1-2024: The CS3D Meltdown, IFRS vs ESRS and The Auditors Ethical Dilemma

Long time, no see! Welcome to the first issue of 2024, with news and insights from the World of Sustainability. Enjoy your reading!

Ethical Dilemma Arises as Auditors Pursue Dual Roles

Is it ethical for an audit firm to simultaneously provide advisory and auditing services to the same client? Concerns are mounting as audit firms are said to be offering companies both advice and audit on ESRS.

Mike Jennings, a seasoned professional in assurance and consulting, currently serving as a director at Anthesis Group in the Czech Republic, recently addressed this issue on LinkedIn.

He writes that he in the span of two weeks have heard of three cases where audit firms sought to advise on implementing ESRS, including DMA work, and subsequently audit the outcomes for ESRS Sustainability Statements, providing limited assurance. Whereafter he writes following statement:

”I used to be an audit partner and believed you should not audit what you advise on or implement for a client. I thought the ethical standards were being beefed up, not relaxed. Seems the need to revenue is important than the ethical considerations…..”

Jennings' post sparked a flurry of comments from fellow sustainability professionals, echoing concerns over this questionable practice.

"I'm aware of several Big Four firms engaging in DMA execution, ESRS implementation (such as gap assessments, roadmaps, etc.), and then auditing the same client. They know it's unethical, but choose to overlook it, as long as the client consents," one commenter revealed.

Another commenter emphasized that "Audit firms cannot provide both offer consultancy services and sustainability assurance. CSRD regulations are explicit on this matter"

A former PwC employee commented that "If we do not act rigorously to ensure the credibility of auditors, then they will become a mere formality to make companies spend more money on bureaucracy".

Comment: This issue is ripe for robust discussion. If permitted, such practices could undermine the integrity of the entire ESRS system and also expose auditing firms to significant risks. As Jennings writes "Just imagine the newspaper article - ESRS opinion shows errors in client’s report, which was prepared and all the data gathered and checked (and calculated) by a firm in the same network as the audit firm. That would go down like a lead balloon."

This is a topic that without any doubt will be up for more discussion, and it feels as if the issue should be relevant in the following context...

The International Ethics Standards Board for Accountants (IESBA) initiate a public consultation on two Exposure Drafts (EDs)

The drafts aim to address the ethical considerations surrounding sustainability reporting as organizations gear up to adhere to global disclosure regulations. One draft focuses on International Ethics Standards for sustainability assurance, while the other deals with the involvement of external experts. This initiative, which has support of IOSCO, aligns with broader efforts to ensure the effective implementation of sustainability regulations by regulators and standard-setters. Feedback is May 10, 2024, for the Sustainability Assurance ED and by April 30, 2024, for the External Expert ED. Read more.

Global Sustainability Reporting: A Crossroads of Standards and Commitments

How will global sustainability reporting evolve over time, and what conflicts could arise? Here is a report and analysis from the front row at?IFRS Sustainability Symposium in New York, signed by Jonathan Mill?ng, Head of Sustainable Finance at Ethos.?

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The ISSB's (International Sustainability Standards Board) IFRS S1 and IFRS S2 are the IFRS Foundation's equivalents to the ESRS (European Sustainability Reporting Standards) and its disclosure standards.

The main differences between the two regimes are that the ESRS focuses on both financial (outside-in) and impact (inside-out) materiality (double materiality), while the IFRS S1 and S2 mandate disclosures only on financial materiality, excluding the impact perspective altogether.?There is also a stronger focus on sector-specific disclosures in?IFRS?S1 and S2, stemming from the framework's foundation in the SASB (Sustainability Accounting Standards Board) Standards.

Brian Moynihan, the CEO of Bank of America, opened the IFRS Sustainability Symposium in the end of February with a pre-taped remark, stating his and the bank's support for the ISSB framework. It aims to streamline and simplify the "alphabet soup" of sustainability reporting standards for companies by incorporating both the SASB and TCFD, and establishing a collaboration agreement with the GRI. Some individuals who were previously influential members of the GRI, such as Ndidi Nnoli-Edozien, are now with the ISSB.

Shortly after Moynihan voiced concerns over supervisory authority-enforced sustainability disclosures (like the EU’s ESRS), the stage was overtaken by protesters from Climate Defiance for about 30 minutes.

“There is now concern that the ‘alphabet soup’ of voluntary, non-financial disclosures, which we’ve done so much to consolidate and bring into the ISSB, is being replaced by a range of non-standardized, regulated disclosures.”

The remarks by the BofA CEO and the Climate Defiance protesters’?overtaking the stage reflect the tension between the EU’s and ESRS’s focus on double materiality disclosures versus the ISSB’s focus on strictly financial materiality.

Given the conflicts and similarities between the CSRD/ESRS (EU) and IFRS/ISSB?(global), there is a need for advisory services and internal finance, sustainability, legal, marketing, and investor relations capabilities that understand the practical implications of ESRS compliance and reporting for US- and UK-listed entities, whose primary regulatory regime and authority is not the EU.?EU companies will have no trouble reporting according to the ISSB given the ESRS’s strong focus also on financial materiality.

US- and UK-domiciled private equity firms or general partners may also fall under the purview of EU regulations if heavily exposed to European assets. The EFRAG has not been clear on the distinction between indirect versus direct exposure and how it may affect reporting obligations.?Regardless, all global companies, including US and UK companies?even if not?covered by ESRS reporting obligations through European subsidiaries, assets, operations, or otherwise, will still need to provide sustainability data to European counterparts whose value chain they are part of – that is, if they consider it good business to remain as that European company's supplier.

Even if the ISSB and commonwealth countries (with Singapore being the latest to sign on to the ISSB) are attempting to?avoid?the heavy-handed and granular ESRS reporting framework of the EU by crafting one that is looser and focused strictly on financial rather than impact materiality, such companies?likely?will not be able to evade the EU regime's capture of extra-territorial companies wishing to access the still rich European consumer market.

Furthermore, banks, corporates, and asset owners around the world outside of the EU are racing to announce science-based net-zero pathways to 2030 and 2050, promising to be the first to get there. However, the practical steps that need to be taken are missing from many, at least public, business and investment strategies. After the initial investment in marginally reduced emissions, the plans and costs needed to reach net zero by 2050 often seem too large, too radical, and too risky to implement. Doing so will require massive amounts of operational and capital investments that many boardrooms are not ready to sign off on now, as there is no data to show why and how much it will cost, as well as which revenues they can expect to gain.?But at some point, such promises must be backed up by action – just like lofty financial promises that aren’t met and not based on substance will eventually?affect?your stock value.

When standardized, comparable, and uniform sustainability data becomes widely available?through both the ESRS and ISSB, it will empower such bold decisions.?Boards and executive management teams, born to make big decisions, will have the data to drive that bold decision-making – either towards a climate transition or away from it.

And for boards not ready to make such decisions, the market will instead. Any data that is out there and can be trusted, the market will analyze and use in some way to support their decision about a company’s future or non-future. The only difference now is that the future is either one that runs on clean energy or one that runs on fossil fuels.

Make your bet.

Contribution by Jonathan Mill?ng

The CS3D Backlash: Why? And What Happens Now?

Last week the European Member States stopped the The Corporate Sustainability Due Diligence Directive (CS3D) after it suddenly lost support. Here is a brief conclusion of what happened and what needs to be done to break the deadlock.

The Corporate Sustainability Due Diligence Directive (CS3D) is poised to be a groundbreaking legislation compelling large corporations to uphold human rights and environmental standards throughout their supply chains. After extensive negotiations and preparations, the decision drew near in the EU Parliament at the end of February.

However, the final vote on CS3D was postponed by Member States due to insufficient support, particularly from Germany. Concerns over its impact on businesses prompted Italy to withdraw support as well. Despite efforts by the Belgian Presidency, the European Council failed to approve CS3D. France's last-minute proposal to restrict its scope, exempting 80 percent of companies, is said to have contributed to its downfall.

Heidi Hautula, Vice President of the European Parliament, Chair of EP Responsible Business Conduct working group (RBC wg) uses words as ”European horse-trading” and comments the outcome as ”a sad day for human rights, the environment and the competitiveness of European businesses.”

She also outlined potential consequences if CS3D is not decided upon:

”Fall of the directive would lead to a fragmented internal market and a patchwork of national legislation on responsible business conduct. The lack of an EU-level law would be a slap in the face to thousands of companies that already have in place due diligence processes in line with international standards and expect a level playing field.”

With the current Parliament's term ending soon, the Council has until March 15th to reach a compromise. The Belgian Presidency of the Council stated that it has "to consider the state of play and will see if it’s possible to address the concerns put forward by member states, in consultation with the European Parliament”, according to an article in Lexology.

"Political will and leadership at the highest level is now needed to break the deadlock”, Hautala writes in her post at LinkedIn. ?

EU Parliament Approved Nature Law

The European Parliament in the end of February passed a crucial law aimed at rejuvenating nature. The nature law is significant, requiring member states to restore nature across a fifth of land and sea by 2030.

EU Environment Commissioner Virginijus Sinkevicius praised the law as a commitment to preserving biodiversity and vital ecosystems for farmers' benefit. It aims to reverse the decline of Europe's natural habitats, 81% of which are in poor condition, with specific targets including peatland restoration to absorb CO2 emissions.

The final policy is weaker than initially proposed. Since its 2022 proposal, the law faced opposition, resulting in weakened aspects such as diversifying features in farmland. The law is now awaiting approval from EU member states.

EU Reaches Accord on Enhanced Oversight for ESG Rating Activities

In middle of February, the Council and European Parliament struck a tentative deal on regulations governing environmental, social, and governance (ESG) rating activities. These regulations are designed to bolster the trustworthiness and comparability of ESG ratings by enhancing transparency and integrity within ESG rating firms and mitigating potential conflicts of interest.

Under the new regulations, ESG rating providers must obtain authorization from the European Securities and Markets Authority (ESMA) and adhere to transparency mandates, particularly concerning their methodologies and data sources. Read more

A Sustainability Managers Diary Post on New "Grim" Climate Figures

Kaj T?r?k, Chief Sustainability Manager at Max burgers, recently wrote a "diary post" on LinkedIn on the pressing situationen with the climate and lack of action in policy.

"The new climate figures are in, and they're grim. January 2024 was the eighth consecutive month with the highest global monthly temperatures ever recorded.../.../...

Ironically, the Nordic countries are now experiencing unusually cold weather. This is partly due to the rapid melting of Greenland's glaciers, which is weakening the warm Gulf Stream.

Imagine your body as a map, with your toes representing Morocco and your head representing Sweden. Right now, it's as if your toes are in a sauna while your head is outside in a snowdrift."

Comment: A interesting and good example on how forward leaned and communicative sustainability professionals use their platform for taking a stand and calling for action.

Behold: The ESG World

Thank you David Carlin at Cambium Global Solutions, for sharing a mapping over sustainability frameworks, standards, and milestones.

Comment: One could argue that ISO 14001 launched in 1996 should be added to the map. And a tip is to (if you do not already) follow David here on LinkedIn. As a founder of Cambium Global Solutions he is an advisor to governments, corporates, and financial institutions. David has also led the creation of UNEP FI’s risk programming, working with over 100 global financial institutions on topics of climate stress tests, risk modeling, TCFD and TNFD disclosure.

Brief update on ESG, Standards, Disclosure & Reporting

Devil is in the (ESRS) details...

EFRAG has recently released the second set of Explanations to respond to stakeholders' technical questions on the ESRS.

Webcast: EFRAG Sustainability Reporting Technical Expert Group meeting the 29th of February ?A meeting with focus on questions at an early stage of the development of a potential EFRAG position.

The composition of the EFRAG Banking, Capital Markets and Insurance Advisory Panels (EFRAG?BAP, CMAP and IAP respectively) is set. What organizations and persons will be contributing to the development and maintenance of the sector specific ESRS on financial institutions.

EFRAG Workshop: How to Utilize Digitally Tagged ESRS Statements (29th of February)

Something that's essentially new for everyone in ESRS is the digital tagging of sustainability information. Recently, EFRAG hosted a webinar on this topic.

"It was a very insightful and productive meeting where participants could provide feedback on formulations and participate in votes on specific issues. The standard for digitally tagging ESRS is now open for consultation until April 8th," comments Scarlett Roa Brynildsen, sustainability expert and founder of Brundtland Sustainability Agency.

EFRAG published drafts on sustainability reporting standards for SMEs. The consultation will be open until 21 May 2024.?

ISSB Update and podcast available, 27th of February

IFRS & GRI: Interoperability considerations for GHG?emissions when applying GRI?Standards and ISSB Standards

GRI Launches new biodiversity 2024 standard and a sector specific mining standard

GRI launches new Biodiversity 2024 Standard

Thank you for reading!

I am grateful for any feedback, tip or contribution to this newsletter (which at the moment is a hobby of mine). I have also initiated a CSRD Implementation Taskforce-network with 170 Swedish members meeting and sharing insights and experiences on regular basis. I am soon about to switch into English and open up for European members. Please knock on the door to the LinkedIn group here if you are interested in becoming a member.

Upwards and forward!

Mikael Salo