The European Union’s approval of its Corporate Sustainability Reporting Directive (CSRD) this week has given the greenlight to a regulation that’s expected to provide financial institutions with more comprehensive ESG data and go some way to eradicating greenwashing.
The long-awaited rules will bring non-financial companies into the EU’s sustainability reporting regime, forcing them to submit their own ESG data and metrics. They will be compelled to disclosure their carbon emissions and the impact of their business activities on everything from local communities, biodiversity and social injustice.
The approval has been hailed by ESG data and technology companies for finally providing legal tools to fill huge gaps in the sustainability data record – an issue that has left financial firms open to accusations that the investment products they sell aren’t as green as they claim.
CSRD will apply to large listed and private companies, included listed SMEs, more than tripling the universe of reportable firms to more than 50,000. That will significantly increase the amount of ESG information that financial institutions will be able to use to make investment and risk decisions, and to label products they sell to sustainability investors.
“Mandatory sustainability reporting standards will undoubtedly help to provide asset managers with both a higher quality and quantity of ESG data, which is absolutely essential when attempting to implement an effective ESG investing strategy,” Kifaya Belkaaloul, head of regulatory at NeoXam told ESG Insight.
CSRD was unanimously ratified by the 27 heads of state that make up the EU’s policy-setting body, the European Council. It followed the measure’s approval by the European Parliament two weeks ago. Also, in the past few days, the first set of European Sustainability Reporting Standards (ESRS) were finalised by the Advisory Group on Financial Information in Europe (EFRAG), setting in stone the double materiality principle established by the CSRD.
The approval of CSRD is among the biggest developments in a milestone year of ESG regulatory announcements. In March the US’ financial overseer, the Securities and Exchanges Commission (SEC), published its first major proposal on climate-related disclosures. And in recent weeks the UK’s Financial Conduct Authority (FCA) has outlined its own SFDR-like sustainable reporting intentions and announced the creation of a body to examine how ESG rating companies should be regulated.
The exact wording of the CSRD will be hammered out by EFRAG. Over the longer-term it’s hoped the rules will lead to a faster transition to a zero-carbon economy and make companies more accountable for the impacts they have on the world.
“Data relating to the environmental and societal footprint would be made available to anyone interested,” said Jozef Síkela, Minister of Trade for the Czech Republic, in a council statement. “At the same time, the new extended requirements are adapted to different sizes of companies and a sufficient transition period is provided for companies to prepare.”
For manufacturers of investment products, CSRD is a key piece of legislation that will enable them to better comply with the Sustainable Finance Reporting Regulations (SFDR). Current rules require them to declare the ESG performance of assets in their portfolios and funds. However, many of those companies are not obliged to publicly disclose their data, forcing financial institutions to fill the gaps with estimates and proxies, a process that’s been questioned by critics as producing often inaccurate and inconsistent results.
“CSRD is undoubtedly a crucial piece of the puzzle that will allow asset managers to further promote sustainable investing and to more accurately meet their regulatory requirements,” said Tanguy van de Werve, Director General at European Fund and Asset Management Association (EFAMA).
At a recent A-Team ESG Insight webinar, EFAMA’s regulatory policy adviser on sustainable finance and ESG, Anyve Arakelijan, said she expected CSRD also to help bring convergence to the disparate reporting standards that currently guide disclosures. Such a development would further strengthen the ESG sector, whose lack of universally accepted reporting guidelines has also been criticised as a source of discrepancy and inconsistency in the data record.
CSRD strengthens the Non-Financial Reporting Directive (NFRD), which was established in 2014 to encourage companies to give stakeholders information on their sustainability performance.
But the rule was seen as a relatively weak means of transmitting vital ESG data because it only applied to about 12,000 very large companies that were likely to have reporting procedures in place already. About 50,000 companies must be CSRD-compliant by the time it comes into force in 2024. Non-EU companies with turnover of more than EUR150 million (US$155m) must be compliant by 2029.
CSRD will not be the remedy to cure all ills. For instance, it won’t apply to the vast majority of companies in the EU, which are small and medium-sized enterprises that provide the supply chain services and other connectivity that keeps the region’s economy in motion.
Nevertheless, Helena Vines Fiestas, Commissioner of the Spanish Financial Markets Authority, told a summit this year held by the Principle for Responsible Investing (PRI), that she expected the regulation would “be an inflection point”, and would lead to the fuller reporting of ESG data.
The council said that CSRD would be rolled out from 2025, when large NFRD-compliant companies will be required to report on the previous 12 months. Implementation will progress to other large companies, SMEs and finally overseas companies, who will report for the first time in 2029.
The timetable for compliance has been questioned by some leading ESG market participants.
“It is vital that firms get the utmost value from the information that they do have access to before that date – central to this is having a robust and flexible data management infrastructure in place,” said NeoXam’s Belkaaloul, while EFAMA’s van de Werve said the industry would be left “picking up the ESG data pieces in the meantime”.
Janine Hofer-Wittwer, senior product manager for financial information at Swiss financial services giant SIX said she was concerned that the exclusion of smaller companies would present more difficulties for financial institutions.
“The challenge of sourcing comparable data arises for companies that are not active in the EU and don’t fall under CSRD but are also part of investment managers’ portfolios,” Hofer-Wittwer told ESG Insight. “Alignment of these frameworks and metrics is key and underway in relation to climate risk reporting, but also necessary and currently fragmented for other key sustainability risk areas. This in turn might create fragmentation across the reporting value chain, including investors.”
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