In the world of sustainability reporting, the European Financial Reporting Advisory Group (EFRAG) is paving the way for small and medium-sized enterprises (SMEs) with two different sets of simplified standards. The standards complement the existing European Sustainability Reporting Standards (ESRS) framework, which mainly applies to large companies under the Corporate Sustainability Reporting Directive (CSRD). These standards aim to address the reporting requirements for listed and non-listed SMEs through appropriate disclosure requirements.

This article is based on the latest information on the LSME (for listed SMEs) and VSME standards developed by EFRAG. As the standards evolve, readers are encouraged to keep up to date.

Why are there these additional standards?

The ESRS for listed SMEs (LSME) represent a mandatory set of disclosure requirements. However, the Voluntary ESRS for SMEs (VSME) provide a comprehensive framework for non-listed SMEs to improve their sustainability reporting. EFRAG's main objective is to simplify sustainability reporting for SMEs in order to meet the increasing demand for sustainability data from large companies and to increase transparency while taking into account the resources and capabilities of SMEs.

As a complement to the CSRD standards, the Voluntary European Sustainability Reporting Standards (VSME) represent a pioneering initiative developed specifically for non-listed small and medium-sized enterprises (SMEs) as part of the EU's broader sustainability initiatives. These voluntary standards, which are currently under development, are designed to help SMEs improve their sustainability reporting, particularly if they are part of the value chain of larger, regulated companies that are required to disclose their sustainability requirements. In contrast to the mandatory standards, the VSME framework offers non-listed SMEs the flexibility to engage in sustainability reporting as they see fit, while creating a dynamic pathway for sustainable business practices across different companies.

Key objectives include:

• Involvement in the transformation: actively involving SMEs in the transition to a low-carbon economy.
• Access to sustainable finance: Making it easier for SMEs to access sustainable finance channels while minimizing the risk of unfair competition with larger, listed companies.
• Cost-effective transition: Avoid financial burdens for SMEs by not increasing the costs of their sustainability transition.
• Appropriate sustainability criteria: Ensure that SMEs meet appropriate sustainability criteria as required by stakeholders.
• Reduction of the cascade effect: Active measures to mitigate the negative effects of the so-called cascade effect.

Understanding the CSRD and EFRAG's ESRS: Catalysts for sustainable finance

To understand the VSME, a brief overview of its basic pillars is required - the Corporate Sustainability Reporting Directive (CSRD) and the European Sustainability Reporting Standards (ESRS).

The CSRD, launched by the European Commission in April 2021 as a cornerstone of the EU Green Deal and the Sustainable Finance Initiative, represents a transformative step in corporate reporting. Its adoption by the EU Parliament in November 2022 and official implementation in January 2023 marked a major legislative step forward with significant implications for companies falling under its scope.

This directive represents an improvement and extension of the existing Non-Financial Reporting Directive (NFRD). Its scope has been extended and now covers 49,000 companies that require a more comprehensive approach to sustainability reporting.

One example of this is the introduction of the double materiality assessment, which requires companies not only to report on how sustainability issues could pose financial risks, but also to identify and communicate their own impacts on people and the environment. In addition, the CSRD introduces a mandatory framework for review and audit processes to ensure a higher level of accountability in reporting.

To implement the ambitious goals of the CSRD, EFRAG took on the role of technical advisor to the European Commission and developed detailed guidance and metrics that are essential for the implementation of sustainable reporting practices. The ESRS were designed as a roadmap for companies to navigate the complexities of sustainability reporting and provide a structured approach to reporting their environmental, social and governance (ESG) impacts.

LSME and VSME: A response to the call for sustainability reporting for SMEs

The 2022 Flash Eurobarometer reveals interesting insights at EU level on SME sustainability initiatives, based on a survey conducted from November to December 2021:

• Almost 20% of SMEs are working strategically towards climate neutrality, with 4% claiming to have already achieved this goal. In addition, 31.6% of SMEs actively offer green products and services.
• A considerable 89% of SMEs are implementing measures to increase resource efficiency, with almost a third seeing only minor obstacles to the implementation of such measures. Around 26.6% consider the associated costs to be an obstacle.
• When it comes to financing green initiatives, 62% of SMEs rely on their internal financial resources. External support is balanced, with 20% relying on public funding and a further 20% on private funding from banks, investment companies or venture capital funds. Non-financial support, such as consultancy, is predominantly sought from supply chain partners (35%), business associations and clusters (23%) and private consultancy and accountancy firms (21%).

The building blocks of the VSME framework

The VSME standard is a voluntary framework designed specifically for companies whose securities are not traded on regulated markets within the European Union. It defines and categorizes small and medium-sized enterprises into three groups based on their balance sheet total, net turnover and average number of employees during the financial year.

Although non-listed SMEs fall outside the regulatory framework of the CSRD, they are actively encouraged to adopt the VSME standard. This covers similar sustainability issues to the ESRS for larger companies and operates on the principle of proportionality.

This approach ensures that reporting is aligned with the fundamental characteristics of each company and provides a customized path to sustainable reporting that takes into account the key characteristics of the companies.

Who is subject to the CSRD: reporting thresholds

Similar to the CSRD, the VSME standard defines requirements that enable non-listed SMEs to disclose relevant information about the negative impacts of their business on people and the environment and how environmental and social issues could affect their financial status, performance and cash flows.

The standard is divided into three modules: the basic module, the Narrative Policies, Actions and Targets (PAT) module and the Business Partners module. Based on the specific activities of non-listed SMEs, additional information (metrics and narratives not specified in the standard) will be required to address common sector-specific issues. Finally, the sustainability report should provide information that is relevant, credible, comparable, understandable and verifiable.

Basic module

The basic module outlines relevant requirements and metrics that focus on the environmental, social and business practices of non-listed SMEs. Comparable information compared to the previous year is required from the second reporting year onwards. A materiality analysis is not required for the disclosure of these requirements. Below is a detailed list of the disclosures and metrics required by the Basic Module.

Disclosures for the basic module

• Disclosure B 1 - Basis of preparation
• Disclosure B 2 - Practices for the transition to a more sustainable economy

Basic metrics - Environment

• B 3 - Energy and greenhouse gas emissions
• B 4 - Air, water and soil pollution
• B 5 - Biodiversity
• B 6 - Water
• B 7 - Resource utilization, circular economy and waste management

Basic metrics - Social issues

• B 8 - Workforce - General characteristics
• B 9 - Workforce - Health and safety
• B 10 - Workforce - remuneration, collective bargaining and training

Basic metrics - business practices

• B 11 - Convictions and fines for corruption and bribery

Narrative-PAT (Policies, Actions, and Targets) module

This module defines narrative disclosures related to policies, measures and objectives (PAT) that must be reported in addition to the disclosures in the basic module if the company has implemented them. This module is suggested for companies that have formalized and implemented PAT.

A materiality analysis is required to disclose which sustainability topics are relevant to the company, in addition to a brief description of how these topics are managed through existing or future policies, measures and/or targets. Engagement with key stakeholders is also required. Here are the Narrative PAT disclosures.

Disclosures for the Narrative-PAT module

• Disclosure N 1 - Strategy: Business model and sustainability-related initiatives
• Disclosure N 2 - Material sustainability topics
• Disclosure N 3 - Management of material sustainability topics
• Disclosure N 4 - Key stakeholders
• Disclosure N 5 - Governance: Responsibilities in relation to sustainability topics

Business Partners Module

This module specifies data points that must be reported in addition to the disclosures in the basic module and are expected to be included in data requests from lenders, investors and corporate customers of the company. A materiality analysis is required to disclose which sustainability topics are relevant to the company.

Here are the disclosures for the Business Partners module.

Disclosures for the Business Partners module

• Disclosure BP 1 - Revenue from certain sectors
• Disclosure BP 2 - Responsibilities in relation to sustainability topics
• Disclosure BP 3 - Target to reduce greenhouse gas emissions
• Disclosure BP 4 - Transition plan for climate change mitigation
• Disclosure BP 5 - Physical risks due to climate change
• Disclosure BP 6 - Ratio of hazardous and radioactive waste
• Disclosure BP 7 - Alignment with internationally recognized instruments
• Disclosure BP 8 - Processes for monitoring compliance and mechanisms for remediation of non-compliance
• Disclosure BP 9 - Violations of the OECD Guidelines for Multinational Enterprises or the UN Guiding Principles
• Disclosure BP 10 - Work-life balance
• Disclosure BP 11 - Number of trainees

Customization of the VSME modules

Non-listed SMEs can structure their sustainability reporting under the VSME standard by choosing specific modules that are in line with their strategic objectives. Four different options are available to these companies:

1. Option A: This focused choice concentrates on the basic module.
2. Option B: For more comprehensive reporting, this option combines the basic module with the narrative module and addresses policies, measures and targets. This option also introduces a double materiality assessment.
3. Option C: This option, which is aimed at transparent business relationships, comprises the basic module and the Business Partners module. It also integrates a double materiality assessment.
4. Option D: The most comprehensive choice includes all modules - Basic, Narrative and Business Partners. Reinforced by the double materiality assessment, this option offers a comprehensive and well-rounded approach to sustainability reporting.

Under the VSME, non-listed SMEs must also indicate whether their sustainability report contains information from subsidiaries (consolidated) or was prepared individually.

Important notes:

• The current reporting framework for the basic and narrative modules does not include Scope 3 greenhouse gas emissions, which are addressed exclusively in the module for business partners. In addition, the EU Taxonomy KPIs are also currently excluded. It is also important to emphasize that all official EU languages are accepted for the disclosures.

Conclusion

The introduction of the VSME standards offers non-listed SMEs a flexible sustainability reporting option that is proportionally adapted to their needs. These standards not only promote transparency and sustainable business practices, but also facilitate access to sustainable financing and strengthen the competitiveness of companies. Adapting the reporting requirements to the specific characteristics and capabilities of SMEs ensures that these companies can actively contribute to the transition to a sustainable economy.