The EU is introducing legislation that will require companies to report on their non-financial sustainability information. The Corporate Sustainability Reporting Directive (CSRD) is considered to be a building block to achieve global agreements to counter climate change in the Paris Agreement and the EU wide ‘The Green Deal’ strategy. Both of these ambitious but necessary international initiatives have goals to limit the global average temperature rise to 2 degrees celsius, with efforts to limit it at 1.5. The CSRD is a means to an end when it comes to achieving these goals.
The directive will be rolled out in a phased approach where large companies are affected first. Under CSRD legislation, the sustainability performance of EU businesses will be subject to reporting standards that can be compared to current financial reporting. This new regulation will allow others to objectively assess the state and behavior of a company, compare it with others, and counter greenwashing. The EU CSRD is therefore expected to become a value driver for forward-looking businesses.
CSRD is a more ambitious update of the Non-Financial Reporting Directive (NFRD) already in place. With these requirements, the EU will become the global frontrunner in sustainability reporting as the continent is setting an example. This affects companies because their impact on the environment will be made visible and openly accessible to everyone.
The EU came out with the European Green deal with the ambitious goal of becoming the first “Net-Zero” continent by 2050. Meaning that individual states and companies will need to become leaders in the transition towards a sustainable European economy. The first sub-goal set on the road towards “Net-Zero” is stopping the increase of CO2 emissions by 2025 and reducing emissions by 55% until 2030. The main strategy to achieve this is to reorient capital flow towards sustainable development and investment. Meaning that the EU wants investments to flow towards those initiatives and businesses that will provide sustainable solutions and contribute to the halt and reduction of CO2 equivalent emissions.
How do you change the direction of capital flow? - Through reliable and available information.
The EU has been trying to make non-financial information more readily available and consistently reliable with several initiatives:
With this first international goal approaching fast it is becoming more important every day to create substantial change. However, current initiatives are falling short in efforts to achieve that change.
Originally, the NFRD had the purpose of promoting openness about the corporate social responsibility (CSR) of a business. However, many stakeholders (including investors) found this level of reporting standards to be incomplete and missing vital information. It was indicated that the current initiatives have several shortcomings that have led to disappointing results:
As a result of these shortcomings, users of non-financial information are not able to accurately predict sustainability performance and related risks of their investments. This effect was specifically noticeable between different member states of the Union. Subsequently, it has been impossible for the capital to consistently flow towards sustainable and inclusive growth and development which slowed down the process of reducing GHG emissions.
The EU is upgrading the regulation that is currently in place (NFRD) with the new, ambitious and stricter CSRD because the transition towards a sustainable economy is happening at a pace that is too slow. By tightening the ropes the EU is attempting to now not only incentivize, but also force companies to be transparent about their sustainability performance.
The biggest changes from NFRD to CSRD are:
With the new CSRD regulation the EU is attempting to decrease discrepancies, increase transparency and promote sustainable behavior throughout the entire continent.
The EU has highlighted the following benefits for businesses of increased requirements in the CSRD:
The European Union is backing this up by dedicating 30% of its expenditure to climate-related projects for the coming years. Subsequently, they are now implementing the CSRD regulation to get individual companies to make similar commitments.
The CSRD has sharpened the scope for which companies will be included under this legislation in order to create a significantly larger effect. This will result in an increase of total number of companies that are required to be compliant from 11.000 to more than 50.000.
The question of who and when they have to be compliant is influenced by three company characteristics:
Two out of three characteristics have to be met or exceeded before the organization will be required to report.
All organizations already within the existing scope of NFRD.
All organizations that have a net turnover of €40 million, total assets of €20 million and more than 250 employees.
Separate standards will be published at a later time.
Non-EU undertakings: businesses that have a revenue of €150 million and have a subsidiary company within the EU have to adhere to the same standards.
The EU is going to require companies to adhere to several standards. It must be noted here that some standards have not fully been made available just yet. The European Sustainability Reporting Standard have published the following final draft for reporting standards:
Businesses are required to report on the governance structure of the organization. Think for example about transparency, CEO to average employee wage gap.
Businesses are asked to elaborate on the company business model, strategy and policies in relation to sustainability.
Businesses are asked to describe key performance indicators and targets in relation to sustainability.
Companies are asked to elaborate on the role of sustainability governance within the organization. Think for example about questions in regards to the integration of sustainability professionals in the management team.
Companies are required to report on the concept of how the business impacts the environment and how the environment impacts the business. (E.g. a fishing company impacts fish stock in the ocean, lower fish stock in the ocean impacts profitability of the fishing company).
Businesses have to describe the risks and opportunities in relation to sustainability. This includes climate- and financial risk and opportunities.
The Taxonomy Regulation establishes six environmental objectives
ESRS
To prepare for the coming legislation, many businesses have kicked off their net zero journeys to achieve sustainability leadership today. This consideration is often made over two axes: to gain a competitive advantage in their own markets, and to generate long-term value as a forward-looking business. In other words: achieving a future-proof license to operate. Businesses that haven’t acted yet are recommended to prepare as soon as possible.
Not only do these businesses want to be prepared to meet the minimum requirements, avoid fines and reduce risk from regulatory consequences, but they also want to get ahead of the curve. Businesses that act too late will face the fact that becoming sustainable is a long-term investment where change does not happen overnight.
By taking steps now, the results will show before the first deadlines set by the EU. Once those deadlines pass, the companies that were too rigid and complacent in their decision-making will be exposed as unsustainable entities. Contrary, companies that act now will be leaps ahead of the competition, reap the benefits of their efforts, and create a competitive advantage.
Read more about how becoming sustainable can benefit the planet, as well as your business, here.
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