How Europe’s planned ESG standards may upend climate targets for some companies

With the public hearing phase over, the EU is now closer than ever to having a common set of ESG reporting standards that increases transparency around corporate climate actions. How climate action targets are structured and communicated, along with increased transparency on background information, means that some companies may need to re-structure their climate action targets.

What is the real purpose of ESRS E1?

Under the EU’s Corporate Sustainability Reporting Directive (CSRD) the task for a common ESG reporting standard was handed off to the European Financial Advisory Group (EFRAG), who issued the draft European Sustainable Reporting Standards (ESRS) for public comment in April 2022. It is very clear when reviewing the draft standard for Climate Change (ESRS E1) that the disclosure requirements, including the detailed guidance, have three parallel purposes. The first is to improve the transparency of what enterprises are actually doing to address climate change mitigation and adaptation, and their related exposure to material financial risks and opportunities. The second is to feed information into the measuring & evaluation of the results of the many EU’s Green Deal regulations, initiatives, and incentives that focus on addressing climate change. While the third is to align corporate climate change disclosures with timelines and information needs under the Enhanced Transparency Framework of the Paris Agreement, for which the EU needs to report on its progress. Luckily for companies, the latter two purposes will be addressed by the EU and its member states directly through information tagging and data mining of corporate sustainability reports.

Origins of “Net-Zero”

In June 2020 “Net-Zero” gained the wider used formal definition in the private sector with the Race to Zero initiative spearheaded by the UNFCCC, though it was defined by the IPCC as late as 2018 in the Special Report Global Warming of 1.5 ºC. Where the IPCC basically defines Net-Zero as a global mass balance in CO2 emissions caused by human activity plus the removals achieved by human activity. In simple terms what we put out (emitted) must also be put in (permanently stored), all on a global scale. This wider used formal definition also focused on reaching the global state of Net Zero by 2050 or 2070, so that global temperature rise does not exceed 1.5°C or 2.0°C respectively. The Race to Zero wider definition started the process to define the ambiguity between the competing claims of organisations’ impacts on climate change caused by their value chain emissions and removals, plus the use of off-sets from outside the value chain.
Shortly after the Race to Zero, The Oxford Principles for Net Zero Aligned Carbon Offsetting where launched in an attempt to address these competing claims (and practices) of the use of climate neutral, GHG neutral, carbon neutral, compensation…etc., within the context of Net Zero. Technically this comes down to addressing different states of mass balance of GHG emissions from an organisation’s value chain and the use of removed and/or avoided GHG emissions outside an organisation’s value chain, as part of the pathway to reach the state of net zero over time.
In October 2021 the Science Based Target Initiative (SBTi) launched the Net-Zero Standard which provides guidance and tools companies can use to set science-based net-zero targets. In this standard reaching Net-Zero is purely in the context of the IPCC’s 2018 definition, but at a company level, and it specifically does not include offsetting in the target of Net-Zero. Instead, off-setting is placed in a separate column as an option for neutralizing residual emissions or to finance additional climate mitigation beyond their science-based emission reduction targets.

ESRS E1 may upend climate and Net-Zero targets of companies

The ESRS E1 (draft) requires that companies disclose targets which they have adopted to address climate change mitigation and adaptation, as well as material climate-related impacts, risks and opportunities. Under ESRS E1, when a company’s target is related to reducing GHG emissions they must include Scopes 1, 2, and 3 either separately or combined, though that SBTi targets require all scopes (e.g. the value chain). In a win for transparency, companies will need to explain the scope, methodologies, and frameworks applied in setting their targets under ESRS E1. In addition, under ESRS E1 targets will also need to be set on a 5-year rolling basis from 2025, where the baseline is set every 5 years.
Following the SBTi approach, ESRS E1 strictly forbids companies from including offsets (carbon credits, removals, and avoided emissions) in setting and achieving targets. Companies will be able to use offsets to disclose GHG neutrality claims under ESRS E1, but this means that GHG neutrality shall not be linked to adopted GHG emissions or Net-Zero targets. Though, companies should take note of the consumer marketing practices regulation and guidance in their jurisdictions of operation, as some countries have really tightened up on the demand for scientific documentation needed to make GHG emissions neutrality claims.
What is important in terms of off-sets, is that ESRS E1 (and SBTi) recognises the need for investment in CO2 removals and avoided GHG emissions outside a company’s value chain. ESRS E1 has a specific disclosure requirement for these investments, and whether companies choose to or not make GHG neutrality claims they can still invest in climate-related impacts either directly or through offsets. This is important for companies who want to make a positive impact but where the majority of their GHG emissions come from Scope 3 sources that the company has little or no control over.

What ESRS E1 means for companies

The ESRS E1 (daft) standard means that companies cannot be complacent and will need to continuously update their climate-related progress and periodically update their targets as well, showing real short-term climate action as well as medium- and long-term targets. In setting those targets and reporting on progress, off-sets are no longer a part of the equation, so for some companies retooling will be required. However, for the sake of global climate change companies really should continue to invest directly or indirectly (via. offsets) in CO2 removals and avoid GHG emissions outside a company’s value chain. For some companies this may mean sticking to an annualizes neutralization strategy by keeping this separate from corporate targets, other companies my choose to change their narrative to “investing in climate action” separate from targets, both require that companies transparently report on what and how they invest in climate action both internally and externally.
Though CSRD and ESRS legally only apply to large companies and listed SMEs registered to do business in the EU, their B2B customers and partners (in and outside the EU) should be very aware that GHG emissions reporting applies to value chains and that sharing GHG emissions related information may very well be a cost of doing business with EU companies.

What ESRS E1 means for investors and the general public

The ESRS E1 (draft) is certainly a major improvement in transparency of reporting on a company’s climate impact and risks. Though it may confuse investors and the general public because companies are not required to set Net-Zero targets, and companies may individually set GHG emissions targets for Scopes 1, 2, and 3 either separately or combined. This means that competing companies in the same sectors may have GHG emissions targets that do not offer an apples-for-apples comparison. ESRS E1 also means that investors and consumers will need to have short memories, or clearly understand that the targets they heard a company make in 2022 may be very different from the target set in 2025. Therefore, basic climate reporting knowledge is needed by both investors and the general public to understand what a company is actually achieving.
Now that the public comment period for the draft ESRS is over, it remains to be seen what changes will be made to the reporting on climate change actions in the final version. Though it is important to note that EFRAG is still in the process of drafting sector-specific standards and guidance and companies should consider joining that consultation process.

About the author

Douglas Marett has spent close to two decades addressing climate change and sustainability actions for governments and companies at a global scale, and is the Managing Director of both GH Sustainability and enablesus.
This article was originally published on LinkdIn.
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