4 ESG regulations companies need to watch

The EU Taxonomy and the Corporate Sustainability Reporting Directive (CSRD) mark significant milestones in the evolution of sustainability reporting in the European Union. 

EU Taxonomy explained
The EU Taxonomy was published in 2020 with the aim of creating a classification system for determining which economic activities are sustainable and significantly contribute to one or more of the Taxonomy’s environmental objectives. 

These objectives include:

• Climate change mitigation and adaptation
• Sustainable use and protection of water and marine resources
• Transition to a circular economy
• Pollution prevention and control
• Protection and restoration of biodiversity and ecosystems
  

Delegated acts to the Taxonomy provide the technical screening criteria for significant contribution to environmental objectives as well as the templates and instructions on how to calculate and report the Taxonomy KPIs for financial and non-financial institutions (CapEx, OpEx, Turnover, Green Asset Ratio and others).

CSRD explained
Proposed by the European Commission in 2021, the CSRD builds upon the existing Non-Financial Reporting Directive (NFRD), and it aims to enhance transparency and the quality of reporting on environmental, social, and governance aspects by companies.

The directive was developed to address gaps and weaknesses in the existing NFRD. It is part of the broader EU efforts to promote a more sustainable economy and improve the integration of environmental and social factors into corporate decision-making processes. 

The 3 main CSRD objectives:

• Increasing transparency 
• Enhancing comparability
• Strengthening corporate responsibility

The introduction of the CSRD rings in a new era of sustainability reporting and will have significant implications for companies and their stakeholders. 

Companies will need to revise their reporting processes to ensure compliance with the new requirements. They will need to assess their operations through double materiality – which consists of impact materiality (how an entity affects its environment) and financial materiality (how the environment affects the entity and its financial position). These developments call for investments in data collection, management, and auditing systems.

European Sustainability Reporting Standards (ESRS) were developed by the European Financial Reporting Advisory Group (EFRAG) and are in the process of being published as a delegated act in the Official Journal of the European Union. They represent a crucial element of the CSRD and are being hailed as the evolving standards for corporate sustainability reporting activities. If you have not already, we assure you that you will hear about it everywhere soon.  

For the first time ever, ESG information and corporate sustainability disclosures must be reported in a standardized, comparable, and more consistent format across the EU – just like financial reporting.

What are the major challenges and opportunities for affected companies?

• Double materiality: The idea that both the financial impact and the impact on society and the environment must be considered when assessing the materiality of an issue.
• Connection to EU Taxonomy: ESRS requires disclosure of information in accordance with the EU Taxonomy, especially the Taxonomy KPIs (NFRD- and CSRD-affected companies are automatically in the scope).
• Wide-ranging information requirements: Forward-looking and retrospective information as well as qualitative and quantitative information shall be included. Where applicable, also information about the company's value chain, including its own business activities, products and services, its business relationships, and its supply chain.
• Mandatory external assurance: Requirement for external audit of sustainability information (first years only limited assurance needed). Ultimately, it should be the same level of assurance like it exists with financial data.
• Sustainability reporting in management reports: Mandatory disclosure of sustainability information in the management report requires a change in terms of reporting structure (inclusion of new and different types of information).
  

Fundamental changes to the adopted delegated act compared to the draft EFRAG ESRS

• Material and mandatory disclosures: General mandatory disclosures are only required for ESRS 2 (General Disclosure). The other standards are now all subject to a materiality assessment.
• Additional phase-ins: Certain opt out possibilities for the first year of reporting have been defined. 
• Voluntary disclosure requirements: The Commission has further converted several mandatory datapoints proposed by EFRAG into voluntary datapoints (i.e., why the company has deemed a particular sustainability topic to be non-material). 
• Further flexibilities in certain disclosures: For example, financial effects arising from sustainability risks, on engagement with stakeholders, and in the methodology for the materiality assessment process.

The issuance of sector specific standards for SMEs and standards for non-EU companies in scope was originally scheduled for mid-2024, however, the latest update from the European Commission’s 2024 work programme pushed it for 2026.

The Corporate Sustainability Due Diligence Directive (CSDDD) focuses on mandatory human rights and environmental supply chain due diligence for companies. The Directive requires setting up due diligence processes to identify adverse impacts. Developing and implementing prevention action plans, obtaining contractual assurances from their direct business partners, and subsequently verifying compliance will be necessary. 

What is the difference between the CSDDD and CSRD? 
The EU’s recent Corporate Sustainability Reporting Directive and Corporate Sustainability Due Diligence Directive are closely linked, with both pieces of legislation working together to reinforce each other – and to ensure that matters related to human rights and environment are properly assessed and implemented by entities in their own operations and value chains. 

While the CSRD covers the reporting phase, the CSDDD ensures companies integrate proper procedures and assessments of their efficiency. 

Why CSDDD?
This harmonized legal framework within the EU

• protects human rights
• increases trust in businesses
• improves risk management and adaptability
• helps companies be more transparent about their negative impacts on the environment

It is the company's responsibility to identify, stop, prevent, mitigate, and account for negative human rights and environmental impacts in its own operations, subsidiaries, and value chains. 

What are the necessary steps for companies?

1. Integrate due diligence into their policies 
2. Identify actual or potential adverse human rights and environmental impacts 
3. Prevent or mitigate potential impacts 
4. End or minimize actual impacts 
5. Establish and maintain a complaints procedure 
6. Monitor the effectiveness of the due diligence policy and measures 
7. Publicly communicate on due diligence 
   
   

A status quo update
We don't know what the final CSDDD will look like. What is clear however, is that at some point (most likely end of 2025), companies will need to implement human rights and environmental due diligence to all the entities in their organization – plus their supply chain. Moreover, they will need to demonstrate to external stakeholders that they have done so. 

Now that the plenary of the European Parliament has finally adopted its position in June, the so-called ‘trilogue’ negotiations with the Council and the European Commission have started. The outcome of these negotiations will shape the final version of the CSDDD.

Double materiality refers to the idea that both the financial impact and the impact on society and the environment must be considered when assessing the materiality (assessment of relevance of specific information for corporate reports) of an issue.

Impact materiality involves identifying sustainability matters that are material in terms of the impacts of the entity's own operations and its value chain (inside-out view), based on the severity and likelihood of actual and potential negative impacts on people and the environment. 

In addition, an entity is exposed to environmental risks which affect their operations and position: Financial materiality (outside-in view). A sustainability topic is material from a financial perspective if it triggers financial effects on undertakings, i.e., generates risks or opportunities that influence or are likely to influence the future cash flows and therefore the enterprise value of the undertaking in the short, medium, or long term, but are not captured by financial reporting at the reporting date. 

What are the benefits of incorporating double materiality into your materiality assessment?

1. Improved risk management: Companies can better identify and manage risks that could affect their long-term success. This can help companies avoid costly disruptions and reputational damage.2. 
2. Enhanced stakeholder engagement: Companies can better engage with stakeholders, such as customers, employees, and communities. This can help build trust and support the company's activities.3. 
3. Long-term value creation: It can help ensure that the company is creating long-term value for both shareholders and society. By addressing non-financial impacts, such as environmental and social risks, companies can create a more sustainable and resilient business model.4. 
4. Improved reporting: Companies can provide more comprehensive and transparent reporting to stakeholders. This can help build trust and accountability and improve the company's reputation.5. 
5. Regulatory compliance: Many countries are now requiring companies to report on non-financial impacts. By incorporating double materiality, companies can better meet reporting requirements.

What are challenges or issues your company may face?

• Lack of standardised metrics: Unlike financial metrics, which are well-established and standardised, non-financial metrics can be more difficult to measure and compare across companies and industries.
• Complex stakeholder expectations: Different stakeholders may have different expectations about what constitutes a material impact. It might be challenging for companies to identify which issues are truly material and how to prioritise them.
• Limited resources: Conducting a comprehensive materiality assessment can be time-consuming and resource-intensive, particularly for small and medium-sized enterprises that may have limited resources to devote to non-financial reporting.
• Inconsistent regulatory requirements: While many countries are now requiring companies to report on non-financial impacts, there is still significant variation in regulatory requirements across countries and regions. This can make it challenging for companies to develop consistent reporting practices.
• Risk of greenwashing: Companies may face the risk of greenwashing or making false or misleading claims about their environmental or social impacts. This can erode trust and credibility with stakeholders and harm the company's reputation.
• Lack of materiality expertise: Incorporating double materiality requires a high level of expertise in both financial and non-financial reporting. Companies may need to invest in training and hiring staff with these specialised skills.

“The regulatory environment is ever-changing and dynamic – that is why we want to provide our customers with up-to-date information, curated by our RBI Regulatory Advisory team,” explains Teodora Radosavljevic, Group Supervisory Affairs & Regulatory Governance at RBI, “Our goal is to help clients navigate the complex landscape of ESG regulations and reporting standards.”