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CSRD, ESRS, ISSB, TNFD: The ESG Alphabet Soup is Driving Businesses to Move from Disclosure to Governance
6 min read
A new wave of standards and regulations are coming into force to address this by introducing disclosure requirements that include strategy, governance, and risk management. This article looks at what these new standards mean for businesses, and why they should be pursuing the smart way to ESG by taking a governance first, metrics second approach in 2024.
Deciphering and Digesting the ESG Alphabet Soup
ESG and sustainability reporting has largely been voluntary for all but the largest listed and “public interest” entities that fall under the scope of the European Union’s Non-Financial Reporting Directive (NFRD). The market-led initiatives (SASB, GRI, TCFD) have only taken businesses so far. Often resulting in adherence being done on an optics-only, check-the-box basis, entirely separate from the core business strategy.
However, that is all about to change. And as a result, more rigor will be required to comply: that includes setting up an adequate governance process, with clear oversight, responsibilities and integration with the business strategy. We provide some guidance below on these new legal requirements and compliance standards.
What is the Corporate Sustainability Reporting Directive (CSRD)?
The European Union’s Corporate Sustainability Reporting Directive (CSRD) expands upon the requirements of the previous EU directive (the Non-Financial Reporting Directive (NFRD)), requiring more companies to disclose their ESG performance and publish sustainability reports in more detail than was previously necessary. Notably, the CSRD requires in-scope companies to take a “double materiality” approach and assess the wider material impacts they are having on society in addition to the material financial impact ESG is having on their bottom line.
Another key aspect of the CSRD is value chain reporting which requires in-scope companies to report information regarding material impacts, risks and opportunities relating to their supply chain, customers and partners. In total, the CSRD includes over 1,000 data points comprising quantitative and qualitative data and requires an independent third party to provide limited assurance of compliance with the standards they are based on.
Who Does the CSRD Apply to?
EU companies who meet two or more of the following criteria are required to comply with the CSRD:
- Net turnover of €50 million or more
- Total assets of €25 million or more
- 250+ employees
The CSRD also requires EU-incorporated parent companies and large EU subsidiaries of non-EU companies to comply as well as SMEs that are considered to be “public interest” entities.
When Does the CSRD Come Into Effect?
- January 1, 2024: Companies that are already obligated to report under the EU NFRD are required to start reporting from FY2024 with their first CSRD report issued in 2025.
- January 1, 2025: Large companies covered by the CSRD need to start reporting from FY2025 with their first CSRD report issued in 2026.
- January 1, 2026: listed SMEs must implement the CSRD from FY2026 with their first CSRD report issued in 2027.
- January 1, 2028: Non-EU companies with large EU subsidiaries must implement the CSRD from FY2028 with their first CSRD report issued in 2029.
The European Sustainability Reporting Standards (ESRS) Explained
As the name suggests, the European Sustainability Reporting Standards (ESRS) are the reporting standards for sustainability within the EU and form the basis of the CSRD, providing companies with a structured framework for reporting. The ESRS were drafted and developed by the European Financial Reporting Advisory Group (EFRAG). Initially, the ESRS is made up of 12 standards that cover the topics of Environment (ESRS E1-E5), Social (ESRS S1-S4), Governance (ESRS G1) and General Requirements (ESRS 1) and General Disclosures (ESRS 2). Additional sector- and SME-specific standards are also under development, and standards for non-EU companies required to report under CSRD are expected to be adopted in 2026.
Importantly, ESRS 1 sets out mandatory principles for report preparation and disclosure including a materiality assessment based on double materiality that should be applied to narrow down the scope of CSRD reporting based on what is material. ESRS 2 specifies what information should be reported irrespective of the outcome of the materiality assessment and includes four areas:
- Management of impacts, risks and opportunities
- Metrics and targets
What about the International Sustainability Standards Board (ISSB)?
In June 2023, the International Sustainability Standards Board (ISSB) announced its new standards: IFRS S1 - General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2 - Climate-related Disclosures. The ISSB standards provide a global framework designed to bring consistency, comparability and reliability to corporate sustainability reporting to meet investors' and creditors' needs for ESG information to support their investment decisions.
Several governments and regulators around the world, including IOSCO and the UK have expressed an interest in adopting the standards and integrating them into their sustainability reporting regimes.
Additionally, the ISSB has taken over the Taskforce on Climate-related Financial Disclosures (TCFD) recommendations, with the Financial Stability Board officially disbanding the TCFD during COP28.
What about the Taskforce on Nature-related Financial Disclosures (TNFD) Framework?
In September 2023, the Taskforce on Nature-related Financial Disclosures (TNFD) published its final recommendations for nature-related risk management and disclosure. The TNFD recommendations are largely consistent with the ISSB standards and the impact materiality approach used by the Global Reporting Initiative (GRI) that has been incorporated into the ESRS.
Putting the ‘G’ into ESG with a Focus on Governance
These reporting regulations are not really about reporting. They're about building a governance process. Here's the evidence:
- Out of 82 disclosure requirements in the ESRS, around 50% are about targets, policies, actions, and governance oversight - not metrics or KPIs.
- Not by chance, the first disclosure requirement you can find in the climate standard (ESRS E1-1) is: "Transition plan for climate change mitigation". Not scope 1, 2, or 3 emissions - but "do you have a strategy and what is it?".
- The materiality assessment is not simply used to determine a threshold for reporting and disclosure, but to define accountability and set up ongoing governance oversight.
- ESRS 2 GOV 2 demands to disclose: "whether, by whom and how frequently the administrative, management and supervisory bodies, including their relevant committees, are informed about material impacts, risks and opportunities (i.e. the output of the double materiality assessment), the implementation of due diligence, and the results and effectiveness of policies, actions, metrics and targets adopted to address them.
In other words, companies working on the implementation of CSRD and/or IFRS (IFRS is very similar in terms of governance requirements as both ESRS and IFRS borrow from the TCFD recommendations) cannot look at these only from a reporting perspective. If they do so, they will struggle to meet the minimum requirements, have headaches with auditors and supervisory authorities, and find themselves in a difficult position to comply with other upcoming regulations such as CSDDD.
So, now is the time for companies to take a more holistic and integrated approach and not just because the regulators are introducing requirements that compel them to do so. Unfortunately, there’s been no lack of crises in recent years (COVID, geopolitical conflicts and the impact of climate change) to underpin the need for good governance where accountability and action based on what’s material and important to a business are the main focus. It’s become increasingly important for companies to (re)assess their approach, establish a committee who are empowered to drive the necessary changes, invest in effective programs and implement robust tech-enabled processes that enable them to identify and navigate impacts, risks, and opportunities with confidence and ease.
Gathering and Analyzing the Right Data for Strategic Decision-Making
Data still plays a central role in the shift from disclosure to governance, but just not as the first step in a company's ESG journey. It may sound counterintuitive, as only a couple years ago the main advice you would get from leading organizations was “just get started, doesn’t matter where - measure something and report out”. That advice doesn’t apply anymore in a context characterized with heightened regulatory and public scrutiny. Companies must gather and analyze data from various sources (internal stakeholders, regulators, policymakers, media, competitors, suppliers etc.) to inform their ESG strategy and establish the key material issues to prioritize. It's imperative that companies hone in on the areas where they can make a meaningful positive impact and set targets accordingly. There’s no point in rushing into ESRS gap analysis and data gathering without having completed the strategic and governance steps first. Then it's time to monitor and report on progress as well as keep up-to-speed with changes and developments in the broader ESG landscape. It’s a bit of a cliché, but it’s a case of getting the right data in front of the right decision-makers at the right time so they can make objective, evidence-based decisions. Only then can companies truly understand and own their ESG strategies.
Market-leading companies worldwide are using Datamaran’s AI-powered platform to lead with governance and proactively monitor their ESG risks and opportunities in real-time. To find out more, complete the discovery call form below.