Criticism of ESG is increasing. There is dissatisfaction in the business community about the increased regulatory burden, while various specialists question the effectiveness and reliability of ESG as a benchmark for (the improvement of) social performance. We largely agree with that criticism, and furthermore expect that the introduction of CSRD will suffer a similar fate. How should you deal with this as an organization?
In this article we provide an overview of the problems with the CSRD – and ESG in general – and tell you more about our view on this. We believe that sustainability reports are valuable and indispensable in the transformation towards a more sustainable business community, but always as a means, and not as an end in itself.
Increased regulatory burden on companies
The EU Corporate Sustainable Reporting Directive (CSRD) requires companies with an annual turnover of €40 million to report on the ESG themes most relevant to them. The larger the company, the greater the reporting burden. ESG accounting must be set up, requiring external advisors to guide the process. This puts additional pressure on accountants, because in addition to the financial reports, they also have to check the ESG reports.
And that is a problem in the eyes of the business community, as evidenced by the response from VNO-NCW and MBK-Nederland. More regulation leads to higher costs and limits the freedom to do business. A logical thought in itself, because as an entrepreneur you want the freedom to determine how you run your company and how you commit to a better world.
More risk of climate lawsuits
The CSRD will lead to more transparency. And more transparency will lead to more insights into the (negative) social effects of business processes. A few examples of mandatory reporting:
– The number of internal corruption cases
– The difference in salary between men and women (the gender pay gap)
– The CO2 emissions of the entire value chain
So suppose you have a large supermarket chain. Then you not only report the CO2 emissions of the distribution centers, the stores and all your transport, but also on the CO2 emissions of all the products you sell and the customer’s use of your products. For example, the degree of recycling of the packaging or the customer’s CO2 emissions during their journey to your store. This type of information gives the company itself, but also its stakeholders, much better insight. Entrepreneurs can use these better insights to improve their social impact, or ESG performance. But some entrepreneurs also fear that this increased level of transparency will lead to an increase in mass claims, following the example of the climate lawsuit against Shell.
ESG ratings can be misleading
For larger companies, the annual interaction with ESG rating agencies has become a standard process. These ratings provide a company rating in terms of ESG, in the same way that these rating agencies provide their company rating with regard to financial performance.
And that’s where things go wrong. ESG is a developing field, and this especially applies to transparency and reporting. According to Harvard Professor George Serafeim, the leading researcher in this field, ESG ratings give the wrong impression: the ratings are less about actual performance in the areas of Environment, Social and Governance, but much more about the degree of transparency about ESG.
It is therefore possible that a company with clearly serious abuses in the chain – such as a major polluter or a violator of labour laws – still receives a high ESG rating, provided that the reporting on this is good enough. That is why the EU is calling for more rules on how these ratings are established. And that’s where things go wrong again, as we argued in the Dutch Financial Times. Because a transparency and ESG-ratings are not goals but means to create impact.
CSRD and ESG: transparency as a goal?
Because of all the attention on transparency about E, S and G, and the CSRD, it seems as if this is the goal. Transparency is of course an adequate means to increase the actual ESG performance of a company. The assumption here is that more transparency leads to better performance. An assumption that is also correct in theory. There are several solid studies that also support this assumption. Particularly in the long term, significant improvements are seen in, for example, the reduction of CO2 emissions. That is why the EU has also made the CSRD part of the Green Deal.
We also expect that more transparency about ESG will ultimately lead to better ESG performance. In the short and medium term, however, we expect that attention will mainly be paid to the reporting itself and improving this reporting. We also expect that many companies will actively aim to create the most positive image possible with their CSRD reports. This makes CSRD and ESG transparency a goal in itself, and that cannot be the intention.
More focus on transparency of ESG risks leads to chores
Identifying and mitigating risks is an important aspect of the ESG approach. And the focus on transparency further increases this aspect. This is happening all the more because we notice in practice that internal responsibility for ESG is shifting to the financial department. This shift in responsibility will lead to a tension between ESG risk management based on the CSRD and taking advantage of opportunities to make an impact. Due to this approach, the CSRD is increasingly seen as a chore. And chores have never led to successful change.
What also does not help here is the enormous influence that accountants have on the implementation of the CSRD. An accountant has completed one of the longest training courses in the Netherlands and knows everything about the financial auditing of companies. An accountant is well equipped to carry out audits, but not about everything. There are limits to the knowledge and skills of the accountant, and ESG is such a limit. However, the accountants will be and remain leading, also in the audit of the CSRD. And to deliver quality and limit risks, checklists and manuals are used. Indeed: that in turn leads to more chores.
CSRD and ESG transparency as a means to achieve real impact
We regard CSRD and thus transparency about ESG as a further professionalization of something we used to call Corporate Social Responsibility (CSR). The CSRD is therefore part of that professionalization drive, but it must remain a means.
We use the CSRD and the ESRS as a practical framework to create a shared language. This language is understood both internally and externally. We then make substantive choices based on the analyses in this language and not purely transparency-driven choices. For example, the outcome of a materiality analysis is input for determining the ESG strategy. But the ESG strategy is not only determined by materiality. A GAP analysis not only includes the GAP between reporting requirements and current reporting practice. A GAP analysis goes further and also looks at the GAP between ESG strategy and realization. In our opinion, good CSRD implementation is not about publishing an ESG annual report, but about achieving ESG goals. In this way, an organization can really improve its ESG performance not only in the long term, but also in the short and medium term. Engaging with impact. Empact.