CSRD – A catalyst for change

The EU’s Corporate Sustainability Reporting Directive (CSRD), which strengthens the rules concerning the social and environmental information that companies have to report, entered into force on 5 January 2023, and the first set of companies subject to the new rules must start reporting in 2025, for the financial year 2024.

ESG Risk Review talked to Lisa Lipuma and Julien Hornacek, both directors within risk & analytics, the advisory team of WTW, about the issues and challenges around the CSRD.

Are there expected to be changes to the CSRD? Are reporting requirements likely to be watered down?

Julien Hornacek: The CSRD is a cornerstone of the EU’s Green Deal (officialised in 2019) and its ambition to promote corporate accountability on sustainability. Significant watering down of requirements is therefore unlikely as this would undermine its purpose.

Adjustments may occur, however, to clarify standards (such as sector guidance) or ease implementation burdens for SMEs, as seen with the phased approach for smaller entities.

Either way, it would be foolhardy to announce that no changes are possible, as the recent speeches on these subjects by France ex- PM Michel Barnier and ex-ECB President Mario Draghi have shown. Finally, the start of Donald Trump’s second term in office in January will very probably strengthen the influence of the anti-ESG lobbies, to an extent that is difficult to estimate at present.

Is the CSRD expected to be the gold standard for sustainability reporting and replicated globally?

Julien Hornacek: Many consider the CSRD to be a global benchmark because of its mandatory nature and its emphasis on double materiality. The fact that this reporting framework is supported by the European Union, and its extra-territorial nature, make it clearly unavoidable.

Although replication might vary regionally, principles such as double materiality are likely to shape global norms. UK Sustainability Disclosure Standards may have a double materiality component as early as 2025.

Other frameworks do exist, however, such as the ISSB, which favours simple materiality over double materiality. This difference in approach may appeal to other countries, whose objectives may differ from those of the European Union.

In any case, its alignment with international frameworks such as the ISSB and the GRI obviously strengthens its influence at global level. For example, countries such as Canada are studying the possibility of adopting similar standards.

Can you explain exactly what is meant by double materiality?

Lisa Lipuma: Companies are encouraged to carry out in-depth assessments to identify the most relevant ESG issues they face. It is in this context that the principle of double materiality has emerged, an approach that enables companies’ sustainable development performance to be assessed holistically. Double materiality requires companies to assess:

• Impact Materiality: How their operations affect the environment and society.
• Financial Materiality: How sustainability risks and opportunities impact their financial performance.

This dual lens ensures that companies address both societal and investor concerns. By moving from single materiality (which is mostly a financial approach) to double materiality, there is a paradigm shift, aimed at obtaining a global view of a company’s interactions with society and the environment.

What are the challenges the directive poses, particularly around data management and reporting?

Lisa Lipuma: The CSRD requires companies to publish detailed data that may not currently exist for most organisations. As a consequence, the vast majority of organisations will have to define and implement IT architectures to enable them to identify data where it resides, process it and structure it in the required format. As the CSRD is an annual report, companies will also need to ensure that the data published can be easily updated, which will require a system that allows this to happen.

Over and above the obvious complexity of such a project, this also means major costs to be incurred, and a large number of stakeholders to be managed and on-boarded.

Finally, there are two sub-topics that are perhaps more complex than others within this reporting.

• Climate change reporting is a particularly complex topic to disclose. While organisations generally possess most of the data required for all other topics, albeit in a state that is sometimes unsuitable, they very rarely possess climate data, given the relatively recent nature of this subject. Organisations are therefore obliged to create this data from scratch, usually with the help of external service providers.
• This reporting covers the whole of the organisation’s value chain: suppliers, customers, partners, neighbours, etc. As the aim is to clearly understand the impact of an organisation in as broad a sense as possible, this necessarily implies looking at all third parties, and therefore being able to retrieve the associated data.

How can companies ensure that it doesn’t simply become a compliance tick-box exercise?

Julien Hornacek: It is essential to bear in mind that one of the objectives of the CSRD is to redirect capital flows towards companies considered to be more sustainable. Consequently, it is clearly in every company’s interest to have a very high standard of reporting, highlighting all the actions undertaken.

The first step for any organisation is to get top management on board. Without this ‘tone at the top’, it will be impossible to change the culture towards valuing sustainability over and above compliance.

It is also important that the objectives of the CSRD are part of the company’s overall strategy, ensuring that they are aligned with long-term sustainable development objectives.

That is why communication is also a critical vector. Explaining the ins and outs via dedicated sessions, clearly explaining what this reporting will enable, are necessary steps in getting stakeholders on board.

In fact, CSRD should be seen as a kind of catalyst. Because this reporting enables all investors to see what organisations are doing (and not doing), it becomes an opportunity for transformation, driving genuine value creation.

Is the biggest issue with relation to CSRD around the supply chain?

Julien Hornacek: The supply chain is often cited as the most complex aspect, for example when it comes to reporting Scope 3 emissions. But more broadly because it extends the scope of analysis considerably.

What’s more, third parties can be of any size and located in any part of the world. This requires the ability to retrieve data from their suppliers, whose reliability is not always guaranteed, particularly for small entities in developing markets.

How can companies manage the CSRD disclosures and reporting requirements? Whose role is this within a company?

As CSRD is by its very nature a cross-functional subject, such a project cannot be managed by a single person. Consequently, one of the good practices could be to set up an interdepartmental working group, involving notably teams responsible for sustainable development, finance, investor relations, legal affairs, purchasing, risk management, human resources and information technology.

Of course, having a dedicated project team (for the largest groups), with an ad-hoc project manager, can be relevant. Where such a team exists, it is often the chief sustainability officer (CSO) or equivalent who leads these efforts.

It should be noted that there is (still) no such thing as ‘one size fits all’, and that each organisation will structure its taskforce as appropriate.

What are the risks around sustainability reporting? Will CSRD give rise to a new wave of ESG-related lawsuits?

Lisa Lipuma: The first risk, when looking at the CSRD, is that of regulatory non-compliance. The validity of this reporting will be subject to the opinion of statutory auditors, whose conclusions will themselves be validated by the competent authorities. A non-compliant approach could therefore be accompanied by a penalty, both for the legal entity and for directors and officers (D&O).

Then there is the question of reputational risk. Because such reporting requires precise communication on what is being done and what will be done, any organisation that fails to follow its roadmap or, worse still, whose roadmap is assimilated to greenwashing, could find itself under fire from a wide range of stakeholders.

Going a step further, it is also possible that certain organisations, as is already the case, will attack other organisations on the basis of these reports, pointing the finger at insufficient action on disclosed risks, such as climate change.

Will the CSRD’s reporting requirements help the insurance industry develop new products?

Lisa Lipuma: It is undeniable that this regulation will bring changes to the insurance sector. Some examples can be found below:

• Because insurers are also rolling out ESG roadmaps, it is likely that underwriting facilities (increased capacity, attractive rates) will be offered to those whose reports show good ESG performance.
• By obtaining a better analysis of companies’ exposure to ESG risks, particularly those linked to climate, insurers will be able to offer targeted cover, for example in renewable energies, and more broadly for all economic activities that may be exposed to extreme weather conditions.
• The obligation to reduce greenhouse gas emissions will be accompanied by the development of mechanisms to achieve these objectives, and therefore by dedicated insurance solutions.
• The increase in the risk of litigation for executives will also prompt insurers to offer tailor-made D&O liability insurance policies to deal with exposure to ESG-related liability.

What will be the impact of CSRD on insurers and their underwriting policies?

Julien Hornacek: The CSRD is part of the European Green Deal, which aims to redirect capital flows towards more sustainable investments. As one of the world’s largest investors, insurers are clearly targeted by this regulation, which will impact insurers’ investments strategies.

Insurers’ ESG underwriting policies are likely to lead to refusals to underwrite organisations whose CSRD reporting shows poor performance. This is likely to force these companies to adopt better measures in order to be insurable again, thus generating a virtuous circle.