New European Standards: A Challenge for Business
EFRAG has published a new batch of draft standards that are particularly interesting. As a reminder, EFRAG is giving technical advice to the European Commission in the form of draft EU Sustainability Reporting Standards. As part of a drive to strengthen rules introduced by the Non-Financial Reporting Directive, the Commission has a proposal for a Corporate Sustainability Reporting Directive (CSRD). The CSRD is one to watch for any business operating in Europe because:
It applies to most European firms - whether listed on a stock exchange or not as well as small and medium sized enterprises (SMEs)
It extends to non-EU headquartered companies which generate a turnover greater than €150m in the EU and have at least one subsidiary (or branch) in the EU;
That’s a lot of companies! Are they ready?
The new rules, set to come in late 2023 and 2024, set out a big range of reporting requirements. Crucially, they take a wide, “double materiality” perspective which means they don’t just cover financially material topics (which investors are supposedly most interested in) but also extend to topics where the company had a big impact on people and planet - such as many social topics like human rights. All sustainability information will need a limited level of assurance too - $$$ a major expansion of work for the big audit players.
The latest drafts are available here (I must say the EFRAG website is not the best - it took me far too long digging around to find this - who knows how anyone working in a small European firm will know what’s going on…)
Overall impressions: a welcome piece of standardisation that will signal the direction we need on baseline metrics, clarifying what companies need to disclose on a massive range of topics. All the right things are there. But I wonder how business will react to this - once you see the breadth and detail set out, will it overwhelm? I also wonder how far it might end up promoting a ‘box ticking’ mentality, where companies seek to cover the right things, and paint themselves in a good light, rather than giving deep consideration to their impacts, dependencies, risks and opportunities. This is the dilemma with sustainability standards and reporting: it’s not like financial reporting - more complex, contextual and dynamic.
Users - as expected - defined as a broad group, including “users of general-purpose financial reporting (existing and potential investors, lenders and other creditors, including asset managers, credit institutions, insurance undertakings)” but also (going beyond IFRS), “other users, including the undertaking’s business partners, trade unions and social partners, civil society and non-governmental organisations, governments, analysts and academics”. Basically everyone.
“Impact materiality and financial materiality assessments are inter-related and the interdependencies between the two dimensions shall be considered”. Quite right. But the drafts make it clear that the the starting point “is the assessment of impacts”. “A sustainability impact may be financially material from inception or become financially material when it translates or is likely to translate into financial effects in the short-, medium-, or long-term. Irrespective of them being financially material, impacts are captured by the impact materiality perspective.” They also add dependencies “The undertaking shall consider how it is affected by its dependence on the availability of natural and social resources at appropriate prices and quality, independently of its potential impacts on those resources”. We’ll have to see how far IFRS’s approach (evolving) confuses companies with the difference.
There are too many topics to list here but a few I dived into the workforce ones first to take a look at how the phrasing has evolved, and some of the potential challenges ahead:
S1-10 – Adequate wages. This phrasing has changed here to align with other EU but the concept is similar to that of a living or fair wage. This idea has been moved out of the standards around workers in the value chain (e.g. suppliers) and into the workforce. This is quite significant as it means the focus is on a business’s own workforce where it comes to an adequate wage. That’s important, but for multinationals with a big impact into the developing world, it’s not where the biggest wage issues often lie.
S1-13 – Training and skills development indicators. Companies will need to set out “the percentage of employees that participated in regular performance and career development reviews” as well as “the average number of training hours per person for employees” (both broken down by type of employee and gender). This was always a topic where different standards has different metrics. Basically investors were supposedly after the monetary cost, but others thought the time metric gave a clearer picture of quality. As more human capital standards develop, it will be interesting to see whether this topic continues to point in different directions depending on the user.
S1-17 – “Incidents and complaints and severe human rights impacts and incidents” Companies will need to disclose “the number of work-related incidents and/or complaints and severe human rights impacts and incidents within its own workforce and any related material fines or sanctions for the reporting period”. This includes anything connected to work around discrimination by gender, racial /ethnic origin, nationality, religion /belief, disability, age, sexual orientation. This will be an interesting one where I wonder how far companies will report high incidents. Performance data based on companies monitoring incidents always has this challenge. Will those reporting the most be the ‘worst’ companies for discrimination - or just the most transparent?