The quantity and quality of sustainability information will improve significantly in the next few years when approximately 50,000 European companies will have to meet extensive sustainability reporting requirements due to the introduction of the mandatory Corporate Sustainability Reporting Directive (CSRD). This is the most significant change in financial reporting since the introduction of International Financial Reporting Standards (IFRS). It is not just a technical update in reporting standards but an organisational change and strategic boost to green transition. Next, I will explain why so.
As part of the Sustainable Finance Action Plan, the European Commission will gradually make sustainability reporting (CSRD) and its independent assurance mandatory for listed companies AND other large companies during 2024–2026. A company is classified as significant if it meets at least two of the three size criteria:
- It has more than 250 employees.
- Its turnover is more than 40 million euros.
- The balance sheet is more than 20 million euros.
In the Nordic countries, we have many capital-intensive unlisted companies that employ less than 250 people, but they have heavy assets. Therefore, for example, many companies in the construction industry, real estate, and logistics now have to start reporting on their sustainability for the first time. According to the latest estimates, the reporting reform concerns approximately 1,200 companies in Finland. Only about 10% of them are listed companies. Most of them have never reported on their sustainability performance. Sadly, many of them are unaware of what's coming.
Sustainability reporting under the lens
Sustainability information must be published in the annual report in the same way as the income statement and balance sheet – it will become an official part of company disclosures. Therefore, it must be approved by the board. Disclosing sustainability information in the annual report also means that it will come under the scope of official financial supervision in the same way as other financial information published by the company.
"Failure to report sustainability information will lead to the same sanctions as failure to report financial information. Motivated by these changes, board professionals are now eager to learn their new legal responsibilities."
The new reporting requirements are extensive, and these European Sustainability Reporting Standards (ESRS) require companies to report on a range of issues, from transition strategy to the gender pay gap of employees. The standards include two sets of crosscutting standards, five environmental (E) standards, four social (S) standards and two governance (G) standards. These 12 standards are presented in about 50-page documents, covering over 1,100 data points. Some standards will be mandatory for all companies, while some will depend on the materiality assessment.
The effect also extends to small and medium-sized companies
Let's illustrate what it means in practice for a few required sustainability issues, namely climate strategy and gender pay gap reporting, as they become mandatory for all companies. As part of the climate issues, companies must disclose information on their greenhouse gas (GHG) emissions, which cover Scope 1 (direct emissions from own operations), Scope 2 (purchased energy) and Scope 3 (emissions from the value chain). The role of Scope 3 emissions is significant, forcing a snowball effect on many small and medium-sized companies. Suppose these smaller companies want to maintain their competitive edge and stay in the supply chain of big companies (who must report under CSRD). In that case, they are expected to deliver their Scope 1 and 2 emissions to their principal company. Especially those companies, who have publicly communicated their carbon-neutral strategies, are expected to provide evidence of reduced emissions.
Disclosing the gender pay gap among employees is an excellent example of a social responsibility issue that will likely cause management headaches. This measure is relatively easy to calculate because the data is already available from the HR system. Public disclosure of this info might have a greater impact at the organisational level. How do employees react to significant differences? How does it impact on employee satisfaction? New recruitments? Company brand and reputation? Ultimately, this is a managerial problem either fix the problem (which is likely to increase salary costs) or explain it plausibly. Sustainable investors are likely to react negatively to large gender pay gaps because fixing the problem will likely reduce the investment's profitability.
Implementing the CSRD
The implementation of CSRD will also change roles and responsibilities in reporting practices. Independent of who is leading the reporting process, cross-disciplinary cooperation between experts with different skills and backgrounds is increasingly needed. Financial reporting professionals can only prepare these integrated annual reports with the content skills of sustainability professionals and vice versa. The help of IT professionals will be needed in creating data collection processes – in many companies, certainly from scratch.
"Finally, the role of top management can't be highlighted enough – their views on the company's strategy and future are at the heart of reporting."
At the end of the day, a board is responsible for everything. Meaning that ESG needs to be discussed in the audit committees and integrated into internal controls and risk management processes.
An opportunity to get ahead?
Pioneering companies will undoubtedly benefit and can show a strategic edge towards their peers. Still, there will be many companies whose actual sustainable development does not match their advertising or expectations of society. Every single company should analyse how their stakeholders – paying customers, business partners, and investors – react when ESG data must be transparently disclosed, and it will be easily available from the European single-access point. How do they respond if the company's sustainability performance does not meet stakeholders' expectations? All this is likely to affect the company's reputation and market value. Investors who care about their assets see increasing sustainability information as an opportunity to identify winners – not an ideological issue.
"Reporting sustainability information to external stakeholders is essential, but it is even more important that management knows how to use the information in strategic decision-making."
The most foolish thing would be to give information freely to competitors and not use it yourself. It also requires experienced professionals to learn new things and maintain their competitiveness.
We'll discuss these themes, and many others, in the Sustainable Finance programme.
About the author
Hanna Silvola is an Associate Professor of Accounting at Hanken School of Economics. Her research interests include ESG measurement, reporting and assurance, sustainable finance, and sustainable investing. She has international experience from, among others, the London School of Economics and Stanford University (USA). She also serves as an expert member of the European Securities Market Authority's (ESMA) sustainable finance advisory working group.
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