While the disclosure of ESG information began as a voluntary practice, we are seeing a shift towards sustainability disclosures becoming mandatory for businesses. In the past, regulators have tended to focus on environmental issues; for example, the EU has adopted the implementation of the Green Deal and Sustainable Finance Agenda. Other regions are similarly introducing environmental regulations, such as the US, where the Securities and Exchange Commission (SEC) has proposed climate change-related disclosure requirements, and New Zealand, which has recently introduced a Climate Disclosure Law. The focus on regulating the E has commonly been at the expense of the S and G, perhaps due to the complexities in introducing disclosure standards for more abstract issues, such as corporate governance, in comparison with environmental topics, such as emissions or water use.
We are now seeing the horizon of regulators widening. It is fair to say the EU is leading the march towards mandatory disclosure requirements across the full range of environmental, social and governance factors. At the forefront of the EU’s efforts is the Corporate Sustainability Reporting Directive (CSRD), which will update and expand on the measures already in place under the Non-Financial Reporting Directive (NFRD).
The CSRD, which has the double materiality concept at its core, will mean that E, S and G disclosures will no longer be voluntary. This marks a shift in the road for regulation, as while the NFRD recommended reporting on social and governance aspects, it had no actual sanctions in place in case of non-compliance. The CSRD, on the other hand, will make reporting across a wider range of ESG issues legally binding for a larger scope of companies.
The good news for companies is that the CSRD will provide greater clarity on the information that needs to be reported, in order to meet investors’ need for globally comparable sustainability information. The NFRD, in comparison, lacked precision in its requirements, and allowed companies to disclose against a variety of frameworks.
The CSRD will introduce stricter reporting requirements under the new EU Sustainability Reporting Standards (ESRS), currently being developed by the European Financial Reporting Advisory Group (EFRAG). The ESRS will establish a reporting framework that will allow companies to report in a systematic and comparable manner, helping them to cope more efficiently with the ever-increasing demands for sustainability information.
This means that companies impacted by the CSRD, especially those that operate in multiple jurisdictions, need to start assessing what disclosure requirements they will face, and will need to start taking steps to ensure compliance with the CSRD. As the pace of regulation continues to pick up, it is increasingly important for impacted companies to get their houses in order, whether that be through a double materiality assessment or a gap analysis against CSRD requirements, so that they are in a position to unlock the benefits of compliance in future.
Author: Jamie Macfarlane