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The ESG landscape is changing fast, and its only going to compound over the coming months and years. With the EU at the forefront of introduction new regulation that will impact many (and in time) all companies that operate in the EU.
This is causing a scramble to get on top of what this means practically for businesses, as they look to put in action strategies to ensure they can meet regulatory requirements as well as drive sustainability strategies that support the longevity of their businesses.
This article helps to distil down these changes into easy to digest information that can support companies in getting up to speed.
Why don't we start with explaining all the Acronyms?
Non-Financial Reporting Directive (NFRD)
Preexisting legislation from 2014 that required large listed companies, banks and insurance companies ('public interest entities') with more than 500 employees to report on ESG performance, around 11,700 companies in the EU. This will over time be replaced by new legislation detailed below. The legislation to this point has been very, for lack of a better word, woolly. In effect, companies can report what they want (or feel is relevant), how they want (In a manner they feel is useful). We explain below why this has been sub optimal and what changes the EU are looking to achieve through newer regulation.
EU Taxonomy Regulation (Ok.. this one doesn't have an acronym)
A framework specifically intending to set criteria to determine if an economic activity can be considered sustainable.
Corporate Sustainability Reporting Directive (CSRD)
The new unified framework for the reporting of non-financial data (E.g ESG impacts) by companies who operate in the EU, including subsidiaries of non-EU based parent companies. The reach of the CSRD is far greater than the NFRD that it will ultimately replace. With around 49,000 organisations impacted over time on a phased manner in line with the below time frames.
2024
Starting with those that are already required to report through NFRD.
2025
Other large EU based companies not previously subject to the NFRD, to start reporting in 2026 on 2025 data (greater than 250 employees, EUR 40 million+ turnover, or EUR 20 million+ total assets, with two of three criteria met)
2026
SMEs based in the EU will be required to commence their reporting in 2027 on 2026 data (companies with more than 10 employees and EUR 20 million+ turnover)
2028
CSRD will apply to companies that are incorporated outside of the EU that do business inside the EU, reporting in 2029 on 2028 data. (Net turnover of more than €150 million in the EU at consolidated level and which have at least one subsidiary which is large or listed, or a branch with net turnover of more than €40 million in the EU)
European Sustainability Reporting Standards (ESRS)
The new Sustainability Reporting Standards which will be mandatory for companies under the CSRD to comply with.
EU Sustainable Finance Disclosure Regulation (SFDR)
Rules and disclosure requirements for financial market participants specifically, where they must provide information about how they deal with environmental and social factors and risks to their investments.
Industry specific requirements, with financial markets being the first, however others are on the way for other industries and so this is expecting to remain a developing landscape.
The raising of the bar
Below we consider the implications for EU companies, and the broader landscape. Assessing what key changes are happening as a result of this legislation.
Loss of Flexibility
As we mentioned, the previous legisation (NFRD) providing a large amount of flexibility to companies and does not require the use of a non-financial reporting standards or framework. This meant companies could disclose information they feel is relevant, in the way they consider most useful. The impact of this however has been selective disclosure, as well as inconsistency of data, which has made comparison and understanding more of a challenge for consumers and stakeholders.
How is this solved? Well with SFDR and mandated reporting standards of ESRS, companies have clear guidance on the required disclosures, with additional sector specific requirements that will also follow. The aim of this is to bring environmental and sustainability reporting on a par with that of financial reporting.
This is supported by the recent realise of the new IFRS Standards S1 and S2. For which we will provide further guidance and explanation for in a separate article.
Entire Value Chain Assessment
We explain the concept of emissions across the various natures and how this applied to value chain in our article here.
While many companies have already got to work in tackling the concept of Scope 3 emissions (emissions that are indirect to the company), many have viewed this from the standpoint of what indirect emissions do we buy in the goods and services that we procure.
The principles including with SFDR determine that this is not sufficient, we should consider both the upstream (bought in goods and services from our supply chain), as well as the downstream. This refers to where do our products and services go, how are they used through the value chain and across their life cycles, and what are the associated environmental and social impacts further down the line.
Double Materiality
This has been considered by many to be a large extension to the scope. First, materiality will not be an unfamiliar term to many with experience in company reporting. In summary Is something large enough that it could influence the decisions of those that are the intended users of the information. In the case of company reporting, shareholders and investors.
The double materiality concept requires that companies must first consider, is something material to the company (called the 'outside in' viewpoint) but also are the companies impacts material to society and the environment at large ('Inside out'). When we talk about materiality in this context, specific reference to made to capture both financial materiality (as we have known it previously), as well as impact materiality. As well as calling out that this is both upstream of the company (Its supply chain), but also downstream (Its customers, the future use of a companies products). In other words, what are the material impacts across the entire value chain, regardless of contractual relationships. That pretty broad.
The Future
The intended purpose of the legislation is to drive future change, and therefore as well as reporting on historic performance, we must also look to the future and the plans and actions companies expect to take to realise improvements across environment, sustainability and governance. The principles highlight that we must link the past, present and future, reporting progress made against the last years baseline on a consistent basis, and consider short-term (1 year), medium term (2-5 years) and long term (greater than 5 years) actions plans and targets that the organisation has.
If this sounds a lot to you like your ESG processes will follow a similar track to your company financial planning and reporting processes. We tend to agree. Perhaps therefore the question to ask is, well should companies be looking to extend upon and bring together both their financial and sustainability processes into a connected, efficient approach? This has a lot of merit, especially given the methods and approaches to identifying emissions typically start with financial data and analysis and are estimated based on emissions factors. We introduce and unpack these approaches in our article here which you may find useful reading. Expect more content on where this is heading shortly, for which you can subscribe below to receive.
Assurance
Organisations should apply the fundamental principles of information quality (relevance and faithful representation) as well as the enhancing qualities of information (comparability, verifiability, and understandability).
Sounds cool, what does that mean?
Relevance
This very much refers back to the topic above on materiality, as being the enabling factor to ensuring relevance. Extended upon through the concept of double materiality concept detailed above.
Faithful Representation
Company directors are responsible to ensure that information is complete, neutral and accurate. Meaning it should not be selective or bias to create a positive stance, giving equal weighting to the bad as the good, as well as the risks, as well as the opportunities.
How to handle
Given the subject matter and the limitations on measurement and the need for estimations. Companies must identify the limitations and uncertainty that exists and work to resolve and enhance their accuracy where possible to do so. Meaning, get started and be shown to be improving and iterating your maturity such that it leads to enhancements to improvements in data quality to ensure it can be compared, verified and understood.
The need for these factors stresses the importance for the processes of preparing the information to be traceable and repeatable such that companies can validate and form a suitable opinion on its accuracy. As a result, companies should choose a method which is logical and understandable, that resides in their control, rather than relying on third party heavily standardised and nontransparent solutions. The company should own and manage the solution to be able to provide this level of assurance.
Support
We are working with EU based companies to support them in their ESG journey, with technology solutions that drive accurate measure and report, importantly which is tailored to their business and industry needs and with calculations that are verifiable and explainable, from wherever their starting position. As well as future looking planning solutions that can support turning strategic initiatives into actionable plans that drive real sustainable change in their organisations.
If you would to discuss your particular circumstances, feel free to message me directly or visit our website here to find out more.