The launch of the EU’s Corporate Sustainability Reporting Directive (CSRD) and the ongoing work of the IFRS’s International Sustainability Standards Board (ISSB) have naturally led to extensive discussion of the implications for compliance. These far-reaching changes will impact both large companies, imposing upon them specific new duties, and, indirectly, their smaller current or prospective suppliers.1
However, having too narrow a focus on reporting practicalities risks ignoring the bigger picture. The shift toward mandatory, standardized ESG reporting will have a dramatic effect on how stakeholders perceive companies’ ESG performance. We can expect changes to investor attitudes, the roles of key corporate executives, and the structure of business models.
Recent surveys report that even listed firms that practice structured ESG reporting find themselves unprepared for the demands of mandatory sustainability reporting. This is particularly the case for those companies to which CSRD applies.
Currently, companies can choose to report against any of a range of standards (such as GRI, SASB, etc.). Even the companies making a genuine attempt to give a clear account of their activities and progress are likely to pick the regime that makes them look as good as possible. Owing to the standardized reporting scope, some companies that are celebrated for their ESG performance today may be seen in a new (and dimmer) light. Meanwhile, others will demonstrate previously unappreciated strengths.
At least on financially material topics, regulators will shift the focus of reporting from anecdotal evidence of ESG-related activities to the impact of each company. This is particularly true for environmental measures relating to issues such as Scope 3 emissions, water consumption, and biodiversity. At the same time, new, standardized measures may arise, for example on worker mental health. Such outcome-focused reporting will oblige companies to ensure their ESG efforts are effective, rather than simply impressive on paper. This will help to define good practice and promote meaningful competition for some ESG dimensions.
The new mandatory reporting frameworks, and particularly the CSRD, do not come without issues. The CSRD leads to an excessive number of metrics on which companies must report. Some might even prove counter–effective or have little impact. For example, the Sustainability Accounting Standards Board (SASB) metric includes the number of electric vehicles sold, but this tells us very little about overall emissions; for that, we need to know more about the source and production of the electricity itself.
Even with the high volume of data that companies must publish, it will be difficult to draw clear conclusions about their performance and future competitive ESG advantage. A positive view here is that, with time and learning, there will be a less-is-more approach when it comes to metrics. As mandatory ESG reporting begins to provide unprecedentedly standardized, quantified, and comparable data for companies across the market, ESG standards will evolve, just as financial reporting standards have done.
Although ESG investing is a long-established activity, high-quality standardized data on which to base investment decisions is still lacking. Investors frequently fall back on their professional judgment, informed by algorithms they have developed themselves from data they have purchased from various sources. This situation may help explain inconsistencies in the relationships between financial profit, share price, and ESG performance, and also some discrepancies between different ESG rankings.
New technologies and a “learning by reporting” approach, in turn, make investors more demanding in terms of ESG performance. While today investors reward even target setting for ESG, going forward they will focus on the accuracy of target achievement against newly standardized reporting metrics. Correspondingly, they will reward surpassing of and penalize deviation from those ESG targets.
Companies will soon be obliged to produce transition plans to net zero, with detailed milestone targets. In the future, this could be replicated for transition plans to zero plastic, zero freshwater use, and even some social measures. ESG forecasts could be equally valued as earnings forecasts, as a measure of management quality and company performance. Unfulfilled forecasts will not merely annoy activists and concern shareholders; they will undermine share prices.
Such an evolution will also put pressure on companies in jurisdictions with less demanding ESG reporting requirements to conform to the new rules. If investors, banks, and other stakeholders demand this information, firms will quickly see the value of being prepared to adopt high reporting standards. There will likely be a ripple effect of new reporting rules that will drive a competitive dynamic worldwide.
Providing accurate ESG data in reports will, therefore, be considered as important as providing accurate financial performance details. Higher stakes will inevitably lead to the question of who within the corporate structure is responsible for the issuance of sustainability data.
Two likely possibilities exist. One is that the CFO will be further strengthened by the new reporting responsibility being tied into the finance function. The other is that CSOs will achieve a higher status by being given the responsibility of CFOs’ non-financial counterparts. Some companies may invent new corporate designs to cope with the changing sustainability reporting requirements.2 To date, there is no clear best practice for the reporting hierarchy.
Initially, different companies will take different paths, with preferred arrangements for specific sectors or jurisdictions emerging over time. Essential to success will be that ESG and financial data are consistently aggregated into integrated reports that explain succinctly the risks and opportunities inherent in the ESG dimension, and how they impact the overall corporate strategy.
Investors and other stakeholders will want consistent, integrated, and compelling financial and ESG data narratives from companies. They will expect explanations not only of the results in each field but how ESG activities influence the financial bottom line and how economic activities support ESG outcomes. Ideally, there will be evidence of a virtuous circle, with financial and ESG initiatives feeding into the success of each other.
Coherent, compelling reporting will not happen on its own. The new regulatory frameworks offer a very strong invitation – and, in some sectors, an obligation – to innovate new products and services, and to deliver them within “planetary boundaries.” Successful companies will see tighter regulation and reporting as an opportunity to disrupt their industries on the most important ESG dimensions.
The most dramatic example of this effect can already be seen in Europe’s automobile industry. Regulations on passenger car emissions have forced carmakers to invest in new mobility solutions to replace the traditional internal combustion engine. Other industries will see similar impacts from ESG regulation and mandatory reporting. Agriculture, for example, may see models emerging that promote biodiversity and decrease pesticides, water consumption, and emissions. Elsewhere, resource-intensive industries will look harder for opportunities to implement circularity.
In summary, what may initially appear to be a routine update of regulation could drive a once-in-a-century shift in how markets evaluate corporate performance. This would upend fundamental beliefs about the information companies need to issue and what constitutes best practice. Those not prepared for this change will join the likes of Blackberry and Nokia as firms that did not see the future coming. Those who seize the opportunity will be tomorrow’s corporate leaders.
Dr. Kiri Trier, the beauty giant’s regional sustainability chief, explains her drive to change customer habits and make cutting waste, refilling, and recycling part of their daily bathroom routine....
As companies jostle for sustainability leadership, these competitive rivalries are proving unexpectedly powerful in accelerating environmental action, while strategic collaborations can amplify the impact....
With solar power flooding grids, the duck curve creates both challenges and opportunities for businesses. Learn how smart companies can harness this shift to cut costs and boost efficiency....
As the global environmental crisis accelerates, biodiversity often plays a hidden role for companies. This article examines how businesses can address this risk through an effective nature-based strategy....
Explore first person business intelligence from top minds curated for a global executive audience