More meaningful corporate sustainability reporting required in business decisions
The backtracking by lawmakers on mandatory requirements for corporate reporting could undermine the original intention of the Corporate Sustainability Reporting Directive, users of disclosure statements fear.
Corporate reporting on sustainability matters is grossly inadequate. Despite clarifications by global accounting and auditing bodies, discussion and quantification of financially material sustainability risks and opportunities remain largely absent from statutory financial reporting. And, owing to the lack of legally binding standards pertaining to non-financial reporting, companies selectively disclose information in sustainability reports to weave self-serving narratives that too often bear little relationship to their actual impacts.
Stakeholders and any other parties that rely on these statements – from providers of conscious or not-so-conscious capital, to non-governmental organisations promoting environmental or human rights protection – lament the lack of relevant and reliable data to support their investment and/or engagement activities.
The realisation that climate change could present financial risks to the economy and that sustainability considerations were becoming an integral part of investment management has steered the activity of regulators and standard setters towards enhancing climate and other sustainability disclosures by and for investors.
Jurisdictions concerned with promoting a transition of economic activities towards resilience to and mitigation of unfolding environmental crises are also using sustainability disclosures to encourage the integration of sustainability issues into business decisions.
Among major jurisdictions, nowhere is this rule-making activity more advanced than in the EU. Recently, however, corporate lobbies have driven lawmakers to backtrack significantly on sustainability legislation, including reporting, to the dismay of users of sustainability information.
On July 31 2023, the European Commission adopted the Delegated Act, laying out the first set of European Sustainability Reporting Standards under the Corporate Sustainability Reporting Directive.
The CSRD succeeds the Non-Financial Reporting Directive, which mandated fewer than 12,000 EU entities to publish non-financial statements that required neither standardisation nor audit. It imposes sustainability reporting standards and assurance upon nearly 50,000 companies – EU-listed companies excluding micro-enterprises; large companies whether European or subsidiaries of non-EU groups; as well as insurers and credit institutions.
Materiality issues
The CSRD upholds the “double materiality” principle that has been the hallmark of the original EU approach to sustainability reporting since the NFRD. Under the approach, entities are required to report not only how environmental and social issues create material financial risks and opportunities for them (financial materiality lens), but also how their activities and value chains affect people and the environment (impact materiality lens).
Crucially, the ESRS requires an entity to disclose the process it applies to identify its sustainability impacts, risks and opportunities and assess their materiality. This materiality assessment promotes genuine integration of sustainability considerations into strategic management and guards against companies resorting to a tick-box approach to disclosure.
However, contrary to the spirit and letter of the CSRD, and to draft rules developed with multi-stakeholder support by the commission’s technical advisers, the ESRS falls short of imposing mandatory disclosure of the core sustainability indicators that financial institutions require to comply with the extant EU sustainability regulation.
Reporting entities are allowed to disclose voluntarily in respect of certain environmental and social issues that are central to the bloc’s sustainability commitments and ambitions; they may withhold disclosures pertaining to issues they deem non-material (without having to disclose the details of their assessment, except in respect of climate change issues); and they enjoy flexibility in respect of required disclosures.
There is widespread concern that such leeway threatens to undermine the intentions of the CSRD to increase the availability and quality (relevance, comparability and reliability) of corporate sustainability information and combat greenwashing. These concerns are well placed, as assurance and supervisory practices in the field will require strong guidance and sufficient time to reach a high level of rigour.
The commission’s technical advisers have been tasked with rapidly producing guidance on materiality assessment, while the International Auditing and Assurance Standards Board is inviting feedback on its freshly unveiled proposal for a standard on sustainability assurance.
Materiality being in the eye of the beholder, guidance should recommend the disclosure of materiality criteria and thresholds, and promote the adoption of science-based references whenever possible. For the same reason, representatives of various stakeholders should convey to organisations tasked with assisting preparers and auditors that certain information should be disclosed irrespective of their materiality to the reporting entity, and they should contribute to identifying minimal disclosures and disclosure thresholds where possible.
The ESRS expects materiality assessments to be informed by dialogue with affected stakeholders and users of sustainability statements. Anchoring such entity-specific exercises on insights drawn from collective efforts would make good economic sense.
While investors and other users of sustainability information have legitimate cause to be disappointed by the lawmakers’ backtracking on mandatory disclosures, their commitment and efforts to promote the adoption of guardrails for sustainability reporting and assurance can still pave the way for the eventual fulfilment of their needs.
Frédéric Ducoulombier is director of the EDHEC-Risk Climate Impact Institute