In the last several years, the world has been going through a so-called green transition, which is so far successful but not too much. The Paris Agreement laid down specific goals and set challenging targets, and business was identified as the main driving force behind the changes. But business means people, which is why it was quick to see what actually works in action, what looks good only on paper, and where there are some serious gaps. This very same business today is caught up by norms and regulations that dictate how to measure all the environmental impacts and define a business as sustainable or not.
Once again, experience showed that the companies’ successes and failures can be questioned. It turns out that the evaluation methods can be applied differently, and that standards are vague, which makes it acceptable for everyone to „make them up“. This, of course, was not left unacknowledged by the European institutions and led to new regulations that aim to create order into chaos. The result is that businesses that are still getting used to the application of current ESG requirements and policies will face new or revised regulations. And if you think that none of this concern you, read until the end – here are the new requirements.
CSRD – have you checked if you fall under this new European directive?
It is entirely possible that your business will soon have to report according to CRSD or Corporate Sustainability Reporting Directive. The directive was adopted by the European Council and the European Parliament in June and actually complements the pre-existing Non-Financial Reporting Directive. Not only will more companies have to report ESG information, but it will also have to be easily comparable. In short, finances show how profitable or unprofitable a business is. However, when finances do not play a role, it is again about finding a way of evaluating and estimating the achievements or the losses, which can be seen most easily through numbers. How will this happen? By adhering to a common European standard for reporting sustainability-related information, which is precisely what this new directive introduces.
It is estimated that the CSRD will cover nearly 50 000 companies, many of which were not falling under the pre-existing regulation. The old rules obliged public companies with more than 500 employees to prepare and submit a report, but now the threshold drops by half – requiring all companies with more than 250 employees and more than €40 million in turnover and/or €20 million in assets to publish audited sustainability reports that follow the new European standard. For companies listed on the stock market, the requirement remains, with the exception of companies with fewer than 10 employees.
Companies already covered by the existing NFRD are expected to publish regular verified reports on their environmental and social impact activities from January 1, 2024. „Newcomers“ are required to begin on January 1, 2025, reporting their impacts for 2024. This means that if you really fall under this new directive and are not yet doing anything about it, you will be significantly late. From 2026, the reach of the directive will broaden again, as the Commission plans to create a sustainability reporting standard for small and medium-sized enterprises, as well.
However, here comes the problem with measuring indicators. There are different standards by which you can activate your ESG strategy. The most common one, not only in Europe but globally is GRI, which accounts for over 50% of the reporting. But there are others, with different methodologies and therefore different conclusions. Against this backdrop, the European Union is developing an entirely separate European standard that applies across the community. This raises the question of how comparable this standard will be to the others, whether there will be two types of reporting, and what should companies that already have a history of sustainability management do: should they change their data collection and reporting? These questions are still unanswered, and the final version of the European standard is expected to be presented in November 2022.
Taxonomy – for those who wanted it (or not)
The EU Taxonomy Climate Delegated Act, or simply the Taxonomy, is not something new, but business is just beginning to feel its repercussions. This document identifies which activities contribute the most to Europe’s environmental goals and guides investors on where to invest their money. In addition, the Taxonomy introduces disclosure obligations for companies and financial market participants.
Similar attempts have been made before. Again, we are talking about an act that makes things clearer and more regulated by relying on experience. For example, in terms of the criteria for verifying which activities are sustainable and which are not, there are two options. On the one hand, the decarbonization of companies is taken into account, and what they have actually done to reduce carbon emissions. On the other hand, we look at something that has long been talked about, but far less often outlined in a clear way – adaptation to climate change. Yes, the climate is changing and so are the ecosystems, and a business’ ability to adapt to these changes is a part of its sustainability. For instance – if you develop a business in an area that is frequently flooded, you can turn things in your favor and start growing rice.
Large companies in Europe are now obliged to find if they are within the scope of the Taxonomy and see how sustainable their activities are. Banks and other financial market participants can use this information to determine which businesses are sustainable and which are not. Thus, the European institutions are now under their rule – they hold the money and decide which companies to finance. And their capital can now benefit the companies that prove they follow the ESG policies.
Taxonomy, however, reveals a major weakness that is often seen in ESG reporting – the regulation is mainly devoted to the environmental aspects while the social and corporate aspects are simply highlighted and barely touched upon.
CSDD – business as a responsibility
The European Commission introduced the Corporate Sustainability Due Diligence (CSDD) earlier this year. In short, it seeks to change corporate behavior from within by making companies more accountable. Companies within the scope of the CSDD must have established mechanisms to identify the real and the potential negative impacts on human rights and the environment and to implement the necessary measures to prevent them.
At the root of all this is the notion that a business does not exist in isolation but is linked to suppliers, transportation, manufacturers, and others who also have their impact on society and the environment. Companies are expected to require their partners to follow the company’s rules and code of ethics, or otherwise replace them. This entire approach comes from the European Commission’s decision to enforce its regulations through big businesses, which pressures the smaller ones.
The CSDD is currently going through various stages of approval in the EU and may undergo changes. It is expected to cover tens of thousands of companies in the community and around 4,000 companies outside the union, most of them from the UK. However, the impact of the regulations is likely to be felt by smaller companies that are affected indirectly, simply because they are linked somewhere along the chain to larger ones. Control continues to be the main question – Member States need to monitor whether all these requirements are met, yet this is expensive and will take time.
The main idea behind all the changes and new regulations we have talked about so far is to merge sustainability reports with annual reports of companies – along with the financial results and all the other reporting parameters that make up the public image of a company. All of this will help investors, consumers, politicians, and all stakeholders to assess both the financial and non-financial outcomes of a business. The purpose of these results is to encourage companies to develop and implement more responsible and sustainable methods in their work. The question concerns the approach – how do you convince someone that something is good for them, and can you really prove it?