Many companies are required to disclose metrics associated with their business operations and financial position. These requirements typically apply to organizations over a certain size, as measured by income and number of employees, and are put in place to ensure that businesses are transparent regarding their financial positions and business performance. As investors and consumers have become more interested in non-financial performance metrics, a multitude of “sustainability” reporting frameworks have started to crop up. These can be called Non-Financial Reporting, ESG Reporting, or Sustainability Reporting.
Sustainability reporting standards aim to achieve double materiality, looking at both how sustainability issues affect organizations’ performance, position and development (the ‘outside-in’ perspective), and measuring their impacts on people and the environment (the ‘inside-out’ perspective). The primary users of sustainability information disclosed in companies’ annual reports are investors and non-governmental organizations, social partners and other stakeholders. There are two emerging standards areas related to non-financial reporting by companies. The first is Carbon reporting, and the second is Environmental, Social, and Governance (ESG) reporting. For both of these, companies are obliged or encouraged to report on themselves, depending on the countries in which they operate, and their size.
The landscape for the European Union is particularly tricky to understand, as there seems to be a different convoluted acronym for every part of the process! There is a directive for non-financial reporting that came into force in January 2023: the Corporate Sustainability Reporting Directive (CSRD). It replaces the Non-Financial Reporting Directive (NFRD). CSRD applies to large public-interest entities with more than 500 employees that are based in the EU or are multi-national companies with subsidiaries in the EU, covering about 50,000 companies in total. The legislation obliges companies under scope to report in compliance with reporting standards adopted by the European Commission as delegated acts.
The proposed standard providing the reporting framework is called the European Sustainability Reporting Standard (ESRS), and is currently under review. It is expected that the first reporting under ESRS will happen in 2025. In layman’s terms, the ESRS will be the standard against which those 50,000 companies will have to report. The ESRS is being developed in cooperation with the Global Reporting Initiative (GRI), Shift, and WICI. The latest draft version has over 80 mandatory reporting topics, and over 1,000 data points that must be reported. For businesses affected by EU legislation requiring them to disclose this information, the task will be onerous, to say the least.
In addition to this work being carried out specifically for EU companies, the International Financial Reporting Standards (IFRS) is working on rolling out its own standard, via the International Sustainability Standards Board (ISSB). IFRS is not affiliated with EU government, but has pledged to “align” the ISSB standards to the ESRS framework. The aim of the ISSB is to set a more global standard that could be voluntary or compulsory, depending on government prerogative. Industry experts remain skeptical and nervous about the conflicts and political battles that are going on as various groups vie to lay down the winning gauntlet for sustainability reporting. That is only natural given the onerous nature of providing the level of content required to complete the standard submissions.
In addition to the ESG reporting requirements outlined above, there are carbon-specific disclosures required by the Streamlined Energy and Carbon Reporting (SECR) legislation passed in the UK and the proposed SEC legislation that is likely to be adopted in the US. There are also a number of voluntary schemes for reporting on carbon, including the Task Force on Climate-Related Financial Disclosures (TCFD). Carbon emissions reporting covers three areas, Scope 1, 2, and 3.
Scope 1 refers to the emissions over which companies have direct control. These sorts of emissions would come from from burning petrol or diesel fuel in a fleet of vehicles (if they’re not electrically-powered), direct fuel, chemicals, or materials that the company consumes when producing, or any other emission generating elements over which the company has full control.
Scope 2 refers to the emissions associated with energy company consumes, primarily electricity, steam, heat and cooling. So, for example, the electricity the organization uses to power its manufacturing processes, or charge its electric vehicles, would be counted in Scope 2.
Scope 3 emissions refers to emissions not directly associated with the company itself, but with its activities. The majority of Scope 3 emissions come from a company’s supply chain. Typically, Scope 3 emissions are the largest contributor to a company’s footprint, often estimated to make up roughly 75% of total emissions associated with a typical company. Most regulations have a more relaxed approach to reporting and liability associated with the accuracy of Scope 3 reporting, as it is quite difficult to measure.
Supply Chain Reporting
In addition to a company reporting on its own ESG performance, a number of companies have voluntarily chosen to measure, or are compelled by legislation, to conduct due diligence on the ESG performance of actors in their supply chains. For example, the Modern Slavery Act of 2015 passed in the UK dictates that organizations over a certain size must have a Modern Slavery Policy Statement and work to ensure there is no Modern Slavery in their supply chains.
The Norwegian Transparency Act became active in 2022 and requires companies over a certain size operating in Norway to carry out due diligence on all actors in the supply chain. The aim of this due diligence is to ensure there are no human rights infringements happening anywhere in the supply chains of these organizations.
The German Supply Chain Act that came into force in January 2023 requires that organizations over a certain size operating in Germany must carry out due diligence on their entire supply chains to ensure there are no human rights or environmental offenses being carried out in the delivery of goods and services to them.
The Uyghur Forced Labor Prevention Act (UFLPA) passed in the US in 2021 ensures that no products (primarily polysilicone for solar panels or the panels themselves) can enter the United States if they were produced in Xinjiang, an area in China with a high prevalence of forced labor. Uyghur populations in the area are being forced to work in labor camps to produce 40% of the world’s polysilicone supply. US Customs and Border Protection (CBP) has reported that, as of September 2022, it had already targeted 1,452 cargo entries under the UFLPA, valued at $429 million.
Legislation like the above will continue to pressure large organizations to measure and disclose information regarding the ESG performance of the businesses with whom they contract. These ESG assessments are not expected to match the over 1,000 disclosure points encompassed in the ESRS. However, while companies will not likely require their suppliers to complete a full ESRS submission, it is certainly sensible that companies align the requirements of their supply chains to non-financial reporting standards. It would be most efficient, if, at a minimum, the reporting requirements placed on companies – both to authorities and to the organizations to whom they sell (and whose supply chains they act within) – do not require duplication of efforts.
See below for a summary table of voluntary and legislative reporting directives:
*There is also listed here a Task Force on Nature-Related Financial Disclosures (TNFD) that is in development. It is likely to become important in future, as the UK government will consider making its reporting mandatory later in 2023. TNFD aims to quantify the impact of business activities on biodiversity – particularly the impact of business activities on local ecosystems.
Scope 1, 2, & 3 Emissions Eplained
Task Force on Nature-Related Financial Disclosures (TNFD)