Non-financial reporting is becoming increasingly significant for investment decisions and business development. New European standards will require more ESG disclosures, a thorough audit, and verification of the data provided.
The new EU Directive
on Corporate Sustainability Reporting obliges companies to disclose information about the risks, opportunities, and impacts those businesses have on society and the environment. Organizations will be required to report under mandatory European sustainability reporting standards and confirm the reliability of their non-financial information.
Non-financial reporting means notifying investors, partners, and the public about a company’s activities in terms of social and environmental responsibility. Companies disclose information about their impact on the climate, water, and other resources, their social policy towards employees and local communities, and conflicts of interest in management. Many experts criticize the current reporting system for its lack of clear generally accepted criteria. Because of the current lack of regulation, most non-financial reports provide an unreliable reflection of corporate ESG activities.
However, social and environmental impacts can be difficult and expensive to measure. Organizations can create positive and negative effects at the same time and form complex connections between them. Since there are no general ESG reporting standards, ESG data aggregators (for example, CDP, Trucost) use different methods to estimate and compare organizations. It’s difficult for investors to assess the real impact of companies on the environment and society. Lists of sustainable corporations in various popular ESG ratings usually overlap only by 40-50%. Until now, financial organizations had to determine which investments to refer to as sustainable. Meanwhile, the total amount of funds sent to ESG funds doubled in 2020, according to Morningstar.
On 21 April 2021, the European Commission published a draft Corporate Sustainability Reporting Directive that will replace the current Non-Financial Reporting Directive since the information provided by companies according to this document is not systematized enough.
Companies are gradually moving forward in terms of the coverage and quality of their climate-related information disclosures. Thus, the results of The KPMG Survey of Sustainability Reporting 2020
show that the amount of information disclosure by the 100 largest national companies (known as N100) in 52 countries increased by 15%, and the volume of information disclosure by the 250 largest international companies (known as the G250) increased by 8%.
However, the view of climate risk management in reporting is not comprehensive enough. EY published
the results of a survey that revealed that only 41% of companies conduct scenario analysis, and only 15% reflect climate change issues in their financial reports.
The new directive will enable partners and investors of organizations to make informed decisions, including on climate risks. Support from private investors and foundations will accelerate the implementation of the European Green Deal, a set of measures aimed at combating the climate crisis by transforming the EU into a modern, resource-efficient, and competitive economy that can reduce its greenhouse gas emissions to zero by 2050.
All 27 EU member states must incorporate the new directive into their national legislation no later than 31 December 2022. According to the plan, the disclosure will become mandatory, and the requirements will apply to a total of almost 50,000 businesses with a turnover of more than 40 million euros or more than 250 employed. The range of information disclosed in reports will include data about their impacts on the environment and climate, social policy, anti-corruption, corporate governance, and human rights protection practices. Companies will have to publish information about their international supply chains and their suppliers’ compliance with requirements.
Given the importance of the directive and the likely costs, companies will need to start preparing for its implementation at the start of 2022, when the draft standards will be available for public discussion. They will have to analyze and review:
• how data related to sustainable development are identified and collected;
• how environmental, social, and governance (ESG) risks are managed;
• how policies, KPIs, and other targets are developed.
The European Commission proposes to gradually introduce a system of independent verification of disclosed ESG data. The reliability of the information on sustainable development will be subject to high requirements in terms of compliance with standards, qualifications, objectivity, independence, ethics, quality assurance, and supervision. Most likely, European audit companies and supervisory authorities will introduce a software system for verification of company reports. More than half of the facts will be checked using AI
Even though compliance with the directive is required only in EU countries, it affects not only businesses in Europe but also their partners, suppliers, and stakeholders in other countries. It is also likely that international companies will face pressure from investors
from Europe and their requests for similar ESG reporting. Thus, it can become a unified global system of requirements.
The development of general standards will benefit both investors and companies. Equally important, it will shift the world to a sustainable economy and support sustainable development goals.