CSRD: a way to improve ESG performance in a structured way

With the CSRD, many Dutch entrepreneurs will have to deal with new regulations from Brussels starting in 2024. Although the new legislation is not directly related to improving your company’s CSR or ESG performance, it will have a not-to-be-underestimated effect on the operations of every large company. Indeed, being transparent about concrete performance and strategic policies will from now on be a hard requirement of the legislator. In this article, we briefly explain what the new legislation entails and consider the intended effects of the regulations and their relationship with other sustainability legislation, such as the IMVO Act. In addition, we show how companies should deal with this and how they can benefit from it.

The CSRD in a nutshell

Any company with more than 250 employees and a turnover of more than 50 million per year (or a balance sheet total of more than 25 million), will be required by the CSRD to externally report annually on their social impact starting in fiscal year 2024. This reporting must also be approved by an external auditor. In the process, the report must be published in a specific data format (ESEF) so that it can be included in a central public European database.

ESG takes center stage

Central to the CSRD is ESG performance. As such, ESG is de facto replacing companies’ CSR policies. Whereas previously ESG was seen primarily as a translation of the CSR policy for the financial sector, ESG as a paradigm in the field of sustainability is now taking center stage. In the process, ESG is also being positioned strategically within the CSRD.

European Sustainability Reporting Standards

The CSRD has been elaborated by the EFRAG in the so-called ESRSs: European Sustainability Reporting Standards. These are 12 elaborated guidelines that flesh out the mandatory CSRD reporting. These elaborated guidelines still have to be formally approved by the European Commission, but that may be considered a formality (because approval is given via a ‘delegated act’). So companies can now start working with these 12 guidelines.

In addition to general business disclosures (called ESRS 1 and 2 in the CSRD), the ESRS requires reporting on Environment(5 guidelines), Social(4 guidelines) and Goverance(1 guideline). In total, the reporting standard includes a maximum of 82 “Disclosure Requirements” and 1,144 data points. Not everything must be reported on by all companies; in addition to the general information, ESRS E1 (on climate change) and part of ESRS S1 (on own employees) are mandatory for all companies.

Whether an individual guideline needs interpretation is determined based on the importance (materiality) of an issue to a company. For example, biodiversity (ESRS E4) will be more important for a company in the food chain than for a law firm. And a company with production sites in low-wage countries will have to report in accordance with ESRS S2, while a company with many economic activities in countries where corruption is a high risk will have to be transparent on ESRS G1. Furthermore, additional reporting requirements are imposed on companies operating in high-risk or impact sectors. A first version of these additional requirements is expected in mid-2023 (see box).

CSRD makes ESG strategic

CSRD is not just about making a company’s ESG performance transparent. Equally important is reporting on the ESG strategy a company has developed and how it is being implemented. This is also how the ESRS standards are designed: Governance, Strategy, Risk Management & Opportunity and Impact, KPIs and targets. These include stakeholder engagement, expected cash flow developments related to ESG, the risk identification process, supply chain transparency, carbon reduction targets in absolute numbers, the actions involved, the explanation of these, the translation to C-level compensation, and future plans for (improving) ESG performance.

So the innovation of this reporting framework is that a company must not only report on its ESG performance for the reporting period, but also develop a short-, medium- and long-term ESG strategy, including associated milestones and targets. Executives are thus required to create a strategic approach for (much) better ESG performance until at least 2030 and in some cases even 2050. We already wrote this blog about this in 2021.

What changes in business practices the CSRD will actually lead to is difficult to predict, but the trend is clear: more disclosure ultimately leads to better ESG performance across the board. And that is what the European Commission is also counting on. The connections to other laws and policies are numerous. Some important ones:

• The Green Deal is not a law but EU policy to be implemented in all relevant laws. In doing so, the Green Deal is also driving new laws, such as the CSRD.
• The IMVO law has now been much discussed in the Netherlands, in Europe it is called the CSDD and is about doing decent business, especially in the supply chain.
• The EU Taxonomy clarifies which activities can and cannot be called sustainable, based on their scientifically tested contribution to preventing climate change or mitigating its effects (adaptation).
• In addition, the elaboration of the CSRD in the ESRS explicitly links to international standards such as the TFCD, SASB of the ISSB & IFRS, GRI transparency guidelines, OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights.

From the legislature, as should be clear by now, ESG or CSR is no longer looked at without obligation. Companies are now being required to drive positive impact. The idea is that as a result, the companies of the future will not only become more sustainable, but also more solid and resilient. From academia, there is increasing evidence that a company that strategically handles their ESG also performs better financially; for example, this study from Stern NewYork University from 2022 makes this clear.

CSRD as a way to move toward resilient business practices

ESG has been used as a risk-mitigation tool by many companies for some time. Identifying the negative effects of business operations and making a risk analysis based on this is also logically the first step in implementing CSRD. Especially if we consider that ESG was developed from within the financial sector; risk management is inherently financial. Moreover, approaching the CSRD as a risk management tool brings a certain degree of familiarity. After all, we already know this approach and are now extending the scope to the social side: E, S and the G. At Empact, we call this the “compliance paradigm” and is in fact the first stage of ESG maturity of a company.

The insights generated by the CSRD exercise will need to be placed in a broader perspective in boardrooms to harness their full value. These insights can begin to play a leading role in tactical and strategic issues. Think of the decision for new production location that takes into account expected climate change. Or think about to what extent a long supply chain is still tenable. But also the more strategic questions about PMCs (product market combinations) and business models. I deliberately remain fairly abstract here, because examples oversimplify these insights in my view. Please contact me especially for in-depth examples and a detailed explanation.

In subsequent articles, we present a roadmap for getting started with the CSRD. We will also discuss more specifically the requirements from the CSRD and the ESRS.