ESG and digitalization - Driving Sustainable Business through Data-driven Transparency and innovation

Sustainability reporting is not entirely new. The necessity started some 50 years ago, when the side-effects of economic growth and industrialization on the environment and nature became broadly aware. Together with the publication “The Limits of Growth” by the Club of Rome, environmental impact was globally recognized however, with limited consequential actions.

After the first climate conference in 1979 - many chemical companies started to publish environmental reports at the end of the 1980, but beside creating transparency for marketing purposes, no material change happened.

With the Kyoto protocol signed in 1997 and effective in 2005 onwards, more actions were taken up on country level that sustainability strategies were formulated.

In the 2010s - the development of frameworks started and with the conceptual work of the SDGs in 2016, definitions helped in setting targets for decarbonization, inclusion, equality and fight against poverty.

The Green Deal and the EU Taxonomy are the regulatory framework for what will come effective in 2025: CSRD - together with the disclosure standards ESRS.

The key advancements are:

1. Scope: The CSRD significantly expands the number of companies required to report, including some non-EU companies.
2. Standardization: The ESRS provide a uniform framework for reporting, enhancing comparability between companies.
3. Integration: The CSRD requires sustainability information to be included in management reports, integrating it with financial reporting.
4. Double Materiality: Companies must report both on how sustainability issues affect them and how they impact the environment and society.
5. Climate Action: From 2025, the CSRD will require companies to have a Paris Agreement-aligned emissions reduction plan.
6. Value Chain Reporting: Companies will need to report on Scope 3 emissions, covering their entire value chain.

In this article, I’ll explain the transition needed from financial to non-financial scores and what opportunities this new framework will hold for truly sustainable businesses, that can be built on a digital operating model, that processes data for informed decision making.

From Capital redirection to Operational Environmental Qualification: the shift in sustainability reporting

Sustainability reporting has been around for some time, with financial institutions collecting data to create transparency about the environmental impact of companies' investments. Directives have evolved from merely disclosing investment initiatives to showing how companies have redirected capital towards more environmentally sustainable ventures. However, while Corporate Social Responsibility (CSR) reports are compiled regularly, the relevant data collection is often a point-in-time exercise with limited relation to actual business operations.

Financial performance reporting has a different evolution, allowing for standardized comparison of investment targets. With climate change impacting business operations and financial performance, there's an increased need for disclosure about a company's climate-related vulnerabilities and environmental impact.

• The concept of "double materiality" is now one of the most significant changes coming into practice with the Corporate Sustainability Reporting Directive (CSRD) in 2025, encompassing two dimensions: impact and financial materiality.
• Impact materiality refers to a company's effects on the environment and people, while financial materiality concerns how sustainability-related risks and opportunities could affect the company's financial performance.
• Affected companies are required to conduct a "double materiality assessment" and disclose its results to key stakeholders according to the European Sustainability Reporting Standards (ESRS).

The key difference from previous sustainability reporting requirements is that while the CSRD standardizes WHAT (i.e., Impacts, Risks, and Opportunities—IROs) is reported and to WHOM, it remains relatively open about HOW a company develops a transition plan to net zero. With IROs, companies must now consider both "inside-out" and "outside-in" views of their business operations.

This assessment is a crucial step in complying with new disclosure requirements and serves as a starting point for defining improvement measures. These measures aim to reduce environmental impact while considering social aspects of the business model under a governance that aligns with modern values and ethics. The goal is to avoid harming marginalized communities and develop a company's workforce without sacrificing these principles for financial performance at all costs.

Take aways

The Corporate Sustainability Reporting Directive (CSRD) marks a significant shift in sustainability reporting, introducing the concept of "double materiality" and standardizing disclosure requirements. This new approach requires companies to conduct comprehensive assessments of their environmental and social impacts, as well as the financial risks and opportunities associated with sustainability issues.

???? Double materiality encompasses both impact and financial materiality, providing a more holistic view of a company's sustainability performance.

???? The CSRD standardizes WHAT to report and to WHOM, but allows flexibility in HOW companies develop their transition plans to net zero.

???? Compliance with CSRD requires companies to consider both "inside-out" and "outside-in" perspectives, balancing environmental impact with social responsibility and ethical governance.

Leveraging Digital Solutions to Enhance ESG Performance and Reporting

The upcoming Corporate Sustainability Reporting Directive (CSRD) has expanded non-financial scores for companies to include sustainability aspects. The European Sustainability Reporting Standards (ESRS) will standardize the disclosure of environmental impact information.

• Affected companies must transition to disclose the following aspects of their business operations:
• Environmental impact of business operations and supply chain: Companies need to elevate their understanding of the environmental impact throughout their value chain, including resource and energy extraction during the development, production, and distribution activities. This assessment extends beyond the organization to cover the entire supplier network.
• Stakeholder relationships: Companies must manage relationships with stakeholders in the organization, society, and markets to enhance the credibility of their net-zero transition plans and ensure they address the needs of various communities.

Decision-making transparency and diversity: Scientific thinking should be employed to simulate potential impacts and draw evidence-based conclusions that can be shared with affected communities.

While periodic data collection and reporting on past timeframes may be initially tolerated, the future process must be built on evidencing data. This data will inform measures to support a net-zero transition plan while demonstrating a positive impact on all stakeholder groups.

Given the varying levels of digitalization across companies' business and operating models, preparing for updated ESG reporting under CSRD presents an opportunity to accelerate digital or tech-enabled transformation.

A key aspect of digital transformation in modern business is the abstraction of physical components into digital assets imbued with intelligence through software and data. This process involves:

Transitioning from tangible products and assets to virtual services provided by a digital operating model

• Transforming physical expertise into digital mastery, requiring employees to become proficient in new and emerging technologies
• Using software to extend the lifecycle of physical assets and enhance their value
• Creating digital representations ("digital twins") of physical objects, processes, or systems using real-time data

The degree of abstraction from physical to digital determines the pace of digitalization for a business model. Companies with strong physical domain expertise are better positioned to distill key aspects of their products into software engineering, creating unique digital product experiences and significant transparency to understand the material impacts of their operations.

Our approach to integrating digitalization aspects in setting up CSRD-compliant ESG reporting is an ongoing exercise to ensure continuous improvement during the transition:

1. Relevance assessment (CSRD and ESRS): Focus on ESRS 1 and 2 to understand data requirements (scope and quality); assign business domains and responsibilities for early integration in business operations
2. Onboarding: Conduct a double materiality assessment (DMA) for the first set of standards, e.g., ESRS E1 (climate change), and cover Impacts, Risks, and Opportunities (IROs) to formulate strategic imperatives
3. Configuration: Collect data, identify gaps (to define digitalization measures), select software, and set up the ESG reporting process
4. (As an outlook): Fully integrate domains into a sustainable digital twin

With full integration, such a digital twin aids in making business decisions evidenced by comprehensive data on the financial and impact materiality of a product or service.

In our client work, we initiate the approach with a Minimum Viable Product (MVP) accompanied by a training program. This enables people in the organization to adopt the approach for their specific needs in terms of regularity and scope, delivering their transition plan autonomously. Our ESG Accelerator is part of our LD7 future-ready company program, which aims to prepare people in the organization to manage any transformation independently.

A future-ready company leverages data obtained by intelligent devices and uses algorithms to make sense of the physical world. This allows businesses to:

• Create end-to-end experiences and customer value in the user's context
• Test and optimize operations in a virtual environment before implementing changes in the real world
• Streamline operations, tap into new markets, and deliver improved customer experiences

Take aways

The integration of ESG reporting and digital transformation presents a unique opportunity for companies to not only comply with new regulations but also to gain a competitive edge. By leveraging digital technologies, businesses can create more sustainable operations while enhancing their decision-making capabilities and stakeholder relationships.

???? CSRD and ESRS are driving companies to integrate sustainability into their core business operations and reporting.

???? Digital transformation is key to effective ESG reporting and sustainable business practices.

???? Future-ready companies use data and digital twins to make informed decisions, optimize operations, and create value for customers and stakeholders.

Transforming CSRD Compliance into Competitive Advantage: Leveraging ESG Reporting for Business Success

Complaints about yet another reporting regime are currently widespread. The CSRD legislation process in member states is ongoing, leading some companies to wait for final guidance rather than exploring shaping options.

As environmental awareness grows among consumers and communities express concerns about the environmental impact of tech giants promising local employment, these companies face mounting pressure to develop business models that are both economically viable and sustainable.

• The new CSRD holds companies accountable to a broader range of stakeholders, moving beyond the traditional focus on shareholder value. Increasing attractiveness to these groups offers several advantages:
• In Society: Supporting local communities by mitigating disadvantages from resource exploitation, human capital issues, and climate damage.
• In the Market: Enhancing brand loyalty through transparency about environmental impact.
• In the Organization: Creating a "sustainable" working environment (DEI – Diversity, Equity, and Inclusion) that turns employees into brand ambassadors and attracts future talent.

Companies can gain a competitive edge through data continuity across the organization, enabling:

• Scenario planning and forecasting: better adaptation to tech shifts and other compelling events
• Supply chain optimization: robust and transparent sourcing and distribution
• Product lifecycle assessment and optimization: user and utilization data for prediction and prescription of the asset employment for an optimal use of resources and energy
• Internal carbon pricing: total cost perspective to prioritize company and innovation ventures
• Performance benchmarking considering financial performance and environmental impact

This data continuity enhances accuracy and reliability in data collection, powering algorithms for prediction and prescription.

As markets evolve towards decarbonization, R&D budgets will increasingly focus on clean technologies and digitalization for transparency. Companies with robust, adaptive transition plans towards net-zero and sustainable digital business models will be well-positioned to thrive in this changing landscape.

Take aways

In conclusion, while the CSRD presents challenges, it also offers significant opportunities for companies to enhance their sustainability practices and gain a competitive edge. By embracing this new reporting regime and leveraging data continuity, businesses can create value for a broader range of stakeholders while positioning themselves for success in an increasingly sustainability-focused market.

???? CSRD expands accountability beyond shareholders, offering advantages in society, market, and organization.

???? Data continuity across the organization enables better decision-making and competitive advantages.

???? Companies with robust transition plans towards net-zero and sustainable digital business models will be well-positioned for future success.

Embracing ESG And Digital Transformation is the future of sustainable business leadership

The Corporate Sustainability Reporting Directive (CSRD) and the concept of double materiality are pushing companies to think beyond traditional financial metrics and consider their broader impact on society and the environment.

In my view, this shift represents a significant opportunity for businesses to reimagine their operations and create lasting value for all stakeholders. By embracing digital solutions and leveraging data continuity, companies can not only meet regulatory requirements but also gain valuable insights that drive innovation, efficiency, and competitive advantage.

The transition towards comprehensive ESG reporting and digital transformation may seem daunting, but it's a necessary evolution for businesses that want to thrive in an increasingly environmentally conscious and connected world.

Looking ahead, I believe that the integration of ESG criteria into the financial framework of every company is inevitable: It provides a common language that resonates with diverse stakeholder groups, from investors and employees to customers and local communities. This shared understanding will be crucial in addressing global challenges and creating a more sustainable future for all.

The path forward is clear: ESG and digitalization are indeed two sides of the same medal for sustainable business. Those who recognize this synergy and act upon it will be well-positioned to lead in the new era of conscious capitalism.