In this analysis for Wealth DFM, Iona Silverman, partner and greenwashing lawyer at full-service law firm Freeths argues that while the task of readying firms for the external audit of their sustainability disclosures is a gargantuan one, the potential of these rules to insert profit incentives into ESG will benefit businesses and the environment alike and ultimately justifies their expedited implementation.
The introduction of EU-wide climate disclosure rules for listed companies has prompted concerns that many firms are ill-prepared for the new regulations.
Some listed companies will have to provide extra information under the EU’s Corporate Sustainability Reporting Directive (CSRD), while others will be caught by suggested International Sustainability Standards Board (ISSB) disclosures, in their annual reports for 2024 and onwards.
At a conference in London, Stefan Seidel, head of sustainability at the sportswear company Puma, admitted the European Sustainability Reporting Standards (ESRS) would be a challenge.
Referring to the mandatory auditing of environmental, social and governance (ESG) data, Mr Seidel admitted: ‘We are nowhere near being able to fulfil the requirements of CSRD… So, I think it’s maybe a bit over the top.’
A recent report for KPMG revealed that three-quarters of companies globally are not ready for full ESG disclosure, even though the legislation has been widely publicised over the course of recent years. Of 750 companies surveyed by KPMG for its ESG Maturity Index, only 25% feel they are sufficiently prepared.
The index assessed the views of executives and board members across industries, regions, and different firm sizes to measure companies’ preparedness. As Larry Bradley, KPMG’s Global Head of Audit, explained: ‘Being ESG assurance ready means identifying the relevant regulatory framework and having the right metrics with robust systems, processes, controls and governance for collecting and managing the data.’
This would seem to be a somewhat distant ambition for some companies, just as the rules come fully into force. Under the new regime, the somewhat uncoordinated mixture of voluntary private sector practices will be replaced by tighter regulations for all listed companies.
The European Sustainability Reporting Standards and the International Sustainability Standards Board requirements will compel companies to make material sustainability disclosures, which must be externally audited.
While ESG auditing is not expected to be as extensive as financial auditing, the introduction of the rules in time for the 2024 reporting season will make it much harder for companies to make misleading environmental claims, popularly known as greenwashing.
In the long term, the parity throughout business will mean that investors can make judgments based on comparable cross-industry standards. For many international corporations that may have only recently created ESG briefs, however, the task of improving sustainability credentials while supporting overarching business objectives seems overly challenging on many levels right now.
Sustainability touches every area of a business, meaning companies must consider it at every stage of a supply chain, every stage in the life cycle of a product, and every country they operate in.
The process of accumulating the data and implementing the necessary lessons to be compliant with the incoming requirements will take many months. Those working in ESG for major companies recognise the scale of the obstacles ahead but realise that the introduction of these measures will be beneficial to both corporations and their investors.
The potential of these rules to insert profit incentives into ESG will benefit businesses and the environment alike, and, although it might be a hard pill to swallow right now, justifies their expedited implementation.
For a long time, the incongruence of maximising profitability with environmental governance has been problematic. Though companies may well want to make changes for the better, they still need to ensure they get the best returns possible for shareholders.
Too often, ethical intentions have not aligned with profit. Driven by the bottom line, companies have strived to boost their image by boasting of environmentally conscious practices which often fail to match the hard reality of corporate motivations.
The new reporting requirements, therefore, should help bridge this gap by giving investors reliable tools to choose to invest in sustainable companies, thus linking stronger sustainability credentials with stronger profit margins.
Senior managers appointed to head of sustainability roles have the unenviable task of seeking to measure and improve their company’s sustainability performance while driving value and supporting the company’s overarching business objectives.
The coming months will be testing for those selected. Faced with a new reality in which margins are tied to sustainability means that, however much of a struggle it currently seems, companies should ensure the ESG rules are implemented as quickly as possible.
Regulators, however, have sought to reassure firms worried that they will not come down too hard on them from day one of the introduction of the EU’s CSRD. Even Helena Vines Fiestas, chair of the EU’s Platform on Sustainable Finance, acknowledges that the bloc’s regulations are “a work in progress”.
But this process will never be reverted to how things were before. Industry-wide ESG standards are here to stay.
Rather than be reticent, companies need to embrace the new ESG reporting rules as an opportunity to step confidently into a future in which greenwashing is no longer an option.
