June 20, 2024

Are you on top of Europe’s new corporate sustainability directive?

Europe has put forward its agenda on sustainability reporting to meet the needs of the current time, and we see it likely that the U.K. will follow suit. Now all eyes will be on the United States and China to see how they respond.

“So what is CSRD?”

Most business leaders we speak with have been at some stage of a journey towards more standardised reporting of sustainability metrics. Typically, this starts with some form of a ‘carbon baseline’ or ‘GHG inventory’ development, followed by a more detailed assessment of risks, opportunities, and potential targets. This task is made far harder by the uncertainty around what good looks like, the large (and increasing) number of ratings agencies, and the lack of consistency in standards. Indeed, one of the most frequent questions we have been asked by Chief Sustainability Officers who are new to the role is ‘what should I be measuring?’. The European Commission made an ambitious (and potentially game-changing) step in the right direction several weeks ago with its latest Directive on Corporate Sustainability Reporting, which aims to standardise and simplify sustainability reporting across the EU.

“Fantastic! What’s changed?”

Here are a few of the highlights:

  • Two-pronged approach: companies are required to report on both climate change related risks to their business as well as the impact that their business has on people and the planet. As a result of this, reporting should reflect the equal weight that many organisations (particularly in the infrastructure space) are already assigning to both topics.
  • Target setting: as part of their disclosures, the 49K companies addressed by the Directive will be required to indicate their sustainability targets and provide supporting plans. This is significant because while public commitments to offsetting and ‘Net Zero’ have doubled over the past year, this growth has not been met with equal expansion in publicly accessible impact reduction strategies. Today, still less than 1500 companies have signed up to the Science Based Targets initiative.
  • Forward looking and retrospective: submissions must include both forward looking and retrospective information, to provide context to their reporting. While this is helpful for a number of reasons, we expect that this will be particular useful as companies face the necessity of re-baselining (and re-visiting targets/timelines) — driven by improved understanding of Scope 3 in particular.
  • Digitisation: perhaps one of the most catalytic requirements of the new Directive, sustainability data must be made available in a machine-readable format and digitally tagged. This will radically improve transparency (and therefore also adherence), especially once integrated with the European Single Access Point proposed by the EC as part of the EC Capital Markets Union Action Plan. **We see this as a game changer for the quantity and quality of rules that ESG investors and ETFs can set when making their investment allocation decisions.
  • Penalties: while in Europe it is likely that pressure from customers, investors, and financial institutions will provide enough external incentive for action, the new Directive requires Member States to institute a penalty regime to enforce compliance. As might be expected, penalties will need to be proportionate to both the scale of the breach and the means of the offending entity.
  • Audit: the new Directive requires ‘limited’ (narrower than ‘reasonable’) assurance or audit of sustainability reporting. While this will be challenging for many, it should help move the state of play forward from the highly variable levels of accuracy prevalent in sustainability reporting data available today — as well as help develop a new field of independent assurance providers (beyond the traditional audit firms).
  • Expanded scope: Although global attention is centred on GHG emissions, the Directive’s scope encompasses a wide area of ‘ESG’ territory. While this is logical and timely, some of the environmental reporting expectations hinge on factors that are particularly complex to measure (e.g., biodiversity, ecosystems, circularity). We expect quantifying these impacts to create growing pains for companies.
Super interesting. How does my company get ahead of things?

For any business sustainability teams wondering how to elevate their sustainability reporting game, there’s some good news: the new Directive is not expected to come into force until at least January 2023, with SMEs having further leeway until January 2026. While this provides some breathing room, it really means just a one-cycle trial run (for 2021–2022). Here’s what we suggest for any companies looking to make the most of it:

  • Focus on materiality. Your highest volume raw materials, biggest supplier relationships, and biggest distribution channels are as likely to drive sustainability impact as financial impact.
  • Measure what you can. Most companies already used the ‘spend-based’ method for reporting their GHG emissions (because it’s easiest). There will be similar proxies for other sustainability metrics.
  • Develop a system. The EC estimates that sustainability reporting will cost large companies EUR 1.2–3.6m. We expect the most cost efficient companies to develop scalable approaches to data management.

Europe has put forward its agenda on sustainability reporting to meet the needs of the current time, and we see it likely that the U.K. will follow suit. Now all eyes will be on the United States and China to see how they respond.

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