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For supervisory authorities and many NGOs, the lack of transparency in ESG reporting by companies and investors is a recurring theme. European regulatory developments, including the Taxonomy, the Sustainable Finance Disclosure Regulation (SFDR), and the Corporate Sustainability Reporting Directive, aim to improve the transparency of reporting by both real economy and financial actors.
Stakeholders' demand for transparency regarding the environmental, social, and governance impacts of companies and investors has increased significantly in recent years. What stakeholders want is access to information and data that is concise, reliable, consistent, comparable, and verifiable, expressed in clear language that can be understood by the widest possible audience.
Banks, for their part, are being called upon to place increasing importance on companies' ESG reporting. At the latest edition of Produrable, LCL, a partner of Tennaxia, spoke about the changing role of banks alongside companies in financing the transition, through green financing tools and the need for companies to manage their ESG performance and share data with them. The need for transparency is also evident here.
Transparency is therefore key to ensuring the credibility of the environmental and social policies implemented by companies. It provides evidence of the reality of the commitments made by companies and, as such, is also a prerequisite for financial actors to be able to contribute to ecological, energy, and social transitions.
Transparency in ESG reporting by companies, as well as by financial players, is ultimately the best safeguard against greenwashing. Easier said than done?
Transparency and materiality
The purpose of the Non-Financial Performance Statement (DPEF) was to encourage companies to focus on material information, thereby promoting greater transparency. Ultimately, the idea was to encourage reporters to publish more concise reports. However, the 2019 Medef-EY-Deloitte study showed that the number of pages in EFPDs had actually increased. Transparency should not lead to information overload!
Transparency in corporate ESG reporting should make it possible to identify all aspects of sustainable development that could create or erode value. In other words, it should enable the assessment of the management of environmental and social risks and opportunities that could affect the value of the company. This is simple materiality, also known as financial materiality, which is now advocated by the International Sustainability Standards Board (ISSB), chaired by Emmanuel Faber.
Transparency in companies' ESG reporting must also make it possible to identify their contributions to sustainable development, i.e., their actions that have a substantial positive or negative impact on society and the environment. The integration of this second perspective is in line with the dual materiality required by Europe. Sustainable finance players must be able to assess both the impact of environmental and social issues on a company's activities and the impact of the company's activities on the environment and its sphere of influence.
The materiality analysis itself must be transparent in the reporting. This means specifying the methodology used to identify the issues that were submitted for evaluation by internal and external stakeholders. In doing so, it is important to identify who these stakeholders are and how they were identified. Finally, transparency must be ensured in the assessment grid for risks and opportunities. How much credibility can be given to the publication of a materiality matrix without this necessary transparency?
Transparency and Corporate Sustainability Reporting Directive
Mairead McGuinness (European Commissioner for Financial Services) pointed out last April that "Sustainable investment is about making the right choices. To make the right choices, you need good information." Having access to good, consistent, relevant, comparable, and reliable information is the goal of the CSRD, which is set to propose a single set of ESG standards to be reported on by the 49,000 companies concerned, requiring these companies to be more transparent and accountable in their reporting.
With the CSRD, companies will, for example, have to report transparently on the involvement of governance in decisions and actions taken to contribute to climate change mitigation and adaptation. They will have to show, for example, how this affects and impacts the remuneration of executives, managers, and all employees.
In this regard, according to Ethics and Boards, only 5% of the variable compensation policy for CAC 40 CEOs in 2021 currently includes climate criteria. This figure tends to show that there is considerable room for improvement in terms of making corporate governance's involvement in the fight against climate change more credible. And this is what should be required for financial years beginning on or after January1, 2023.
Still on the subject of climate change, the higher standards and greater precision required by the CSRD should lead companies to clarify the scope of their reporting in terms of their organizational structure. This will also apply to the scope chosen for Scope 3 carbon emissions (for the record, according to a recent BCG Gamma study of 1,290 companies in twelve countries, 9% of companies accurately measure their CO2 emissions. 81% of them omit some of their internal emissions and 66% do not report any of their external emissions). We could add the definition of indicators and details on coverage rates.
With the CSRD, companies will have to report on the results achieved in relation to the objectives set for given periods (a five-year period seems to be emerging). This is a major change. This transparency will make it easier for stakeholders to make sectoral comparisons and thus verify the actual performance level of the commitments made.
In conclusion,
The requirement for transparency has continued to grow since the NRE Act came into force in 2003. The work to standardize ESG reporting by companies and investors, initiated by the European Financial Reporting Advisory Group (EFRAG), will significantly raise the level of transparency required for ESG reporting. It is clear that this will be much more than just another compliance exercise.
For companies with the most experience in reporting, this will require making a few adjustments, providing some clarifications, and complying with the new standardized metrics. For others, it will mean making a significant qualitative leap. In this regard, it would seem appropriate to conduct a gap analysis as soon as possible between the existing situation and the requirements that are emerging, despite the existing uncertainties.
For SAS companies and SMEs with more than 250 employees that were not affected by the DPEF, the sooner they begin considering how to implement the CSRD, the better prepared they will be to face the challenge ahead.
Photo credit: 177923174@Drobot Dean