6 ESG Questions Answered: What Is ESG Reporting, and How Is It Changing?
The need to accurately report on Environmental, Social and Governance (ESG) data is growing in importance. Despite existing regulations in the European Union (EU), there is still confusion about what exactly should be included in ESG reports.
The European Commission’s welcomed new proposals for a Corporate Sustainability Reporting Directive (CSRD) seek to address this issue. But why, and how, is the way that ESG is reported changing? Which companies will be affected? And what does it mean for your business?
What is ESG reporting?
ESG reports disclose non-financial data that hold companies accountable for issues of ethical concern. Specifically, these reports demonstrate the efforts that organisations make to reduce energy emissions, combat climate change, increase efficiency of waste management, improve employee health and well-being, support diversity, equality and inclusion (DEI), impact the wider community, ensure fair executive pay, on top of other concerns.
Companies with strong ESG metrics have been benefiting from their efforts. McKinsey and Company points to five ways that ESG creates value: cutting costs (by lowering energy consumption and reducing water intake), reducing regulatory and legal interventions, boosting employee motivation and experiencing an uplift in productivity, optimizing long-term investments and offering top-line growth opportunities.
This last point—the potential for top-line growth—has been reinforced by our recent survey of ordinary investors, which revealed that 50% of British investors, 66% of German investors, and 66% of French investors feel strongly that their moral beliefs must align with a company before investing.
Why is the way that ESG is reported changing?
ESG reporting isn’t new; organisations within the EU have already established themselves as global leaders in ESG. In some ways, this progress can be owed to the introduction of the Non-Financial Reporting Directive (NFRD) in 2017. But the NFRD has also been widely criticized by investors and businesses alike. They believe that the NFRD reporting framework doesn’t provide enough transparency, nor enough assurance; they don’t like that the term ‘non-financial’ implies that there is no financial relevance to ESG data and they ultimately lack trust in the data shown in the reports.
These criticisms are the main drivers behind the European Commission’s new proposals for the CSRD. As a result, financial and non-financial data are going to be inextricably linked.
How will the CSRD change ESG reports?
The main impact of the CSRD will be felt by the CFO. ESG used to be a concern for sustainability or corporate communications teams. But if, or when, the proposals come to pass, it will enter the annual reporting process. The CSRD will cause finance and sustainability to converge, as ESG is merging with the European Single Electronic Format (ESEF). Here are the main headlines from the European Commission’s proposals:
- The EU's sustainability reporting requirements will extend to all large companies and all listed companies (except listed micro-enterprises)
- External audits (assurance) of reported information (‘limited’ assurance) will be mandatory
- The parameters about the data being reported will become more specific, with companies needing to report according to mandatory EU sustainability reporting standards
- CSRD reporting will likely form part of the Annual Financial Report
What does this mean for your business?
In practice, this means that the CFO and their team will need to collect and analyse data from a range of diverse and disparate sources. With non-financial data sitting directly alongside financial data, it’s critical that reporting processes are no longer managed in silos.
Historically, the story communicated by companies about their health and success has been almost fully dependent on financial information. Now, ESG data will add more depth. The organizations that can clearly and accurately communicate their newly enhanced narrative will establish competitive differentiation.
As the CFO starts to think about how to retool their annual reporting processes ahead of the CSRD coming into force, they should do so with a few firm priorities:
1. Establish end-to-end process coverage
Crucially, the CFO needs to have visibility over the entire expanded annual reporting process. They need a strong degree of control so they are confident in the data presented in their final report. If they centralise the process and work from a single platform, they can fully trace all data and related changes from when data first enters their system to when they finalise their reports.
2. Collect and connect any data, from anywhere
They also need to be confident in their ability to gain access to these new data. These are data that sit with non-financial teams and could be spread across multiple offices. By centralising data collection, the CFO can ensure the consistency of data that they need to create investor-ready reports.
3. Build collaborative workflows
The annual reporting process is complicated enough as it is—adding in new data, new teams, new offices, only adds to this complexity. By creating collaborative processes, the CFO will eliminate a lot of wasted time, reduce the need for extensive final checks and improve cross-departmental teamwork.
Who is impacted?
These changes will directly impact nearly 50,000 companies in the EU. Currently, only 11,000 companies are subject to the existing NFRD requirements.
Importantly, this is an EU-only directive. Now that the UK has left the EU, they are focused on mandating the Task Force on Climate-related Financial Disclosures (TCFD). While it’s expected that the proposals in the CSRD should fall in line with those outlined in the TCFD, the eventual UK-specific mandate will only be focused on reporting data that relates to environmental concerns.
When is the CSRD coming into force?
There are a few steps before EU companies will need to ensure full compliance with the mandate. After the proposal has closed and feedback has been received, the European Parliament and the Member States in the Council will then negotiate a final legislative text.
At the same time, the EFRAG (European Financial Reporting Advisory Group) will start work on a first set of draft sustainability reporting standards. Their aim is to have these ready by mid-2022. The date that the mandate will come into force is dependent on how quickly the European Parliament and the Council can progress their negotiations.
Right now, organisations have the opportunity to prepare themselves for change. They have enough time to rethink their annual reporting processes so that they can confidently collect and analyse data from teams that they may have had limited interaction with in the past. If they take the time now to increase agility, develop real-time management capabilities and improve integration across their ecosystem, they will be able to handle these additional requirements with ease.
