New sustainability reporting requirements pair opportunities with risks

As risk managers address the European Union’s Corporate Sustainability Reporting Directive (CSRD) that came into force this year, they are finding that growth opportunities for their organisation can arise from the new reporting rules.

In fact, the directive requires that companies disclose the material impacts, risks and opportunities (IRO) related to the social, governance and environmental issues they face as a way to help investors, consumers and others to evaluate the company’s impacts on sustainability matters, and how sustainability matters affect the company’s development, performance and position. Companies that meet two of the following criteria will have to comply with the directive: more than 250 employees, annual net turnover of more than €50 million or balance sheet total of above €25m.

Under the CSRD, large EU incorporated and EU-listed companies with more than 500 employees that provide capital market services must report this year, with large companies, small publicly traded companies and non-EU companies that are in scope of CSRD following later timelines.

The process for uncovering material impacts, risks and opportunities for the purpose of adhering to the CSRD won’t be unfamiliar to risk managers. CSRD is a body of regulation on disclosure rules related to sustainability matters, and the implementation of the risk management process will help the companies to identify, assess, quantify and manage such risks. Those who do it early and well will be among the first to take advantage of the opportunities the process uncovers.

Getting started

Companies’ and risk managers’ first steps in adhering to the directive generally involve performing a double materiality analysis to identify and assess material impacts, risks and opportunities for their organisation. This forms the basis for uncovering what needs to be reported under the CSRD. One of the crucial subjects to be reported on is climate change, requiring organisations to carefully evaluate the physical and transitional risks and opportunities stemming from it.

Material physical risks will vary among different types of businesses. Most will consider physical damages to assets caused by extreme weather or impacts on employees’ health as material, and while some manufacturers might identify threats to water supplies as material risks, that might not be the case for other sectors.

Meanwhile, the economic impact of transitioning to a low-carbon economy could be among the material transition risks a company faces, along with regulatory changes, market demand and technology requirements.

Finding opportunities

A thorough analysis must cover the entire value chain. Along every link in the chain, there will likely be both risks and opportunities caused by climate change.

For example, an automaker that manufactures internal combustion engine vehicles might find that the increasing transition to electric vehicles creates a business risk. However, it may well become an opportunity for auto manufacturers that are willing to move towards developing electric cars and trucks to meet evolving regulatory requirements (and changing customer demand).

Alternatively, businesses in the battery industry might see an increased demand for their products following changes in regulatory requirements, which could create opportunities for product development to better compete in the market.

And while businesses might face increasing costs for raw materials due to regulatory changes or decreased availability caused by weather patterns, they might also find opportunities for circular business models such as recycling of electronics or reusing water in production processes.

Critical stakeholder input

Stakeholders throughout the organisation should be involved in the sustainability reporting process as early as possible, with each defining risks and opportunities as they relate to their part of the business. Regarding climate change, for example, they should examine different scenarios that could impact their operations and the criticalities in their part of the business. Insurers can help in this phase by utilising the insurance-related data that can begin with location-specific information, geocodes, insured values and other information. As the work becomes more complex and more granular, refined data will be included in the risk assessment.

Dedicated, location-specific assessments should be performed on sites identified as high risk to assess and quantify the impact of climate change-driven risks on business disruption, either due to damage resulting from acute events, e.g. flood or wind, or chronic risks, e.g. sea level rise or increasing temperatures. Impact on the entire value chain, e.g. suppliers, infrastructure and utilities, must also be considered. The risk assessment process underlying the sustainability reporting exercise informs not only the strategic view of risks, but also operational. Vulnerabilities at the process level at high-risk locations are identified, for example, and the analysis becomes more complex as the interaction of risks at the site level are unravelled.

Transition risk projections will look at factors such as the economic impact of transitioning to a low-carbon economy, how regulatory changes affect operations, market demand factors and technology requirements.

From a strategic perspective, meanwhile, organisations can identify new markets, utilise new technologies, or develop new products.

The importance of involving numerous stakeholders in the process cannot be overstated. The more people involved in scenario-building exercises, the more detailed the view of risks and opportunities is going to be. With multiple stakeholders bringing various data sets to the process, the organisation’s view of risk will become more complete.

Other stakeholders along the value chain have to be a part of the analysis, including the communities in which the organisation operates. The resilience of local infrastructure and utilities, and the safety of the workforce can only be ensured through close engagement with local authorities. Such a collaboration will also ensure the development of effective adaptation measures, benefiting the entire community.

No time to panic

It is likely that risk managers will need outside experts to help in the first few steps of the process. It may seem daunting to determine the boundary conditions of the analysis, such as climate scenarios and time horizons, and the necessary data to be included in the analysis. Guidance will likely be critical until the work is integrated into day-to-day processes.

This sustainability reporting process is iterative, with increasing complexity, reflecting the complexity of the business. Each iteration involves more refined data and increases confidence in the decision-making process.

Regardless of the complexity of the work and the amount of time needed to complete it, risk managers can rest assured that they are well equipped to handle the challenges. Meeting the CSRD reporting requirements is an extension of the work they are already performing – managing their organisation’s risks to protect its people and business, and identifying new opportunities to create value.

Contributed by Amar Rahman, global head of climate & sustainability solutions, Zurich Resilience Solutions, Zurich Insurance Company and Timo Herold, partner, ESG Service Group, Audit – Risk & Compliance Services, KPMG AG