By Teresa Brose, ESG-consultant. This article is also published in Dutch on duurzaam-ondernemen.nl
A sound ESG strategy is necessary for companies that must report in accordance with the new EU Corporate Sustainability Reporting Directive (CSRD). This is the case your company meets two of the following three criteria: your organization employs more than 250 people, has a balance sheet total of more than 20 million euros and/or generates more than 40 million euros in net turnover.
This new reporting standard has the potential to become a game-changer regarding transparency, comparability, relevance and accountability of companies on environmental, social, and governance (ESG) criteria. Let’s take a brief look at the framework itself and what makes it so distinct, before evaluating the probable chances and consequences.
The CSRD framework in a nutshell
The CSRD is an ESG reporting standard under which approximately 49,000 companies in the EU will need to report under. Its objective is to encourage companies to better manage and improve their ESG performance.
The infographic below provides a high-level overview of the reporting framework for the first set of goals, i.e., the environmental goals, which are expected to be completely published in October 2022:
Source: Adapted from European Financial Reporting Advisory Group, Status Report of the Project Task Force on European Sustainability Reporting Standards (PTF-ESRS), and European Financial Reporting Advisory Group, ‘Climate standard prototype’, Working Paper.
The CSRD reporting standard is designed along with the so-called rules of three. It connects the three reporting areas, the three layers of the sector perspective and, of course, the three topics environment, social, and governance. The complete reporting model is called ESG+ and shall ultimately provide for a disclosure named “sustainability statement”, that will be a mandatory part of a company’s annual report.
The novelty of this reporting framework is that a company not only needs to report on its ESG performance for the reporting period but is also required to develop an ESG strategy for the short-, mid- and long-term with respective milestones and targets. Thus, the management boards need to create a strategic approach for (greatly) improved ESG performance for the time until 2030 at least and in some cases even until 2050.
In the next step, companies are required to document how they will implement this ESG strategy by policies they make and concrete actions they take. The results of its ESG efforts need furthermore to be quantified for certain metrics and be reported – this not only on their own operations but also up- and downstream along their value chain. By this, the regulators thus make EU companies accountable not only for their own activities but also for their suppliers’ operations and the impact their products have on ESG criteria.
A further part of the sustainability statement requires companies to state additionally what portion of their revenue, relevant operational expenses, and capital expenditure is eligible and aligned with the classification of the EU Taxonomy. Last, but not least, an ESG risk assessment analysis from an inside-out as well as from an outside-in perspective (the so-called “double materiality” view) needs to be included.
The above is only a very brief summary of the CSRD, as the framework is far more complex and detailed. Companies are well-advised to start preparing for the CSRD better today than tomorrow, as the CSRD also requires a limited assurance by a third party for the sustainability statement.
This limited assurance will later be extended to a reasonable assurance. This means that companies not only need to collect and compile the data and do the strategic planning, but also need to implement robustly traceable and provable processes on how the data was collected. If you would like to get more information on the CSRD in detail, please refer to EMPACT Consulting’s website.
The consequences and chances of the CSRD
Many companies will perceive this new reporting standard as another resource-straining compliance exercise imposed by the EU which adds no or only limited value and needs to be done to avoid penalties and preserve reputation. In reality the consequences and the opportunities that can be derived from the CSRD are more far-reaching and are also beyond saving our planet. This firstly, because of the standardised reporting scheme and the need for quantitative data. Secondly, because the data also needs to be compiled in the ESEF data tagging format, which allows comparing data at a much higher speed. The content and the format of the sustainability disclosure will have the following consequences for companies:
- Interested stakeholders will use this quite precise information to inform themselves on how green and sustainable a company really is so that the opportunity for greenwashing will be reduced considerably.
- Even today, consumers and corporate customers demand this kind of ESG information, as it has become an increasingly important criterion for their purchase decision. Also, the comparability of ESG performance with a company’s industry peers could influence the purchase decision towards the better performing company on ESG.
- The same applies to potential employees, and especially to the younger generations, who do take into consideration if their future employer is an ESG-compliant or -focussed company.
- A further and very powerful interested party in this kind of information are equity capital providers. The EU regulatory regime directs and encourages investors to invest in ESG-fit assets. These investors also need to explain and justify the ESG portion in their portfolios and thus look for respective investment opportunities and related ESG information.
- Compiling a CSRD report will require to a much larger extent than current mandatory reporting standards the cooperation of interdisciplinary teams across the company. It needs at least the input from the finance, CSR/ESG, operations, R&D, sales, and IT departments with the management board as the ultimate responsible body. Additionally, a collaboration with the company’s value chain partners will be necessary.
Considering these probable consequences (and the fact that a company anyhow needs to dive deep into this topic internally and with its business partners), could turn a cumbersome compliance exercise into a strategic and financial opportunity. If you view the CSRD as a start signal and ESG efforts are implemented with a 360 degree approach, chances are good that it cannot only become a value creator for society but also generates financial value for you company. This financial value can be derived from a unique ESG-integrated selling proposition that includes ESG business models, products and services, and respective driven cultures. We as a society are only the beginning of this journey and we have not yet developed best practices on a large scale and with respective commodification, but some role model companies have already proven that it is possible.