ESG reporting in Europe: is the proposed CSRD a ‘friend’ or ‘foe’?

As we slowly progress towards a harmonised set of global ESG (environmental, social and governance) standards under the guidance of the International Financial Reporting Standards’ (IFRS) Sustainability Standards Board (SSB), the EU – a key jurisdiction for the advancement of ESG reporting rules – recently announced a proposal for a new Corporate Sustainability Reporting Directive (CSRD).

Following the formal consultation that took place last year, to which LGIM contributed, the CSRD would replace and greatly strengthen the existing Non-Financial Reporting Directive (NFRD).

But why…?

Well, as we have previously stated, the NFRD left a lot to be desired. ESG reporting by companies across Europe has simply been below the standard that the market needs, either inconsistent or inaccurate. What’s important here, though, is that policymakers have actually listened to stakeholders’ concerns and are changing the status quo.

The goal of the enhanced directive is to ensure that financial-market participants and wider stakeholders have access to high quality and consistent sustainability information. Strengthening the directive means investors can more effectively hold companies to account and also improve their own disclosures to end investors (e.g. through the Sustainable Finance Disclosure Regulation (SFDR)). A strong directive at this level would form the basis for improving ESG disclosures all the way up the investment chain.

So how…?

Often a lone wolf in the ESG disclosure landscape, the European Commission (EC) is continuing with the ‘double materiality’ concept (i.e. companies disclose the risks they are exposed to from both a sustainability point of view and in terms of their own impact on society and the environment) in the CSRD. The EC is also expanding its reach, bolstering assurance, ensuring policy alignment (in the EU and internationally), and going digital.

The details…

1. Scope: the CSRD covers all large companies and all companies listed on EU regulated markets (except listed micro-enterprises).

→ According to the EU, this will now encompass some 49,000 companies, compared with only 11,000 under the current NFRD.

2. Audit (assurance) of reported information is required.

→ At the moment, only ‘limited’ – as opposed to ‘reasonable’ – assurance would be mandated. Limited assurance is restricted to stating that no matter has been identified as materially misstated. Whilst LGIM publicly advocates for ESG information to be audited with the same degree of rigour as financial information, this limited audit exercise is a welcome first step. It should provide additional comfort to stakeholders, including investors, around the ESG data disclosed, and should strengthen the credibility of companies’ ESG data.

3. More detailed reporting requirements are being introduced, including a requirement to report according to mandatory EU sustainability reporting standards – with a first set of standards to be adopted by October 2022. Large listed companies and small- and medium-sized enterprises would be held to account against different sets of standards.

→ The EC has mandated the European Financial Reporting Advisory Group (EFRAG) to develop draft standards. Reassuringly, it mentions that the standards would be aligned with EU policies (e.g. Taxonomy and the upcoming Sustainable Corporate Governance Initiative), and that it would be “building on and contributing to international standardisation initiatives”. By referring to the work currently being undertaken by the IFRS SSB and various existing private reporting initiatives (e.g. GRI and SASB), the EC acknowledges the need for convergence upon one set of sustainability reporting standards, and that further regional fragmentation would not be beneficial to anyone (corporates, investors or other stakeholders).

4. Companies will be required to ‘tag’ the reported information digitally, so it is machine readable and feeds into the European single access point envisaged in the capital markets union action plan.

So, is the CSRD a friend or foe?

Well, as you would expect us to say, it’s early days. A lot depends on the level of ambition in the sustainability reporting standards that the EFRAG are developing. Another key indicator of success is how closely the EU will work with the IFRS SSB, and therefore how aligned or complementary such standards will be to other markets around the world.

However, the signs are positive and, for now, I think we can say friend!