Factors behind uptick in ESG requirements
There are a multitude of reasons behind the uptick in ESG requirements, among the most noteworthy being climate change. Climate change presents many risks to business, for example the impact of natural disasters on the insurance industry. Yet it also presents opportunities, for example the growing profitability of the renewable energies sector, as well as the predicted growth of the circular economy which is projected to be valued at 900 billion by 2030.
Another contributor is the Net Zero emission targets; currently, as of November 2022, 140 countries around the world have declared they are going to commit to or are actively considering committing to Net Zero emission targets. Of course without accurate reporting frameworks, it would be impossible to assess the progress being made towards these goals; in this sense having ESG measures in place adds a layer of scrutiny and provides a way to hold governments accountable.
ESG reporting also works as an accountability measure with regards to Greenwashing, a term which has gained awareness in recent years. As consumer awareness of the climate crisis grows, many people are gravitating towards brands they perceive as ecologically conscious when it comes to making purchases. Some brands have been accused of trying to capitalise on this by misrepresenting their company’s environmental impact, making it appear more attractive to eco-conscious consumers—hence, “Greenwashing.” In this case ESG reporting allows for transparency, guaranteeing that companies meet all the environmental standards that they claim to adhere to, as well as protecting the businesses themselves from being accused of deceptive marketing.
What are the EU ESG requirements?
In the EU, the Non-Financial Reporting Directive (NFRD) currently exists to regulate the reporting for large companies, banks and insurance companies with more than 500 employees. The NFRD addresses several issues pertaining to environmental, social and governance factors however will soon be replaced with the introduction of the Corporate Sustainability Reporting Directive (CRSD). The new directive will be much more detailed in terms of reporting standards and introduce the need to report according to the mandatory ESRS (European Sustainability Reporting Standards) a framework that is still in the consultative stages but will hone in on double materiality. In addition, the CSRD will also require companies to audit the information, as well as digitally tag their reported data to be machine readable and feed into the European single access point. Currently around 12000 companies are subject to the existing NFRD standards however the new directive, which will take effect on January 1st 2024.
Another EU ESG measure is the EU Taxonomy, which came into force in July 2020. The directive imposes disclosure requirements for businesses and financial market participants, meaning companies must report what percentage of their revenue, CAPEX and OPEX is environmentally sustainable. The purpose of the EU Taxonomy is to increase sustainable investments and induce companies to be more environmentally conscious.
What are the UK reporting requirements?
ESG legislation in the UK is still in the fledgling stages, with there currently being no one-size-fits-all directive that covers all factors. It is likely a full encompassing piece of legislation could take years to form, however there are a number of smaller regulatory requirements that encompass different facets of Environmental, Social and Governance values.
In 2019 The Greenhouse Gas Protocol put in place mandatory reporting requirements for energy and carbon emissions. This affects quoted companies, listed companies, large companies, charities and large LLPs. These requirements include scope 1 and 2 emissions, which are the direct result of the company. The directive does not however include scope 3 emissions, which are typically the result of supply chains, and disclosure of this is currently voluntary due to the difficulties in accurately tracking this data.
Directives for social values include gender pay gap reporting, which is subject to all employers with a headcount of over 250. Additionally, the UK Modern Slavery Act requires organisations with a yearly turnover of over £36 million to publish a statement regarding the steps taken to prevent modern slavery in the organisation. Finally, the UK Corporate Governance Act looks at how governance should be operated within firms.
It's clear there’s more to be done with regards to standardised frameworks that are more encompassing of the entirety of ESG. It’s likely that future regulation will be closely modelled on the EU approach, as seen already with the upcoming Sustainability Disclosure Requirements (SDR) directive. The SDR guidelines are still in the consultative stages, however in their current form closely parallel the existing SFDR guidelines set in place by the EU. This new regulation, which is likely to come into force in June 2024, will focus on transparency and aim to combat greenwashing by increasing disclosure requirements. While it’s hard to say what other future directives could look like, it’s likely that further guidelines will be also modelled off existing European legislation.
What can finance teams do to prepare for ESG compliance?
With growing governmental regulation surrounding sustainability, it’s safe to say that ESG as a topic is here to stay and will only become more significant as time goes on. Progressive organizations that have ESG baked into their corporate strategy are well-placed to meet with the upcoming legislation, however all companies should consider what they can do to put measures in place.
