 2020, EFRAG had been requested by the European Commission to prepare the European Sustainability Reporting Standards (ESRS). In May 2021, EU Commissioner Mairead McGuinness officially commissioned EFRAG to prepare the standards after the Commission adopted its draft CSRD in April 2021. As a result, expert groups were established at EFRAG, these being the EFRAG Sustainability Reporting Board (EFRAG SRB) and the EFRAG Sustainability Reporting Technical Expert Group (EFRAG SR TEG), supported by the EFRAG Sustainability Reporting Consultative Forum. In March 2022, the first working papers on the ESRS drafts were published. From the end of April to the beginning of August 2022, EFRAG held a public hearing at which numerous comments were submitted by NGOs, associations and companies, among others. Throughout the fall, the expert groups debated the proposed amendments in several meetings before the drafts were adopted in their current form on 15 November 2022.

The drafts of EFRAG will be submitted to the European Commission in due course. The Commission will then adopt the final standards as a delegated act within the meaning of Art. 290 TFEU.

The current drafts

EFRAG has adopted a total of 12 drafts for the ESRS: Two general ("cross-cutting standards" ESRS 1 – General Requirements and ESRS 2 – General Disclosures), five on the environment (ESRS E1-E5), four on social issues (S-S4) and one on governance (G1). With regard to labour law, EFRAG's draft ESRS 1 ("Own Workforce") is of particular importance.

Labour law specific standards: ESRS 1

Relevant factors in ESRS 1 are working conditions, equal treatment and opportunities for all and other work-related rights.

Working conditions include, for example:

• Secure employment;
• Working time;
• Adequate wages;
• Social dialogue;
• Freedom of association;
• Existence of work councils;
• Collective bargaining, including the rate of workers covered by collective agreements;
• The information, consultation and participation rights of workers;
• Work-life balance; and
• Health and safety.

Equal treatment and opportunities for all cover, among others:

• Gender equality and equal pay for work of equal value;
• Training and skills development;
• Employment and inclusion of persons with disabilities;
• Measures against violence and harassment in the workplace; and
• Diversity.

The other work-related rights refer to such things as:

• Child labour;
• Forced labour;
• Adequate housing; and
• Data protection (privacy).

Disclosure requirements in ESRS S1

In total, there are 17 disclosure requirements for companies in ESRS S1, of which only the first eleven are mandatory. Of these eleven mandatory disclosure requirements, however, the last two can be fulfilled by an affirmative declaration by the company as soon as they are subject to the CSRD (for the relevant dates and thresholds, see the link provided at Allen & Overy Client Alert). The disclosure requirements are as follows:

• S1-1: internal policies that address the management of material impacts on the company's workforce, as well as associated material risks and opportunities
• S1-2: general processes for engaging with the company's own workers and workers' representatives about actual and potential material impacts on its own workforce.
• S1-3: processes to address negative impacts and channels for the company's own employees to raise concerns or complaints;
• S1-4: approaches and measures to take action against significant negative and positive impacts and to mitigate significant risks and pursue significant opportunities relating to the company's own employees, and the effectiveness of these measures;
• S1-5: time-bound and outcome-oriented targets relating to addressing significant negative impacts, promoting positive impacts, and addressing significant risks and opportunities;
• S1-6: key characteristics of the company's own employees, e.g. number of employees, breakdown by gender and nationality;
• S1-7: key characteristics of non-employee workers in the company's own workforce;
• S1-8: information on the extent to which the working conditions and terms of employment of the company's own workforce are determined or influenced by collective bargaining agreements and the extent to which its employees are involved in social dialogue in the European Economic Area (EEA) at company and European level;
• S1-9: gender distribution in top management and age distribution among employees;
• S1-10: disclosure whether all employees in the company's workforce are paid a fair wage in accordance with applicable benchmarks; and if not, what types of employees are not paid a fair wage and what percentage of the company's workforce is paid below the fair wage;
• S1-11: disclosure whether the company's own employees are covered by social security against loss of income due to major life events, and if not, in which countries this is not the case, and the percentages of employees in the countries that are not covered;
• S1-12: percentage of persons with disabilities amongst the company's own workforce;
• S1-13: information on the extent to which training and skills development is provided to the company's own workforce;
• S1-14: information on the extent to which the company's own employees are covered by the company's own health and safety management system and the number of incidents associated with work-related injuries, ill-health and fatalities of its own employees. In addition, the company must disclose the number of fatalities resulting from work-related injuries and work-related illnesses of other workers working at the company's sites.
• S1-15: extent to which employees are entitled to take family-related leave and the extent to which they actually use it;
• S1-16: information on the percentage gap in pay between women and men and the ratio between the compensation of its highest paid individual and the median compensation for its employees;
• S1-17: number of work-related incidents and/or complaints and severe human rights issues and incidents connected to the company's own workforce and any related material fines or sanctions for the reporting period.

Schedule

November 2022 is also the decisive month for the introduction of the European reporting standards beyond the EFRAG drafts: On 10 November 2022, the European Parliament approved the CSRD. The Council of the European Union is expected to approve the Directive at its meeting on 28 November 2022.

Currently, editorial changes to the EFRAG drafts are still open. However, these should not take much time, which is why a transmission to the Commission can be expected in the near future.

The sector-specific standards to be developed by EFRAG by November 2023 are currently still open. The previous drafts ("Set 1") relate to all sectors. In the future, there is to be another set of standards ("Set 2"), each of which is to apply to specific sectors. This means special rules for individual sectors such as agriculture, transportation or coal mining.

Consequences for companies

From an employment law perspective, companies should familiarise themselves with the expected new standards as early as possible. Admittedly, depending on the company, it will still be at least a year before the CSR Directive comes into force; for many companies not yet affected, the year 2026 may still seem very far away, even in view of current crises. Nevertheless, it makes sense to start thinking about the EFRAG criteria now. This is because for most of the ESRS S1 criteria it is not possible to "top up" quickly in order to achieve better results in the reports. Rather, they are very lengthy processes. For example, the gender distribution in top management and the age distribution among employees according to ESRS S1-9 can only be influenced by a long-term rethinking in HR. It is in the interest of companies to tackle the transformation processes promptly so that there are no disadvantages in the reports and evaluations later on.

Conclusion

EFRAG's drafts have set the direction for the future of ESG reporting in the EU, with a clear focus on human rights, diversity and fair working conditions. Companies should already be thinking about their future disclosure obligations and consider whether their company is best positioned for positive ESG reports and what further measures are still required in this regard.