Finding data to support greener investing is challenging. Investors should benefit from the EU's Corporate Sustainability Regulation Directive (CSRD) in the current effort to move toward a more sustainable economy.
According to Hortense Bioy, global director of sustainability research at Morningstar, "at the moment there is a lack of detail and inconsistent data being reported by companies, which leads to a lot of estimates being made by third-party ESG-data providers and asset managers. The CSRD will make it easier for investors to analyse, compare and contrast what companies are doing and the impact they’re having."
The EU's Green Deal and the Sustainable Finance Action Plan were both advanced by the European Commission's April 21, 2021 proposal of the CSRD. It is hoped that in two to three years, investors will have access to standardized and more trustworthy information about the effects of corporate activity on the environment and society.
However, implementation is not always easy.According to Roeland Tso, investment strategist at impact investor Triodos Investment Management, which oversees €6.4 billion in assets, "In our view one of the flaws of the Sustainable Finance Action Plan is the timing. Asset managers and financial institutions are required to report at an earlier stage than the actual underlying investee companies."
“They are required to update prospectuses and provide Taxonomy-related data by July 1, 2023, while corporates [under CSRD regulation] will be required to report at a later stage.”
Asset managers will rely on third-party data vendors that use proxies or estimates to address this issue, he continues, at least for the first few years while "we await better disclosure and reporting from companies."
According to Claudius Baumann, a manager at KPMG with experience in sustainability services, the CSRD may make asset managers' jobs simpler. It could simultaneously support EU efforts to advance sustainable finance and realize political objectives like the EU Green Deal. The Green Deal aims to improve people's quality of life through cleaner air and water, better health, and an increase in economic growth without slowing down the 27-country bloc's economy. According to Baumann, the availability of reliable and comparable data on the current sustainability performance of businesses is essential for the success of a green transition.
He adds that "the CSRD will, on the one hand, provide clear standards … and on the other hand, expand the scope of companies significantly."
The standards in question are the European Sustainability Reporting Standards, which address the manner in which ESG topics should be reported. The European Financial Reporting Advisory Group created these (EFRAG).
The draft proposals for the architecture, guiding principles, and implementation of CSRD were recently made available for public comment by EFRAG. Additionally, options for phasing in the reporting standards were discussed, as well as the suitability of each disclosure requirement.
The Non-Financial Reporting Directive, which was introduced in 2014 but only applied to 11,000 of the largest listed companies in the region, will be replaced by the new directive. The disclosure of information was patchy because there was no disclosure provision, in addition to being too narrow.
"Currently, companies can pick and choose what they disclose, but the CSRD is prescriptive and makes it clear how and what should be reported," according to Morningstar's Bioy. "There is also a concept of proportionality to size and resources. Small companies won’t be required to disclose as much data as large companies. However, there is a minimum baseline of reporting, and the greater disclosure required in areas such as supply chains should have a positive ripple effect beyond Europe."
According to Dr. Anthony Kirby, the lead for wealth and asset management consulting regulatory intelligence at EY, the CSRD's broader mandate covers approximately 50,000 companies, or 75% of EU turnover. This applies to all sizable nonprofit organizations and those listed on.
Markets governed by the EU that satisfy two out of the three requirements listed below: 250 or more employees, €40 million in net revenue, and €20 million in assets.
The catchment area also includes listed small and medium-sized businesses, though their reporting requirements will be less onerous and they will have an extra year to implement.
Although the Commission has suggested a set of voluntary standards that they can follow to aid in the transition to a greener economy, their non-listed cohorts will be exempt.
International businesses will also be exempt from the regulations unless they have a subsidiary within the bloc. In other words, if one of a company's many subsidiaries is in the EU, even if the parent company is based in the US or Asia, it must abide by the CSRD.
Currently, the CSRD is in the trialogue phase, during which the European Commission, Parliament, and Council negotiate a final framework.
According to Baumann, "the ongoing trialogue in Brussels is expected to be finalised latest by the middle of the year. As the directive is to be transposed into national legislation by member states, a first-time adoption can be expected not before the business year 2024."
Similar to the earlier Non-Financial Reporting Directive, there is a concept known as "double materiality," which requires businesses to disclose not only their impact on the environment, society, and the economy, but also any environmental, social, or governance factors that have the potential to materially affect their value and opportunities.
According to Tso at Triodos, "companies will now need to report about both ‘outside-in’ and ‘inside-out’ impact on society and the environment. It is expected that more transparency and better data quality related to sustainability reporting will lead to a better understanding of the impact of companies both from a risk and a positive impact perspective."
In addition to double materiality, companies will have to explain their business model and strategy, as well as how they support the Paris Agreement's goal of keeping global warming to 1.5oC while taking into account the opinions of various stakeholders. Along with the potential effects that sustainability issues may have on a company's value and supply chains, targets for sustainability and progress toward those goals are also anticipated to be made public.
The list also includes intangibles like human capital and intellectual capital. According to the directive, the information must, overall, cover short-, medium-, and long-term time horizons, be both forward- and backward-looking, and include both qualitative and quantitative information.
As a precaution, regulators demand that the data be subjected to "limited third-party assurance," or an external auditor, to verify and assess the data.
The CSRD focuses on data construction and distribution as well as data collection itself. The European Single Access Point (ESAP) initiative, a forthcoming EU project to create a European ESG database with open access, will require management reports to be published in a specific format and the information to be digitally tagged. In light of this, it should come as no surprise that businesses, even those that filed reports in accordance with the Non-Financial Disclosure Rules, will face challenges.
According to Kirby at EY, "the result is that we will go from a desert of data to a deluge. There will be much more detail required, including specific standards for at least 14 sector groups and 40 sectors. Companies will need to ensure that the management team has the right skillsets to measure and report as well as the systems and processes in place. The jury is out on whether it also needs to be driven from the chief operating officer, the CFO or from risk management and compliance."
Could corporates be removed from asset managers' investment portfolios if they do not comply properly with the law?According to Laurence Caron-Habib, head of public affairs at BNP Paribas Asset Management, "at the end of the day, companies will have to make a huge number of modifications on the extra-financial reporting they produce today. When data can’t be disclosed on a voluntary basis, companies will have to find the right balance between the cost and compliance but at the same time, the opportunity to be included in in the investment universe. If they do not provide the data, they will be excluded."
Research director at a consulting firm, Acuity Knowledge Partners, Achin Bhati, concurs. "There will be a high cost for companies to comply with the CSRD. However, there is a silver lining in that they will be more resilient over the long term. Those that do not comply will be seen as less attractive from an investment perspective."
By fLEXI tEAM