#15 - CSRD: The Silent Revolution

In December 2019, the European Union announced its Green Deal. The objective, often summarised as achieving net-zero emissions by 2050, is in fact much more ambitious: beyond climate action and "clean" energies, the goal is to renovate infrastructure (including the real estate sector), develop circular economies and sustainable agriculture, reduce pollution, and protect biodiversity.

It represents a profound and comprehensive transformation of our systems with new rules of the game (regulations and directives) in all domains. The goal, according to Frans Timmermans, Vice-President of the European Commission, is "to improve the health and well-being of our citizens by transforming our economic model."

Why?

Why speak of health and well-being as the motivation behind this deal? The environmental urgency has been known for a long time. But beyond wanting to save polar bears, the problem is quickly getting out of hand and it is our health and safety that is at stake today: temperatures over the past year are already 1.5°C above pre-industrial averages!

Europe is often seen as a leader on the environmental front; but it is also the fastest warming continent... We are witnessing "heat domes", water cycles are becoming increasingly erratic (floods in Slovenia cost 16% of GDP in 2023!), pollution is ubiquitous and affecting all forms of life (83% of freshwater life has been lost between 1970 and 2018!). The list goes on...

The collapse of ecosystems threatens our physical and financial security as much as our social cohesion.

What?

In response to this urgency, the European Union has allocated a budget of at least €1 trillion over the decade and a comprehensive regulatory framework to drive all actors towards greening our activities.

The first major texts, the Taxonomy defining "green" activities, and SFDR (Sustainable Finance Disclosure Regulation), establishing reporting standards for financial actors, are still hard to implement in practice due to a lack of precise and reliable data. They have, in a sense, arrived "too early" (although some would argue they have arrived "too late" given the environmental urgency...).

The Corporate Sustainability Reporting Directive, or CSRD, (and to a lesser extent the Corporate Sustainability Due Diligence Directive, or CSDDD) fills this gap and provides a standardized solution. This text represents a key moment in the development of corporate information. Patrick de Cambourg, chairman of the sustainability reporting board at EFRAG, mentions a "silent revolution," and that is not an overstatement.

Companies will now have to account for the impacts of their activities across all non-financial dimensions: climate, biodiversity, social, etc.

This new set of "accounting" data is of a very different nature from traditional accounting data: non-financial data are inherently prospective and cover the entire value chain. It is thus more about understanding and narrating the future consequences of our actions than providing a simple balance sheet. This foresight must be precise enough to inform the decisions of both private and public actors.

How?

To achieve this, the CSRD will need to be integrated into the "intimate" functioning of companies to profoundly transform them. Beyond regulatory compliance and producing reports, the requirement for foresight represents an opportunity to address sustainability issues by integrating them into the company's strategy, in four steps:

Step 1

A materiality analysis is necessary to understand which issues are important in the context of each organisation to concentrate efforts where they will be the most useful.

Here, the CSRD anchors the principle of double materiality, where both the impacts of the environment on the company (financial materiality) and those of the company on the environment (environmental and social materiality) must be reviewed.

Still at the center of many international debates, this concept of double materiality is gaining ground with more and more countries adopting it.

Also, this second materiality must looked at from a "scientific" perspective, in light of the real needs of the environment. The common practice of mapping stakeholders preferences or feelings to various issues can be useful to facilitate adoption of a transformation plan but cannot suffice at this stage.

Clearly, this will require a significant effort from companies. According to BCG, only 10% of them measured all their emissions in 2022, with a margin of error of 25 to 30% and mostly using Excel... It will now be necessary to measure all non-financial issues!

Step 2

A gap-analysis between the current situation and the target situation should help establish a transition plan, ideally in consultation with all stakeholders.

And since the publication of this plan commits, it must go far beyond a mere statement of intent and specify actions to be taken, intermediate targets, governance processes, etc.

It is worth noting that the Commission recently passed a directive against greenwashing, prompted by the fact that there are several hundred "green" labels, over half of which are vaguely defined or unfounded. Organisations of the world: it is time to get serious!

Step 3

The usual focus on metrics and reporting should only come as a third step. These metrics are defined in the ESRS (European Sustainability Reporting Standard). They should clarify the company's trajectory both externally and internally, and serve decision-makers. Year after year, they will form a narrative that can be compared to the initial action plan and used to improve it.

The ESRS are organized into twelve standards:

• Two general standards specifying mandatory procedures and information required from all companies
• Five for environmental issues, organised in line with the Taxonomy; they include climate, pollution, water and marine resources, biodiversity, and circular economy
• Four for social and societal issues, distributed across the company's value chain; they cover the company's own workforce, jobs in the value chain, affected communities, and finally, customers and end-users
• One for governance aimed at clarifying strategies and processes, especially for managing impacts, risks, and opportunities

Step 4

Finally, the organisation must allocate resources towards the realisation of its action plan.

It is worth noting here that the notion of impact, risks, and opportunities, key in the ESRS, is much more positive than that of PAI (Principal Adverse Impacts) in SFDR or DNSH (Do No Significant Harm) in the Taxonomy. The mere mention of opportunities in the title makes the transformation much more desirable!

However, this allocation of resources should not follow a classic cost/benefit analysis: sustainability issues are physical, not financial; therefore, there can be no compensation.

On the other hand, since non-financial issues are assessed across the value chain, resources (and actions) will generally present opportunities for new collaborations (with competitors and/or new stakeholders).

For example, a factory may innovate in reusing by-products of its production process in another industry, thus implementing circular economy principles.

Start now!

In doing so, the CSRD will have achieved its goal of encouraging companies to gradually evolve their business models to make them compatible with a "green" economy.

To go further, sectoral supplements will be published soon, as well as lighter voluntary standards for smaller companies.

Given that medium-sized enterprises will be subject to these obligations in 2025, there is an opportunity to voluntarily adopt these reporting rules this year and become pioneers in transforming their sector.

And since making strategies more comprehensive and coherent is highly likely to generate value, the return of investment of implementing the CSRD should actually be quite positive!