Most of us would readily agree that Europe offers various things that are unmatched in other parts of the world – great cuisines, rich histories, beautiful villages – and, of course, precedent-setting guidance on sustainability reporting.
Recently, the EU parliament adopted the Corporate Sustainability Reporting Directive (CSRD), with 525 votes in favor, 60 against, and 28 abstentions. In other words, it wasn’t a close vote. This means that over the next few years, roughly 50,000 companies that do business in the EU will have to disclose information about the environmental and social impacts of their business operations.
Room for Improvement
The CSRD addresses shortcomings in current legislation regarding the disclosure of so-called non-financial information under the Non-Financial Reporting Directive. The NFRD was perhaps a good start but it has a number of shortcomings. We won’t jump on the bandwagon of NFRD critics because as is often the case when developing entirely new regulations (or building almost anything from scratch), you start with good intentions and create something that has the features you think it needs to have, but you don’t get it right on the first try.
Under the NFRD, large listed companies, banks, and insurance companies in the EU have been required to report their policies on social responsibility. This covers a range of things, from how they treat employees, to their policies on respecting human rights, anti-corruption and bribery, and board diversity. Under the NFRD, companies also have to disclose information about their business models, due diligence processes, risks and risk management policies, and key performance indicators.
While that may all sound good, the NFRD gives companies a great deal of flexibility in meeting its requirements. It does not specify any particular reporting standard or details about what must be disclosed. Therefore, companies have a great deal of leeway in disclosing information in the way they consider most useful (or, at the risk of sounding cynical, most flattering).
Addressing the shortcomings of the NFRD
The CSRD is more specific than the NFRD. It has detailed reporting requirements covering a company’s impact on the environment, human rights, and social standards.
The new sustainability reporting requirements will apply to all large companies, whether listed or not. And – pay attention, multi-nationals in the U.S. and elsewhere – non-EU companies with substantial activity in the EU, defined as revenues of over €150 million will also have to comply. Small- and medium-sized enterprises (SMEs) that are publicly listed will also have to comply but will have more time to report under the new rules.
According to Deloitte, the CSRD includes the following requirements:
• A company’s business model and strategy (including its entire value chain) must be aligned with the goal of achieving climate neutrality by 2050;
• Targets and progress must be science-based;
• Companies must report on the most significant negative impacts of, and degree of exposure to coal, oil, and natural gas-related activities; and,
• Reporting must apply the concept of double materiality, reporting on how sustainability issues affect the business and how the company’s activities impact people and the environment.
The antidote to greenwashing?
One of the key goals of the CSRD is to help stamp out greenwashing by making businesses more accountable for their claims about sustainability. Needless to say, it should definitely be a big help in addressing concerns that funds may claim to be “green” or ESG-friendly without actually having a solid basis for making those claims. In our view, that is essential for sustainable investing to establish long-term credibility. When the information required by the CSRD is made public in a standardized way, it will be much easier to analyze a “green” or “sustainable” fund’s positions with respect to environmental, social, and governance practices.
But there is more to this than helping to ferret out “bad actors” in the sustainable investing space, at least with respect to big companies doing business in the EU. Among other things:
- ESG scores, rankings, and analyses from ratings firms should improve (for companies subject to the CSRD). These firms, including OWL ESG, currently incorporate information from company disclosures that is at best inconsistent between companies, is often vague and incomplete, and at worst can be misleading.
- Funds that rely heavily or solely on ESG scores and rankings to choose and/or weight the stocks they hold will benefit. That means investors are more likely to get what they think they are getting in choosing these funds.
- Active asset managers that pursue an “ESG Integration” approach, meaning they do not rely solely or primarily on ESG scores but instead seek to incorporate ESG factors into their investment processes along with financial and other criteria, will benefit. They will be able to do their analyses using more detailed information and meaningful peer-group comparisons.
- Asset managers who actively engage with company management to discuss concerns or perceived shortcomings regarding sustainability practices will be able to focus their engagement efforts using company-provided information.
Companies will be subject to independent audits and certification, as financial disclosures have been for over half a century (GAAP accounting was invented in 1936, during the Great Depression – not a coincidence), helping ensure accurate data and reliable reporting. Sustainability information will have to be made available in digital format. In this era, it might seem that publishing information digitally would be the norm, but it is good to have this requirement clearly stated. A cynic might think that companies with something to hide would prefer to release a paper report that an analyst would have to pick through.
The CSRD’s rules will apply on a phased basis, beginning in 2024, as follows:
- From January 1, 2024, for large public companies (with over 500 employees) that are already subject to the NFRD, with reports due in 2025;
- From January 1, 2025, for large companies that are not currently subject to the NFRD (with more than 250 employees and/or €40 million in sales and/or €20 million in total assets), with reports due in 2026;
- From January 1, 2026, for listed SMEs and other undertakings, with reports due in 2027.
- SMEs can opt-out until 2028.
We look forward to incorporating information from company reports prepared in accordance with CSRD into OWL ESG’s data and analytics. As with all of our data, our goal will be to make this information available in a highly usable form, combined with all of the other data we obtain by scouring all types of published information from a wide range of sources. Contact us to learn more about our data and processes.