In an ideal world, companies would routinely deliver integrated reports on their activities, in contrast to the current norm of presenting the financials first, followed by compliance-driven economic, social, and governance (ESG) data or presenting ESG and financial data in two separate reports.
Such a shift in perspectives poses challenges for companies accustomed to treating sustainability reporting as an add-on to comply with new regulations only. But it is a necessary shift, as sustainability becomes increasingly central to business continuity. The German automobile industry, American coal companies, and many others have shown us that transition and physical risks are real threats to an increasing number of industries.
Enhanced regulatory oversight is driving awareness of the need for change. The EU Corporate Sustainability Reporting Directive (CSRD) will require companies to report in accordance with the European Sustainability Reporting Standard (ESRS). In addition, there is the Corporate Sustainability Due Diligence Directive (CSDDD) and, internationally, the ongoing work of the IFRSâs International Sustainability Standards Board (ISSB). Meanwhile, reasonable assurance targets for external auditing are around the corner.
These developments will impact both large companies, imposing upon them specific new duties, and, indirectly, their smaller current or prospective suppliers. Mandatory, standardized sustainability reporting will also have a dramatic effect on how stakeholders perceive companiesâ ESG performance. We can expect changes in investor attitudes, litigation risks, roles of key corporate executives, incentives in top executives’ compensation packages, and the nature of business models.
The ideal output is an integrated report, where the ESG side and the financial side speak to each other.
Some companies are concerned with fulfilling ESG requirements from a compliance perspective, and once they achieve this, they might think about how to better integrate these new sustainability metrics and transition plans into strategy and communication efforts. But could this be a missed opportunity?
Once the new accounting software and related data basis are in place, the internal reporting system is adapted to comply with mandatory sustainability reporting, and the first annual report with mandatory ESG data is out there, will they then, a couple of years down the road, really start a new change process to think about strategy and sustainability? Or is it better to tackle both at the same time? There may not be a better moment to develop a sustainability strategy (or decide against it) than the first sophisticated double-materiality assessment that a company is required to complete.
The ideal output is an integrated report, where the ESG side and the financial side speak to each other. In the process of integrating ESG and financial performance, a strategic narrative can be shaped, and so the report becomes a communication tool, in addition to being a reporting tool for compliance purposes. It conveys a message to stakeholders in a concise value-creation model. It is the document that contains the narrative told to the market, backed up by financial and sustainability data.
Because integrated reporting has impacts on many functions within the company, it is necessary to build the governance and the organizational setup with this in mind. This includes determining who oversees reporting: is it the CFO, another person who manages the ESG dimensions of the company, the sustainability officer, or another customized setting that suits the company best?
Whatever a business chooses, the various functions must communicate and collaborate to get the whole picture of what sustainability looks like. While compliance departments look at risks, there are also opportunities for those with the right governance and strategy. Likewise, several different skill sets are needed to integrate complex new metrics into the accounting system if a company is to move to integrated reporting, to combine financial and ESG elements in internal accounting and reporting systems, target setting, and top executives’ compensation packages.
Until recently, most business leaders took for granted that all accounting and reporting decisions affecting a company were the domain of the CFO and the accounting and finance experts. The rise in importance of sustainability reporting is questioning that mindset.
Having a strategic radar that looks specifically at sustainability trends and regulation is becoming particularly important for businesses so they can identify risks and opportunities before they must report on them. It is striking how many companies have not anticipated and even today are unprepared for reporting under the new mandatory sustainability standards regimes in Europe and elsewhere. It is also striking that planetary boundaries, doughnut economics, and the fundamental principles of impact measurement are not well understood and/or used in many companiesâ sustainability strategy discussions.
The challenges for corporations are unprecedented, given the traditional emphasis on financial results and forecasts. That narrow focus does little to prepare companies for having to explain how they fulfill the Paris Agreement and deliver on the global United Nations Sustainable Development Goals, as is the case with sustainability reporting today. The European reporting standards refer to the Paris Agreement and thereby connect reporting to global politics and scientific frameworks like the planetary boundaries.
Sustainability reporting is not developed by accounting experts only. It has a deep connection to the frameworks mentioned above, and companies need to get this knowledge and mindset on board, as it has severe consequences on reporting. For instance, annual reports have never included forecasts for 25 years (as with transition plans to net zero), and we need new tools to deal with these demands.
Integrated reporting requires that businesses develop a systemic view of regulation and potential scenarios they might face in the future for forecasting exercises. In addition, business leaders must work hard to understand what is required so that they can navigate this new terrain.
We are at a crossroads now, with an opportunity to use integrated reporting as a communication instrument to convey a strategic narrative on sustainability, backed up by data.
âSustainability reporting is not developed by accounting experts only. It has a deep connection to the frameworks mentioned above, and companies need to get this knowledge and mindset on board, as it has severe consequences on reporting.â
It remains the companyâs responsibility to explain to stakeholders that the numbers they report lead to respect for planetary boundaries and that they advance society while boosting their financials.
Businesses face significant difficulties when it comes to meeting new reporting requirements. The CSRD brings with it new demands with its operationalization into the ESRS standards, as firms need to supply high-quality data along the supply chain. Companies might be accustomed to consolidating financial data within the group of companies that they control, but now they need to collect and make sense of data that concerns their whole supply chain, distribution of their products, and use phase impacts such as emissions.
The shift of the whole automobile industry towards electric mobility is easily explained if one knows that more than 70% of all emissions of a car manufacturer occur in the use phase of a combustion engine car (upstream Scope 3 emissions), while only about 20% are in the supply chain (downstream Scope 3 emissions).
Similarly, with the CSDDD, there is also a new accountability aspect because companies need to take responsibility and report on what happens in their supply chains with severe litigation risks for misreporting or greenwashing. This requires a collaborative mindset, and people who can build trust and coalitions across supply chains.
The requirement for listed companies to publish non-financial data together with the annual report will shrink timelines to collect the data, ensure alignment to standards or regulations, draft the report, approve the whole report, and publish. Strong governance, streamlined processes, digital solutions, and stakeholder engagement will be critical aspects of reporting in the years to come.
The new regulatory frameworks also offer a compelling invitation â and, in some sectors, an obligation â to innovate new products and services, and to deliver them within âplanetary boundaries.â By taking advantage of a unique opportunity to embrace strong narratives on material topics, supported by relevant data, successful companies can turn tighter regulation and reporting into an opportunity to disrupt their industries on the most important ESG dimensions.
It is important to acknowledge that mandatory sustainability reporting does not force companies to do what is good for the planet or society. It simply forces companies to report on what they have done based on predefined metrics and to forecast what they want to achieve. It remains the companyâs responsibility to explain to stakeholders that the numbers they report lead to respect for planetary boundaries and that they advance society while boosting their financials.
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