9 September 2022

Large companies shouldn't burden SMEs and act as a catalyst for positive change across the value chain

Letizia Macrì, VP at ESG European Institute, gives her view on the ESRS and why they will be a game changer for Europe

For companies already reporting under the NFRD, reporting under CSRD and the ESRS will not be a dramatic change. However, those that have yet to report on non-financial issues and will have to comply with CSRD face a major challenge.

But I believe the largest companies have a big role to play in helping their suppliers and customers to be compliant with the latest regulation.

Under CSRD, large companies will have to assess the sustainability levels across their value chains and they should not see that as a bureaucratic burden but as an opportunity to act as a catalyst for positive change across the value chain. And of course, the second wave of ESRS exposure drafts, focusing on sector-specific and SME topics, should take into consideration the challenges for SMEs to keep compliance costs down.

Ultimately, sustainability reporting for companies of all size is key not only to attract investments of private capital and to raise debt more easily, but also to access the unprecedented amount of public investments in the green transition.

In fact, all the funds linked to the EU's Recovery and Resilience Facility come with strict sustainability requirements. Therefore, having an efficient corporate structure to report on ESG is not only a legal requirement but can be a differentiation lever in this dynamic environment.

To do that, one of course needs an appropriate reporting framework, in other words, strong accounting standards. I believe the strength of the ESRS released to date lies in their structure. Having a set of cross-cutting and sector-agnostic standards ensures comparability among different firms and industries, a point that has been missing in sustainability reporting so far.

In recent years, the sheer number of different formats and structures of sustainability reporting have hindered the ability to compare the ESG performances of different firms, and the ESRS will address this issue by offering an common and harmonised structure.

In our book "La Misurazione della Sostenibilità", presenting the findings of an ESG European Institute study, we underlined the importance of a layered structure for sustainability disclosure that would entail a first layer of sector-agnostic standards.

Moreover, we highlighted the need for a uniform reporting format that would, on one side, foster the transition towards integrated reporting in order to disclose financial and non-financial information in the same document, and on the other side, revolve around clear quantitative data.

Looking at the non-financial reporting of the 15 major companies listed in Italy, our research uncovered the confusion that can arise from different reporting formats, each relying heavily on qualitative data.

While it is important to describe each company's approach to sustainability, a factor correctly covered by the cross-cutting standards, the best way to reduce the risks of greenwashing is by requiring clear and comparable quantitative data from the reporting entities.

This kind of data will also help the convergence of sustainability ratings, which have so far suffered from a heterogeneity in terms of guiding principles, methodologies and a lack of transparency.

While credit ratings have converged in terms of evaluation methods and show a correlation of 99%, ESG ratings have a significantly lower correlation, ranging from 38% to 71%. The standardization of reporting standards can have a key role in this convergence.

Of the 13 exposure drafts published by EFRAG, for me the two standards covering governance are the most important ones. Because without environmental and social targets cannot be met without an efficient governance.

In light of this instrumental role, the EU has decided to look at the governance section as part of the Social Taxonomy. However, I believe the governance section should have its own dimension, especially for reporting purposes, and we fully agree with the ESRS approach. The two EDs on governance will allow stakeholders to collect much more information in the coming years and further refine reporting practices on this key criterion.

Now the big question, which remains to be answered, is whether the standards and the associated reporting will lead to changes in behaviour and decisions or if it will become a tick the box exercise. Ultimately, it will depend on the individual companies' approach to sustainability.

A true approach to sustainability means putting sustainability at the centre of corporate strategic thinking and implementation. From this, sustainability reporting and disclosure becomes more of a formality. On the contrary, if sustainability is not addressed form the beginning, sustainability reporting turns into a compliance issue which can lead to green- and social-washing. Stakeholders will have a key role in distinguishing between these two approaches. That is where the standards can be enablers, allowing for a better assessment of a company's approach.

We can already see that more and more investors direct their money into ESG investments and young talents are assessing potential employers by their ESG results. It goes beyond personal considerations like work/life balance or working for a company which has shared values (for example not harming the environment or embracing diversity). It touches on career planning as well as working for a company with bad ESG performance may mean being unemployed in the medium to long term.

If companies want to thrive in this new economic model, they need to look at sustainability as pivotal in the corporate strategy and not as an add-on. Companies that won't be able to do so may have a hard time keeping tack with the best ESG performers.