Bruno Sarda
Hello, and welcome to the EY Sustainability Matters podcast. I'm Bruno Sarda. I'm a partner in EY's Climate Change and Sustainability Services and your host for this series. Sustainability Matters is our regular look at ESG and sustainability topics and how they impact organisations around the globe.
In each episode, we explore a topical issue in the sustainability agenda, and I'm joined by a mix of business and thought leaders as well as colleagues as my guests. And this episode is the first of a series of podcasts where we'll take a deeper look at sustainability and ESG disclosure rules and frameworks worldwide, how they're evolving and what they mean for businesses. In episode one, we put the spotlight on Europe and the new EU initiative, the Corporate Sustainability Reporting Directive or CSRD for short. These new rules will actually significantly expand the number of companies required to provide such sustainability disclosures to nearly 50,000 from less than 15,000 currently, and will introduce more detailed reporting requirements on company impacts on the environment, on human rights, social standards, as well as sustainability-related risk. We'll discuss how it aims to work, what changes it will bring to current reporting practices and for whom, and how it will contribute to Europe's 2050 climate neutrality target and Green Deal objectives. With me to discuss the CSRD today, I'm delighted to welcome two of my EY colleagues, Elodie Timmermans, who leads sustainability and ESG reporting and assurance for the Americas, and Christian Orth, who leads sustainability reporting and assurance for EMEIA and is the team's global leader. Thank you so much for joining me today. So, Christian, let me start with you. you're based in Europe. You've been closely involved in the evolution of these standards.
Let's start with some framing and definitions for our listeners, who may not have followed all of this as closely as you have. CSRD is one of many acronyms in this conversation, including, CSRD, NFRD, EFRAG, ESRS. Could you briefly explain what these all mean and how they're connected?
Christian Orth
Bruno, happy to do so and I'm happy to be here in this webcast today. So, here's my quick introduction of all these acronyms. Overall, all these acronyms are part of something we call here the European Green Deal. So the European Green Deal is something that is aiming for Europe to be the first climate neutral continent by 2050, and there are a lot of initiatives which belong together. So, CSRD, that was the one you addressed first, is the Corporate Sustainability Reporting Directive. This is addressed to corporates with respect to all the sustainability reporting requirements, disclosure requirements, but these disclosure requirements have a goal. They are aiming not only at investors, they are also aiming to inform financial institutions, which brings us to the second element of the European Green Deal, which is the SFDR, the Sustainable Finance Disclosure Regulation. This addresses the financial sector to steer money into green investments instead of brown investments. So, we have two elements that are closely related and there's an interaction between them, steering money into activities that support the European Green Deal and the overarching goals. We also have a third element which is the EU taxonomy, so, not really an acronym here. The European Union has already the EU taxonomy in force which requires some reporting on KPIs on environmental goals, in the first step, only on climate change and climate litigation, but in the next step also covering the other environmental goals that are outlined by CSRD, and the three key KPIs that are being addressed are CapEx, OpEx and revenue turnover to be disclosed. So, the EU taxonomy but, even within this one, there's a stepped approach. Out to the first step asking to disclose investments that are determined to be eligible, so that are green investments, and investments that are not eligible, so the, the kind of brown investments. Going forward from this year on, we also have to look at the alignment of these investments. So, it's not only about being a green investment, but also ensuring, sustainable and substantial contribution to those goals. They shouldn't significantly harm any other goals. Just to give you an example, which is simple. If you build a wind park, to generate power, it shouldn't be built in an area where we have environmental issues if we built something in this area, because it's a very bio-diverse area which would then, disappear after we have established, this wind park. And there are also minimum safeguard criteria. So, these are three elements which, then sum up to this EU Green Deal, others to follow, such as European Single Access Point, that's ESAP, and the CS3D, the Corporate Sustainability Due Diligence Directive. You see a lot of acronyms but overall, everything is going in one direction, aiming for the targets of the EU.
Sarda
Great. Thanks for that clarification. One acronym that keeps coming back up that maybe you can also define is the ESRS and how it relates to the CSRD.
Orth
Absolutely, happy to do so. So, the ESRS, that is actually the level two of CSRD. CSRD is outlining what companies are subject to these disclosure requirements, what are the activities those companies need to do with respect to what I just outlined, the financing into green investments. So, while CSRD is a directive, which needs to be transposed into the jurisdictions of the 27 member states, the question is what standards do apply with respect to these disclosure requirements? That has been handed over to the institution Group that has come out with 12 standards. The exposure drafts, we had 13 standards. There was a common period until August 8th this year and just recently EFRAG has handed over the first final draft set of ESRSs - European Sustainability Reporting Standards - to the European Commission for release. So the European Commission will adopt them within the next half of 2023 and then they will become effective 1/1/24 onwards.
Sarda
That's great. Thanks for that, Christian. So, I think you did a great job of framing the relationship between all these things. At its core, I guess, what primary need or problem is CSRD trying to solve that maybe is not currently being met by what is in force now, and in fact, what will that require of companies that they may not be doing today?
Orth
Yeah, that's a good question, Bruno. So, the previous regulation was called NFRD, Non-Financial Reporting Directive. This is in force already. I think it's not necessarily a shortcoming we should deem with respect to the NFRD. I would rather say it's an enhancement, and it's the next natural step. I think the biggest impact is that so far we have run about 15,000 companies subject to NFRD in Europe. This number has now increased to 50,000 entities, including, which is a very last-minute change, third country companies, so parents outside the European Union with substantial undertakings, so subsidiaries or branches within the European Union. So, the initial assessment of 49,000, so we can be crystal clear on this, it must be above 50,000 entities, subject to CSRD and in scope of the new ESRS disclosure requirements. So, talking about content, at the end of the day, these rules and regulations that apply to the 50,000 plus companies, this is not only a compliance exercise on reporting. At the end of the day, you will see that this is more or less the license to operate within the European Union, to also talk about all the activities with respect to sustainable investment, not only into the direction of investors, shareholders, but also to society and environment. So, that's really it. It's a huge undertaking.
Sarda
Great. Well, before we turn to Elodie to get a perspective on what this means to organisations based out of the EU, can you briefly tell us what is roughly the timeline for CSRD and how realistic is that?
Orth
Well, to be very honest the discussion about CSRD, there was a first date set and everybody realised, okay, it is unrealistic to have 50,000 companies required to have 12 standards to be obeyed, so we do see that the CSRD now has a staggered approach. I did mention earlier that as of 1/1/24, this will be applicable, but I have to be more precise. So, as from 1st of January 2024, that's the reporting period, which goes hand in hand with this timeline, does only apply for companies that are currently within the scope of NFRD, so that are already familiar with this kind of reporting. So, these companies are required to report for the reporting period 1/1/2024 until December 31st, 2024, or whatever their fiscal year is, and then they have to report in 2025 and that will be subject to assurance by auditors or other independent assurance service providers, so, it is something that will be assured. Then, a year later, all other large companies will become subject to these requirements, so 1/1/25, to be reported in 2026, and we have a relief for listed SMEs, small, medium enterprises or entities, they have to start reporting in 2027 with respect to the reporting period as of 1/1/26. There's an exception for micro-SMEs, but that's just really a small number of entities that are impacted by this in the EU, but that's pretty much it, with respect to the entities in the EU. Here's now the surprise that came in, in the very late stage: third-country companies, so non-EU companies with branches and subsidiaries within the EU, they will have to report as of 1/1/28 in 2029 and that's something which will be subject to a specific set of ESRS standards we can't talk about today because they have not yet been established. So, a really ambitious timeline and it sounds like far, far away but there's a lot to do.
Sarda
Great. Well, thanks for that overview, Christian. So, Elodie, let's turn to you. So, from a rest of the world perspective and you sit in the Americas particularly, how will non-EU companies either that have subsidiaries, or maybe significant business or turnover in the EU in any of their member states be impacted by the CSRD?
Elodie Timmermans
Thank you, Bruno. And as Christian mentioned, most companies called the third party companies will be impacted by the CSRD. The question is going to be how they will be impacted, depending on their structure. So, it is going to be a complex exercise for all organisations with, basically, subsidiaries or branches or just activities in the EU, to understand the level of their activities, to understand how they are subject to the CSRD, so if you will, the boundaries and scoping, and then as a next step, thinking through what they will have to disclose, where. There is a lot happening right now at the EU level for EU companies and Christian talked about it a little bit, but then what we see organisations doing now is really starting to understand the boundaries they have, how are they structured in the EU and how will they be impacted by the CSRD, meaning will they be impacted as of the start of the implementation of the regulation, early 2024, or will it be 2028, depending on their structure?
Sarda
Yeah, that sounds complex, and not to add more complexity, but we often equate the continent of Europe with the European Union, but in fact there are significant European countries that are not in the EU, for example, now, such as the UK. Is there a prospect that could create yet another layer of complexity or is that already captured in what you covered?
Timmermans
It is adding complexity. It's also, organisations are going to have to refresh on their European Union school studies, because it is, and to your point, like Switzerland or the UK, for instance, will officially not be subject to CSRD, but have also their own regulations that are upcoming. When we talk about CSRD for the EU, it is true that that covers the European Union countries but organisations outside of the EU will also have to pay attention to the countries like the UK, Switzerland or others that will be requiring additional disclosures. Again, that all depends on the types of subsidiaries, the types of entities based in those countries, but it is something that organisations will have to continue to monitor. We're obviously very focused here for the EU or Europe but, that applies across the world too. There are a number of upcoming regulations, especially around climate, that are going to be mandated for organisations. The other aspect to think about is also as we think about what are companies going to have to disclose, the CSRD is very broad when it comes to the standards that organisations are going to have to follow on environmental, social and governance metrics, so you can think about biodiversity, you can think about social, you can think about even capital type of metrics, whereas other regulations or jurisdictions are starting to be focused specifically on climate-related disclosures. And, so, that will also mean that organisations based outside of the EU, we're anticipating to only focus on climate at first, will probably have to focus on the broader set of ESG metrics.
Sarda
Well, that sounds like a lot of work. Question for you both, you advise companies, mostly large companies, but companies of different sizes and different sectors with different geographical footprints. What key questions do companies seem to have, and how are you advising them to prepare?
Timmermans
I think the three main questions we're getting here, and of course you hear questions a lot, but one is, how are all those reporting standards aligning to each other? So, if I am a company based in the US, where I will probably have to disclose in accordance with, might be the ESRS for the CSRD, the ISSB, SASB type of metrics or the proposed SEC rule, how does all those reporting standards align into each other, because as much as in the big picture, they do align to each other, that the devil is in the detail and all of those requirements have nuances. The second aspect is how are we defining materiality on what we need to disclose? So, which metrics do we really need to focus on, and would be aligned to, or important to, our organisation's strategy versus which are the metrics that are a nice to have but will not necessarily add any value for our stakeholders or key stakeholders, or our regulators? And then the third aspect is really processes and controls. So, how can we make those reporting processes more sustainable from a longer-term perspective, more efficient, but really having more sophisticated data collection processes, which will help with clarifying the data completeness but also the accuracy of the data?
Orth
Elodie, I think you're absolutely on spot. The only thing I would like to add is if I talk to clients right now and they approach me, like, Christian, tell me, what is CSRD about? I always say, do you remember the International Financial Reporting Standards (IFRS) implementation, 2005? And they look at me, like, wow, that's, that's massive. And I say, yeah, do you remember SOX (Sarbanes-Oxley) implementation, 2002? They are, oh, that was a pain. And then I say, see, if you add both, that is the implementation of CSRD and ESRSs and then they get pale and then they look at me, like, you're serious? And I say, yes, unfortunately this is the case. So, and then we start, okay, so, how can we limit this to an amount which is doable? And the answer is, hey, let's have a analysis on a country-by-country basis, because as I just outlined, each and every single entity in scope on its own needs to report the sustainability report with 80 plus disclosure requirements which are approximately over 1,000 data points, which need to be obtained, which need to be reported, organised. So, this is really a massive task. But the key point here as always, is there a way to exempt companies by, we hope, grouping the sustainability reports? There are some requirements in CSRD which require a group consolidated structure which many companies don't have in place. There's also a transition period with some options but mostly they say, well, we are reporting already a sustainability report, for example, under GRI (Global Reporting Initiative), isn't that sufficient?
Isn't that an equivalent? Would this redeem us from all these requirements? And the answer is, no. As simple as that, it's a no. So, that's where they really get nervous and, I think this is why we have come up with a very, let's say, structured approach to say, okay, let's determine the entities in scope, how can we exempt these entities, what is the level where we can consolidate and then also look at the staggered implementation approach on the requirements which I just outlined, 2024 through 2028, which helps them to, you know, come up with a plan. And Elodie, then, you know, we really go into all these details. So, it's really broad and deep at the same time.
Sarda
Well, thank you both, yeah, that's, I think covers a lot of ground and potentially, you know, raises a variety of questions. One that comes to mind is, you know, we often hear from companies, is this just more reporting for the sake of reporting? Will this lead to something other than just more information being produced? You know, questions like, will a directive like the CSRD actually drive a transition to a more sustainable economic system or will it deliver the accountability that investors are demanding, or maybe the additional actionable transparency that they seek in their investment strategies. What are your thoughts? Maybe start with you, Christian.
Orth
Yeah, as I said, it's not only a compliance exercise, reporting, so there's really a goal behind this to achieve a sustainable economy here in Europe because that's really the goal of the European Union, nothing else, which is, of course, if you want to become climate neutral 2050 then you have to put the foot on the gas pedal, let's say it this way, because we do hear, you know, COP27, do we really achieve the 1.5 climate goal? Right now, people are like: it's unachievable. So, we also came up with other plans in between, like, 54, 55%, all these things. So, at the end of the day, Bruno, this is really more than just a pure compliance exercise. This is changing the behavior of entities in the way they operate, and the way they interact with their suppliers, with their social environment, with all the stakeholders, so this is why the EU looks at the three pillars of E, S and G: environmental, social and governance, to make sure that these goals are achieved. But, I think, Elodie, same in the US, I guess.
Timmermans
Yes, definitely, and the other thing which regulation like the CSRD will help is, help companies think through where their impacts are and where are the dependencies across their environmental or social or governance metrics. Oftentimes what we've seen is that organisations have set their environmental, social goals in alignment with their visions or their strategies, but then it gets really complicated to actually measure progress against that or even just make changes within their businesses to align to those goals. A broad set of metrics like CSRD, if focused on the right ones, will definitely help organisations to also have a change in their strategy as they intend it to be, but also really start basically checking and measuring where their impacts are and potentially maybe identifying some externalities that they didn't, or they were not aware of in the past.
Sarda
Yeah, that really brings to mind also that level of organisational maturity. You talked about things like process and controls, Elodie. What are you seeing in terms of as these-- the sophistication and the implications of these standards become, you know, more central to I think, Christian, you mentioned even the, you know, the license to operate in particular jurisdictions? How are you seeing this play out in the way organisations basically mobilise and organise internally, for example how is the role of maybe the chief sustainability officer, maybe the chief financial officer or the controller, how are you seeing evolutions within the way organisations approach the work?
Timmermans
It's definitely evolving, and it is changing quickly. I think what we've seen historically is that the Chief Sustainability Officer or the ESG team or Corporate Social Responsibility teams, depending on the name and convention the organisation had, were in the lead for, to basically re- do all the ESG related disclosures as well as working on the ESG strategy. And, so, there were a lot of demands for very limited resources in general. What we're seeing now with the push from investors as well as regulators and the fact that some of those disclosures will be required in mandatory annual reporting, we see that the Chief Financial Officer, the Controller's team, the Investor Relations team, are becoming much more involved in the overall disclosures piece, as well as just thinking through what the strategy is for an organisation. And that creates very broad but more probably comprehensive ESG steering committees or sustainability working groups across the organisations at the top level, which also can drive change and accountability for the organisations. And, so, what we see now is that the finance teams, controllers’ teams are getting more involved in the ESG disclosures aspects of getting to the right data, getting reporting and processes and controls that are close to the level of the finance ones. There's a long way to go, but there is progress there. But which enables basically the chief sustainability officers and their teams to really focus on strategy, on implementation of ESG or sustainability types of initiatives to really drive change. So, in short, I think, just, like, by being able to really, like, change that internal landscape around ESG and sustainability to think through both disclosures and strategy, it will help companies make progress on their overall goals and targets.
Sarda
Christian, from your perspective, does that resonate as well with what you're seeing in the EU?
Orth
That is exactly what we've seen in the EU and I think what Elodie just outlined, to put it in a nutshell, right now the change is driven by disclosure requirements. That is a typical compliance exercise. But to get these informations to disclose, you need the entire company, the entire teams, HR, law, you name it, operations, supply, supply management, distribution, whatever, you choose, they are all involved. So, the entire organisation needs to be part of this journey. And if we reach out to clients and they ask us for help to, you know, assess where they're standing, whether they have gaps, whether they are capable of doing this, there are a lot of elements they do have in place, but they now need to be brought together. This is really something where you see the C Suite involvement and what we also see, at least here in Europe, is that there's a lot of involvement of those charged with governance because they see themselves also in charge and responsible for the reporting, again reporting as a nucleus of the entire development. So, I couldn't agree more to what Elodie just said. It's really a holistic approach that impacts the entire enterprise.
Timmermans
And you really made a really good point, Christian, because what people sometimes forget is that to get to that one number, right, or that scope on greenhouse gas emissions or number of suppliers audited for human rights, there are a number of sub-metrics involved that are all coming from different parts of the organisation and are all being inputted in different systems. And, so, that is something where the complexity of those reporting processes should not be underestimated and this is why it can get a little bit overwhelming for organisations as they start to really document their processes and controls or also just think through, like, okay, what is the level of certainty that we have about that data, just because of the complexity of the data, collections, aggregations and consolidation aspect.
Sarda
Well, thank you both for bringing such expertise, insight and, frankly, clarity, to this crucial issue. It's been a fascinating discussion, for me, even after the prep for this episode, just learned so much and I know you've both written on this topic. I think there's articles on ey.com where people can find your contact info, if they have further questions or want to discuss their needs, but in the meantime, I want to again thank you both for contributing your expertise and I'm sure many will find this episode quite valuable. Thank you.
Timmermans
Thank you.
Orth
Thank you.
Sarda
As I mentioned at the start, this is the first of a series of podcasts looking at ESG and sustainability disclosures. There will be further episodes in the coming months, so please look out for them. Thank you for listening to Sustainability Matters. If you enjoyed this episode, please check out previous episodes on ey.com or wherever you get your podcasts. We'd love for you to subscribe and ratings, reviews and comments are also very welcome. Please also visit ey.com, where you'll find a wide range of related and interesting articles that will help put these bigger topics in the context of your business priorities. I look forward to welcoming you on the next episode of Sustainability Matters. My name is Bruno Sarda. You can find me on LinkedIn and feel free to connect with me there. Thanks so much for listening.
