We’re embarking on the biggest reporting experiment seen in the past century. Businesses of all sizes will be affected.
Instead of simply looking back at past financial performance, reporting requirements will involve projecting forward and striving to measure what we’ve never collectively measured before. Starting in earnest in 2024, this experiment will affect how companies appear to investors, to customers, to suppliers, to partners, to activists – in short, to every potential stakeholder and anyone who’s watching.
There are various standards at play, but the European Union has the most far-reaching directive on sustainability – aka, environmental, social, and governance (ESG) – requirements out there. It is based on a concept known as double materiality, referring to considerations beyond immediate financial impact, i.e., those that create a wider environmental or social impact. Your accounting department has never reported like this before.
If you’re managing a smaller business in the EU, you may have breathed a sigh of relief when you found out the EU’s Corporate Sustainability Reporting Directive (CSRD), with its double-materiality requirements, will only directly apply to approximately 50,000 large or listed companies, most of them based in Europe, starting in the 2024 fiscal year. But the CSRD has the potential to make profound changes for you, too, even if you are out of the legal scope of the directive. It is the toughest benchmark for anyone who might influence your reporting.
In addition to the CSRD, the International Sustainability Standards Board (ISSB) issued its first two sustainability disclosure standards – International Financial Reporting Standards (IFRS) S1 and S2 this summer (at the end of June). These standards are meant to serve as a global baseline of disclosures to meet the information needs of outside decision-makers in many jurisdictions. The IFRS Foundation’s standards don’t go as far as the EU’s in terms of the breadth of disclosure requirements (they are focused squarely on financial materiality), but they are expected to go further in terms of their geographic reach.
Without going into any of the standards’ details, I’d like to outline here why they matter strategically as business undergoes this paradigm shift. I’ll break that down into five pieces of practical advice for approaching them.
This applies to you even if you are a smaller business or otherwise exempt from the EU’s standards, because it will help you position yourself competitively. Imagine you are a small supplier, and your biggest customer is just beginning to report under the CSRD in 2024. Providing your ESG data, particularly on greenhouse gas emissions at the beginning, might be a requirement from your big customer because they need to prepare their Scope 3 (value chain) emissions-reduction forecast. Your company can gain a competitive advantage over competitors who are not prepared to supply ESG data to their big customers who need that data.
The CSRD, when it first applies, will only affect about 0.2% of Europe’s 30 million enterprises. But when you look at value chains, partnerships, and consider the other standards on the horizon, doing the legwork now, according to the most stringent standards, will prepare your company for the brave new world of sustainability reporting. Take the time now to talk to clients and partners about what they might need in the near future.
The accountants who oversee your financial data today will most likely see their jobs much expanded by the reporting of ESG data. Accountants, and for larger entities the internal audit function, should take on the role of strategic consultants to help get the company ready for ESG reporting. We’re witnessing the largest shift in their craft since the automation of bookkeeping in the 1950s. Reorganizations and additional training will be required.
Don’t overpromise. When it comes to public disclosures, do not get carried away with what may appear to be potential marketing opportunities or long-term promises that may never come to fruition. This can needlessly undermine your reputation. Remember: especially if you are not (yet) required to report ESG data, you may want to keep quiet on data to disclose it strategically. There is a long list of companies – including KLM Royal Dutch Airlines and Deutsche Bank’s DWS Group – that overpromised and got into trouble.
Reducing water usage by 5-10% is a good step. But what if you could disrupt your own business model and reduce water usage by 95%? An inspiring example can be seen in the vertical farming industry. Instead of incremental innovation, ventures in this industry aim to revolutionize the agriculture business, stacking crops vertically indoors. They are in the game to entirely reinvent the agriculture business.
What is strategic materiality? I’m using this new phrase to describe reporting disclosures that work to the advantage of business. The ISSB standards require only financial materiality – that is to say, anything that can have a material impact on the financial value of the company. The EU is asking for double materiality, going beyond immediate financial impact, and looking more broadly at a firm’s externalities. But for companies that want to use this one-time change in reporting to their advantage, the search for non-replicable ESG strategies is key. What is a material aspect in your industry where you can outperform all your competitors? Something that is not necessarily based on any standard but driven by the purpose of your company.
If you want to go far beyond mere compliance with mandatory sustainability reporting, then strategic materiality is a useful concept. It’s an opportunity to think about your materiality framework that translates your sustainability strategy into action. This is far from a one-size-fits-all solution to materiality reporting. It is your strategic ESG approach with wise decisions about what to report externally, and what to use in your internal reporting systems only.
As we embark on the largest-ever planetary-wide experiment in ESG data collection, I want to emphasize my prediction that those companies that cannot react fast enough will be replaced by others that can. Mere compliance is not the right strategy if you want to thrive. Looking to the European Union, with the world’s most ambitious ESG reporting standards, will help your company prepare strategically for what’s next.
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