How the EU is So Far Ahead with Corporate Sustainability Reporting, and Why We Need to Catch Up
ESG investing, net-zero targets and double reporting: what does the future hold for the U.S.?
As U.S. companies await formal SEC or state direction on environmental, social, and governance (ESG) matters and sustainability standard reporting, the European Union has made dramatic headway in strengthening sustainability disclosure.
The EU’s Corporate Sustainability Reporting Directive (CSRD), in effect by the end of January 2024, outlines certain guidelines to both encourage ESG transparency in the financial market and help combat rampant greenwashing among European organizations. It also works to track a company’s environmental goals and their sources of growth and risk.
The significance of corporate sustainability reporting in today’s economic climate is irrefutable; ESG “ethical” investing and sustainability strategies have skyrocketed as global climate challenges and calls for equity and inclusion make inroads on the corporate landscape. Combating climate change and promoting corporate social responsibility requires decisive actions from both global business leaders and stakeholders, including reporting transparency and social awareness in ESG areas.
For U.S. companies without operations in the EU bloc, ESG and climate disclosure standards remain cloudy. As conservative politicians and business leaders push against the “woke scam” of ESG investing, recent delays to the SEC’s proposed Climate Related Disclosure Standards have left U.S. companies in wait for the new April 2024 deadline.
With the U.S. lagging behind as sustainability reporting grows in relevance, two important questions arise: how does mandatory reporting look like around the globe, particularly in the EU? And without mandatory reporting frameworks, what are some next steps for U.S. companies?
The EU’s Reporting Standards
The EU introduced the European Green Deal in 2019, with the hope of accelerating the development of a sustainable economy in the region through policymaking. Improving sustainability reporting practices throughout its member states is a primary goal.
The Green Deal put sustainability reporting into effect for member nations. Under the new CSRD, large and listed companies operating within the EU must disclose a comprehensive set of ESG indicators in yearly non-financial reports. In-scope companies will be required to report on ESG and human rights matters, and how they affect growth, productivity, and position through a phased process.
The CSRD, adopted by the EU in January 2023, is the newest amendment to the Green Deal’s sustainability reporting provisions. The CSRD standards expand upon the EU’s Non-Financial Reporting Directive (NFRD), which introduced non-financial reporting requirements in 2016 for a relatively small portion of large-listed companies and public-interest entities. Included within a completed NFRD report are performance markers and comprehensive ESG indicators such as diversity, treatment of employees, and environmental considerations.
The CSRD extends the relevance of the NFRD to a broader spectrum of mandatory reporters, and in-scope companies will be required to address a wider array of ESG interests. These include presenting thorough descriptions of time-bound sustainability targets to comply with the Paris Agreement, principal risks related to sustainability initiatives, and demonstrating the resilience of the company’s business model to these risks.
Issues With the CSRD
While CSRD reporting requirements will roll out over time starting in January 2024, building compliance capability is a large operation requiring massive data collection and verification, cross functional collaboration, and in most cases, completely new reporting infrastructure. Some companies may need to disclose over 1,000 concrete items.
Since regulations like the CSRD are enforced to create more rigorous and reliable non-financial reporting, the previously unstructured methods of data collection are no longer adequate. This company data is normally stored in numerous formats, in multiple systems, applications and sources, sometimes involving multiple third parties. While financial data is typically stored in the rows and columns of accounting systems, non-financial data is far more sophisticated.
Enhanced data collection technology will play a large role in the future of reporting. Data from Deloitte shows that standardized software tools to help track ESG metrics will likely pass US $1 billion this year as EU and US reporting regulations take effect.
Another issue that arises is double reporting, namely between international and national sustainability standards. With future reporting requirements and standards instituted by individual national governments, multinational companies may have to issue multiple sustainability reports to successfully adhere to all ESG reporting standards in every place they operate.
Under the CSRD, European companies will not need to separately report under ISSB standards, but the same might not be said for future ESG reporting in other global regions. This may result in double reporting, triple reporting, or more instances depending on where a company has locations.
International Reporting Standards
As regulations currently stand, the EU is at the forefront of mandatory sustainability reporting, while all other regions and national governments rely on voluntary reporting regulations and non-mandatory International Sustainability Standards Board (ISSB) frameworks. ISSB frameworks were solely created to provide stakeholders with the means to make informed decisions about an organization, and not necessarily to promote sustainability initiatives.
Due to their voluntary nature, crucial industries like textile and oil continue to evade sustainability reporting, even though data shows that stakeholders are increasingly requesting ESG information contained in these reports.
Investors around the globe are hesitating before building portfolios with ESG-unaware companies. According to a survey by McKinsey & Company, 60% of surveyed Chief Investment Officers evaluated their overall portfolio for ESG considerations, and about 80% reported assessing individual company positions in the context of how ESG affects forecasted cash flows. A significant portion stated that they are willing to pay a premium for companies that show a clear link between their ESG efforts and financial performance.
Even with international ISSB standards in place, they are currently weaker than many business leaders and policymakers would like. Not within the reporting requirements are industry-specific data, more robust human rights considerations, and environmental concerns such as biodiversity impact. ISSB standards are also historically susceptible to greenwashing.
The idea of instituting international standards is still a sound one, and in good news, materialized fairly quickly — the board held its first meeting in late 2021, and released its first standards in June 2023. Its challenge will be broadening the scope of international sustainability reporting in the future, and complementing the emergence of national standards like the CSRD.
The UK, Australia and Japan are currently drafting national regulatory frameworks similar to those of the EU, some aligning with the ISSB more than others. Double reporting is still of great concern for lawmakers and business leaders
Where Does the U.S. Stand?
Sustainability reporting is not mandated by legislation in the U.S. as of January 2024, but there are two voluntary reporting structures in place for U.S. companies–one on behalf of the U.S. Taskforce on Climate-Related Financial Disclosures (TCFD), and the Greenhouse Gas Protocol (GHG Protocol).
The TCFD takes into account climate related issues and their effects on company performance, particularly in governance, strategy, risk management, and metrics. It does not advocate net zero or other sustainable goals, and does not take into account corporate social responsibility. The GHG Protocol solely deals with the accounting and reporting of carbon emissions.
With clear gaps in reporting area, the SEC attempted to propose additional mandatory regulations for sustainability reporting in 2022. The frequent pushback in response has slowed the process down, and the April 2024 deadline is hardly a concrete one. Even without formal regulations, many U.S. companies are aware of the rise of ESG investing and corporate responsibility, and do report.
Recognizing the importance of sustainability reporting, many private companies voluntarily disclose sustainability information through the nonprofit Carbon Disclosure Impact Worldwide (CDP). Participants obtain a CDP score, quantifying preparedness of companies for a deforestation-free and water-secure future, as well as overall adherence to the Paris Agreement. This CDP score is not sufficient to grasp the larger picture of a company’s ESG initiatives, but is a good tool to obtain accurate data concerning carbon footprint.
The EU’s CSRD might foreshadow a push for U.S. sustainability reporting policy, as well as the creation of sustainability reporting policies around the world. The EU’s corporate reporting standards have historically been internationally influential. The bloc’s previous use of financial reporting rules helped stimulate their adoption by more than 140 jurisdictions globally. With the hope of other nations following suit, U.S. companies can expect more decisive SEC action in the near future.
ESG and sustainability-related policy is not a passing movement. Increased requests for ESG and sustainability-related information, including pushes for net-zero targets from stakeholders indicate the importance of sustainability reporting. By adhering to these reporting frameworks, companies position themselves as leaders in sustainability, navigating ESG considerations with confidence and purpose. In the meantime, adequately preparing for the large undertaking of sustainability reporting is critical.
