By ESG Analyst Clara Coeudevez
1. Non-financial reporting
For a company, non-financial reporting means communicating the social, environmental and societal implications of its activities, as well as its mode of governance. It is an important foundation of a company’s CSR policy, and involves its relationships and activities with its stakeholders: customers, suppliers, employees and government.
For a long time, corporate reporting documents consisted exclusively of financial data, which sparked interest among shareholders and investors. Overall, financial and economic issues were immediately taken into account in corporate regulations and reporting obligations. With the realization that corporate activities generate not only economic and financial consequences, but also social and environmental ones, the idea of the need for companies to publish non-financial information has gradually gained ground at national, European and international levels, giving rise to the drafting of various regulations.
Following the concept of Corporate Social Responsibility (CSR), which came to light in 1950s, non-financial reporting was first developped in the 1970s and 1980s, in response to increased scrutiny induced by the corporate behaviours in specific industies, such as defense or tobacco. CSR as self-regulated reporting followed, with a focus on internal corporate ethics, philanthropy, and to a lesser extent, social and environmentally friendly policies. Then the focus has shifted from internal decisions, to more strategic and measurable external impacts
Today, non-financial reporting has evolved towards more standardized reports, which include ESG, Social Impact, DEI and CSR. Organizations such as the IFRS Foundation with the ISSB (globally), the SEC (in the United States) and the ERFS (in Europe) are involved in projects to standardize non-financial reporting, accross industries and countries. For larger companies, reported data needs to be audited by third-parties. Beyond the need for reporting, companies that put in place strong ESG strategies, and successfuly audit them, yield better financial result, find themselves more adaptable and benefit from improved risk management.
2. What is the CSRD?
The Corporate Sustainability Reporting Directive (CSRD) is a European Union directive designed to regulate and improve the disclosure of sustainability-related information by listed companies and large entities. The directive is designed to meet the growing demand for transparent, reliable and comparable data on companies’ environmental, social and governance (ESG) performance. Concretely, it requires them to monitor and publish an ESG (environmental, social and governance) report alongside their financial statements, thus giving as much importance to the sustainable dimension as to the economic dimension of their activities. Therefore, the period and scope of non-financial reporting are aligned with those in force for financial statements, and their publication will be made in a specific section of the management report. The project is set to come into force in 2024, and will require the companies concerned to communicate annually on their information relating to CSR issues.
The draft standards were drawn up with the close involvement of investors, companies, auditors, civil society, trade unions, academics and national standards bodies, whose opinions were gathered during public consultations held on several occasions prior to validation by the European Commission.
The CSRD aims to harmonize disclosure practices across the European Union by establishing clear and binding standards for the companies concerned. The aim is to improve the comparability of information between companies and facilitate analysis and decision-making for stakeholders. To achieve this, the use of international disclosure standards, such as those of the Global Reporting Initiative (GRI) and the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) is encouraged.
The directive introduces specific reporting standards for various areas of sustainability, including climate change, biodiversity, Human Rights and other relevant ESG issues. These are the 12 ESRS (European Sustainability Reporting Standards), in the version approved by the European Commission.
The CSRD reinforces requirements for the verification of non-financial information, in order to improve the reliability of reported data. One of the major changes brought about by the new directive is also the requirement throughout Europe for non-financial information to be verified by the statutory auditor (or an independent third party), providing limited assurance at first, then reasonable assurance in a few years’ time.
Double materiality
Double materiality is the cornerstone of the CSRD. All ESG criteria (climate change, biodiversity, social issues, governance, etc.) will be subject to a double materiality analysis:
– Financial materiality: taking into account the positive and negative impacts of sustainability issues on the company’s financial performance.
– Impact materiality: taking into account the positive and negative impacts of the company on its economic, social and natural environment.
This dual materiality analysis should enable companies to identify the main areas where the external environment or their activities induce impacts, risks or opportunities in terms of ESG sustainability. If significant, these impacts, risks or opportunities should be included in the company’s non-financial reporting. In short, the double materiality analysis is the starting point for CSRD reporting.
3. Interoperability with other sustainability reporting initiatives
For several years, the Europe Union, through the NFRD and then the CSRD, has been at the forefront of ESG reporting, pushing other initiatives to accelerate towards standardization of sustainability information.
In the United States, the Securities and Exchange Commission (SEC) published draft rules in April 2022 on climate-related information to be published in registration documents for listed companies.
In 2021, the IFRS Foundation created the International Sustainability Standard Board (ISSB), a second branch alongside the IASB, which has been developing IFRS financial standards for 20 years. The ISSB is due to finalize two draft standards on sustainability disclosures in 2023: one on general rules and the other on climate. Therefore, at this stage, the standards’ scope is limited compared to the ones covered by the ESRS. Furthermore, these two draft standards, which are the result of a private initiative, will need to be adopted by jurisdictions before they can be applied, although Europe and the United States have already chosen to develop their own standards for reasons of sovereignty on subjects that affect public policy.
In this context, interoperability between these different standards represents a major challenge for reducing the reporting workload of global companies. The three climate initiatives are inspired by the Taskforce on Climate-Related Financial Disclosures (TCFD), and are therefore relatively convergent.
The CSRD and its ESRS are, however, more ambitious by definition: firstly, because they already cover all ESG themes, as well as material information for the companies, society as a whole and the environment, whereas the ISSB and SEC standards drafts are, so far, are more focused on the financial materiality of climate; secondly, because Europe is seeking to combat greenwashing by reinforcing the comparability, reliability and auditability of ESG information. In doing so, it is naturally becoming more granular and precise in its requirements. For all these reasons, a CSRD objective would be to ensure that a European company meeting ESRS requirements is also compliant with SEC and ISSB transparency requirements.
4. Conclusion
The scope of the Corporate Sustainability Reporting Directive (CSRD) mandates companies, both inside and outside the European Union (EU), based on their size and location of activities, to comply and report on ESG issues. According to research published in the Wall Street Journal*, more than 1,000 Canadian companies are expected to match the criteria and will have to report. Complying with the CSRD will not only prevent companies from facing financial penalties and reputational damage, it is a challenging and strategic way to assess the impact of current ESG policies, and work with actors along the value chain on how to improve the business’ sustainability.
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