5 ways investors will use EU sustainability reporting to inform their investment strategies

Around the world, jurisdictions are increasingly adopting mandatory sustainability reporting for business. Europe is a frontrunner in this respect thanks to the EU’s Corporate Sustainability Reporting Directive (CSRD). The CSRD requires around 49,000 companies to disclose a wide range of sustainability metrics, with the first phase reporting in 2025 on 2024 data.?

The CSRD is a game changer for business, not only because of its reporting requirements but because it presents exciting opportunities for them to accelerate their transition plans to transform their business models. It is also a game changer for investors who will benefit from having access to high-quality, comparable and reliable information on companies’ business models, strategy and supply chain. With the benefit of this information, investors should be able to better evaluate investment opportunities so they can more confidently channel their capital toward genuinely sustainable businesses.

Preparing to report under the CSRD is a major undertaking though, consuming considerable time and resources. It is also a big focus area for their boards and audit committees, which are supporting them to navigate the strategic, operational and financial implications of the directive. New 安永 research, How can European boards steer sustainability reporting?, highlights some of the challenges that boards are currently facing and how these can be overcome. At the same time, the report emphasizes that CSRD reporting provides companies with opportunities to build even stronger and more trusted relationships with investors.

If you are familiar with the corporate reporting ecosystem, I expect you will have heard some say many times something like: "no-one reads our reports so whats the point?". I know I have; so often in fact I might call it a trope.

Who wants to put effort into something if they believe the intended recipient does not value it?

It is this sentiment that prompted me to write this article. It is for everyone working hard to prepare sustainability reports under CSRD this year. I hope that they will take heart from it and come away with more confidence that the the outputs of their extra efforts will be used, and indeed be valued.

So, how will investors take advantage of CSRD reporting to fully integrate sustainability in investment decisions? Here’s what companies, as preparers, should know:

1. Risk assessment and resilience

Investors can use the sustainability data reported under the CSRD to assess potential long-term investments in light of the material risks and opportunities associated with different sustainability factors, including climate change. For instance, they can evaluate whether potential investments are likely to be resilient to climate-related risks such as physical climate impacts, as well as regulatory and market shifts that may accompany the transition to a net-zero economy. So, it is important that companies disclose their strategies for responding to the risks and challenges they face, such as changing their business strategy or allocating capital to climate-related initiatives.

Additionally, sustainability data can help investors to understand the operational risks faced by companies, such as supply chain vulnerabilities and resource scarcity. Recognizing the challenges that investors currently face with assessing sustainability-related risks and opportunities, the World Resources Institute has developed its Sustainable Investment Initiative, which advances sustainable investment opportunities for institutional investors by providing education and cutting-edge research.

For investors, a major benefit of the CSRD is that it introduces limited assurance on reported sustainability data, which should later transition to reasonable assurance. New or enhanced internal controls systems is likely to be needed for this reporting and assurance. Such systems will help to enhance the credibility of the data and boost investor confidence in the reported information. It will take time to build them, however, so companies will need to be transparent with their shareholders and prospective investors about where they are on the journey.?

2. Performance evaluation

Investors will be able to analyze sustainability reports to evaluate companies’ performance against various sustainability criteria. These criteria include carbon footprint, energy efficiency, social responsibility and governance practices. Having access to this information is a major benefit to investors since high performance in these areas often correlates with better long-term financial performance and lower risks. Additionally, it allows investors to meet their own regulatory reporting requirements such as the Taskforce on Climate-related Financial Disclosures reporting for asset managers and asset owners in the UK, or wider client reporting.

Another important consideration is that standardized sustainability data enables investors to compare companies within and across sectors. By undertaking comparative analysis, investors will be able to identify leaders and followers in sustainability practices increasing their ability to make informed investment decisions. They will also be better equipped to identify and challenge greenwashing.

Already, we can see investors taking a close interest in metrics that can be used to assess companies' sustainability performance. The Sustainable Markets Initiative has developed guidance to help private equity investors identify the metrics that should be most relevant to their decision-making. This guidance highlights that consistent and comparable sustainability metrics should help private equity firms to “build a more profitable and sustainable future” for their organizations and the world at large.?

3. Financial insights

CSRD reporting will also provide investors with a wealth of useful data that they can use to inform their overall decision-making process. As well as being able to better assess risk and compare the sustainability performance of different companies, the reporting will enable them to connect companies’ financial performance with their sustainability practices. This is because sustainability information will be integrated with financial data in companies’ management reports.

Furthermore, under the Directive, companies are required to assess materiality and consider the implications of sustainability issues on the company (outside-in), as well as the impact of their business activities on the economy, environment and society (inside-out). This “double materiality” provides investors and other stakeholders with greater insights into a company’s risks, opportunities and impacts.

The most recent EY Global Corporate Reporting and Institutional Investor Survey published in November 2022 highlights why the CSRD should be a major step forward. At that time, investors felt strongly that they do not get the reporting and data-driven insight they need to inform their investment decision-making. Nearly three-quarters (73%) of investors surveyed for the research said that organizations had largely failed to create more enhanced reporting, encompassing both financial and sustainability disclosures.

4. Strategic alignment

By analyzing companies’ sustainability data, investors can align their portfolios with their own sustainability goals. For example, they might want to invest in companies with strong environmental stewardship or social responsibility practices. Investors can use detailed sustainability data to identify investment opportunities that align with impact investment themes such as clean energy, sustainable agriculture, or social equity.

Furthermore, investors increasingly need this information for fund labelling purposes so they can demonstrate that the companies in a sustainability fund are meeting the objectives of that fund. Earlier this year, the European Securities and Markets Authority issued guidelines on funds’ names using ESG or sustainability-related terms. The guidelines aim to provide asset managers with clear and measurable criteria to assess their ability to use transition, ESG or sustainability-related terms in fund names and protect investors against funds that make unsubstantiated or exaggerated sustainability claims. It is too early to know exactly how investors will apply the guidelines, but companies that provide high-quality information about their sustainability performance seem more likely to be included in sustainability funds if their sustainability performance is viewed as good. Investors can use sustainability data to engage with companies on material sustainability issues, which should lead to improved corporate practices, including enhanced risk management and stronger alignment with the United Nations’ Sustainability Development Goals.

Information reported under the CSRD must be reported against the EU Taxonomy, the EU’s classification system for demarcating environmentally sustainable economic activities. This is a significant consideration for investment institutions since the Sustainable Finance Disclosure Regulation requires them to disclose how their products align with the EU Taxonomy, to encourage them to allocate capital to sustainable finance. They may also use CSRD reporting to meet other sustainable finance regulations. The Investor Leadership Network has highlighted that taxonomies can help to “move the transition conversation away from subjective viewpoints and definition-based qualitative discussion, toward data-driven decision-making.”

5. Engagement and stewardship

CSRD reporting presents significant opportunities for investors to engage more actively with companies and be effective stewards of the assets they manage or own.

There are opportunities for investors to use the reported data to engage with companies in constructive conversations around corporate strategy, operations or governance, with the aim of enhancing sustainability performance and promoting long-term value creation. Sustainability data should inform voting decisions at shareholder meetings. It should also support broader advocacy efforts for higher sustainability standards and practices across industries. We are already seeing examples of investors pushing for change after they’ve analyzed information relating to companies’ sustainability practices.??

Driving the net-zero transition

By making effective use of sustainability reporting, investors can enhance their investment strategies and play a more active role in driving the transition to a net-zero economy. Having a better understanding of companies’ sustainability disclosures and sustainability risk performance will allow them to allocate capital to businesses that take a genuinely long-term approach to value creation, and proactively measure their progress against robust KPIs. This will enable investors to deliver on their mandates and obligations to the ultimate beneficiaries (i.e. you and me), as well as improving their ability to meet their own sustainability targets.

I therefore encourage preparers to embrace the CSRD as far more than a compliance exercise: rather as an important building block in attracting the critical external investment that will set them on course for future success.

Thank you to Séverine Neervoort Andrew Ninian Khadija Ali Charlotte Weston and Ellie Vaughan for all their support as I wrote this article.

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The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.