Sustainability and ESG are the new buzz words around the globe as we aim to create a better and stronger society for the future. The European Union has set up ambitious sustainability targets that will influence what companies and governments will do in the years to come. The key objectives, as set out in 2019 in the European Green Deal, are to achieve climate neutrality by 2050, to decouple growth from resource use, and for growth to be just and inclusive.
As well as increased regulation, a number of other factors are pushing companies towards greater focus on sustainability and greater transparency. For example, clients are demanding more and more information about how their products are made and how services are delivered. We see mass media and the public at large showing a clear interest in the sustainability performance of companies. Moreover, employees and potential employees are increasingly looking at sustainability performance when it comes to choosing which companies they want to work for. So a well-developed sustainability strategy will help recruitment, engagement, productivity and retention.
But no matter which stakeholder group we are part of, there is one common line – we all need clear, comprehensive and comparable information and reports. Reporting on sustainability is not a new topic, but it is very fragmented. At the base of the pyramid, we have the Global Goals like the UN Sustainable Development Goals, the Principles for Responsible Investment and the Paris Agreement. We are all expected to show our progress against these goals. But when it comes to reporting frameworks, the landscape is very diverse. We have the Global Reporting Initiatives and the ISSB standards, we have the Carbon Disclosure Project and Science Based Targets initiatives, we have the Task Force on Nature Related Financial Disclosure, the Task Force on Climate related Financial Disclosure and many more. So it has become complicated for companies to choose how and based on which standards to report and for stakeholders to understand these reports.
A number of steps have been taken at EU level to promote sustainability reporting, such as the EU Green Taxonomy Directive, and the Sustainable Finance Disclosure Regulation. However, under current legislation, companies in Europe have a free choice of sustainability frameworks. Moreover, there are no requirements for assurance or to disclose information publicly. The result has been that sustainability reports up to now have often been hard to access or find in the public domain, hard to understand for the general public when they are available and also frequently contain a lot of greenwashing.
The Corporate Sustainability Reporting Directive (CSRD) and the proposed Corporate Sustainability Due Diligence Directive (CSDDD) are two examples of how the EU aims to change this. They are of particular importance in promoting increased transparency and in defining a common language for a company’s sustainability performance. They will help make sustainability reporting more meaningful, because businesses can more easily be compared with one another. Although focused on companies of certain sizes, these two Directives will have a domino effect on almost all businesses that will be felt sooner rather than later. Ultimately, they will help to make sustainability reporting as much a formal part of the reporting exercise as traditional financial reporting.
The CSRD will revolutionise the way sustainability reporting is carried out. It will increase the number of companies required to produce sustainability reports by around 320% with effect from 1 January 2024 and apply to even more in subsequent years. But perhaps even more importantly, through the domino effect, the CSRD will influence the life of smaller entities as well, because of its requirements for reporting on supply chains in relation to topics of importance such as climate change, biodiversity and the circular economy.
The new Directive does not ask companies to make bold sustainability commitments, so it does not set targets. However, it does require them to disclose, in a very transparent manner, how they treat important subjects like climate change, employees’ well-being and their internal control mechanism to prevent risks of all sorts. Companies will have to follow a precise set of disclosing rules named European Sustainability Reporting Standards (ESRSs). Furthermore, the sustainability report will have to be part of the annual management report. Limited assurance in the first phases is mandatory with mandatory reasonable assurance expected to be introduced at a later stage.
The ESRSs are currently in draft stage, with expected approval in June, so there may be some modifications. However, these would most likely be minor, so it would be advisable for companies to start preparing now for the new requirements. The first year of reporting under CSRD is in 2025 for the financial year 2024 for companies with more than 500 employees. Companies with more than 250 employees will follow after two years and, later, SMEs will also be covered. However, as we have mentioned, the domino effect means that companies in the supply chain will have to comply with this Directive.
The second upcoming piece of EU legislation which will have a major impact on the sustainability field is the Corporate Sustainability Due Diligence Directive (CSDDD), which was proposed by the European Commission in February 2022. This has a stronger human rights angle than previous legislation, and also aims to make sure that that the Board of Directors is fully engaged in sustainability policies. This new draft regulation is under negotiation, but it basically requires companies to conduct due diligence processes not only on their own operations, but also on their subsidiaries and companies from the value chain with which there is a direct or indirect relationship.
Although this Directive is still in the negotiation phase, its broad principles are clear, and so it would make sense for companies to start preparing for the CSDDD now by taking a few steps towards aligning with its requirements. They should update their due diligence policy, or introduce one if it does not yet exist. They should put in place a code of conduct that should be followed by company employees and subsidiaries. They should also engage with their suppliers to prepare for what is to come.
Sustainability reporting is now widely considered to be as important as traditional financial reporting and legislation is being introduced in the EU and elsewhere to enforce this principle. Businesses need to prepare for new requirements, but should also understand that sustainability reporting is not merely a compliance matter but is increasingly expected by stakeholders and hence is critical to their long term commercial viability.