The 4 Steps Necessary to an ESG Report, Thanks to Which The Value of Your Internal IT Will Skyrocket
19. 12. 2022
Reading time: 10 minutes
More than 1,000 companies in the Czech Republic will soon have much more detailed emissions and sustainability reporting than before. In 2024, the CSRD (Corporate Social Reporting Directive) will come into force, particularly relevant to the environment. While the reporting obligation won't force companies to decarbonize, the market will probably cause them to take concrete action. "There is already pressure on companies to collect data, report transparently and credibly, from all sides, from investors to customers to their employees," says David Janků, reporting consultant at Frank Bold Advisory, in the Adastra podcast.
Ivana Karhanová: The new CSRD, Corporate Sustainability Reporting Directive, will come into force in 2024. In short, non-financial reporting will show how companies approach environmental, social, and corporate governance issues. In the Czech Republic, it will apply to more than a thousand companies in the first phase. Today's guest is, therefore, David Janků, reporting consultant from Frank Bold Advisory. Hello.
David Janků: Hello.
Ivana Karhanová: You have an office in Brussels. Your lawyers are involved in drafting legislation on reporting sustainability on the EU taxonomy. Let's explain what these terms mean: CSRD, SFRD, and EU taxonomy.
David Janků: They are all part of one package, which is much talked about in the Czech media. That's also about the Green Deal, which is two magic words. But, of course, everybody knows about them mainly in connection with cars. But, of course, there is a lot more to it, as you say, precisely the individual regulations.
There's a bit of a hierarchical system. The whole system is set up to respond to market movements. The regulation is mainly about transparency. It's not that it imposes any obligations to act. If we go from the top, the highest is the SFDR, that's the sustainability in the Financial Sector Regulation, which sets out conditions for investors, classifications of green products, that they have to have some remuneration policies linked to sustainability, do some risk analysis, and so on.
They will now also have to collect certain data from the new year. In terms of their investments, that is, where they are investing, in what areas, and the risks. So that is the SFDR. We already have that in force from 2021, and some of the obligations are still coming to an end. But the biggest package is already in place for investors.
Then we have the CSRD, which you talked about. The text of that directive has been approved in the last few weeks. But that directive is still accompanied by sustainability reporting standards, which are being analyzed and finalized. The European Commission will approve them in a short time. So by the end of the year, they should be in force, or rather completed, and the standards will be binding and, together with the directive, will apply from 2024 onwards in various phases.
Then you mentioned the EU taxonomy. That is a regulation of legal nature, but it does not set out any specific obligations in isolation. It is more of a compass for investors to know which investments are sustainable and which are not. It sets some limits for certain sectors and certain activities. It is a very technical document, hundreds of pages long.
There are six objectives. Two have been issued so far, and four more are to come. So it is a kind of compass, the whole regulation, and investors can look at it to assess whether the project or activity they are investing in is green. So those are the main tools.
Others are coming up. This is now the CSRD directive on due diligence, which will be the first one in this package to set out some obligations to act. But it will only apply to the biggest companies with a certain turnover, size, and number of employees, and it will only apply in X years. It is still under negotiation.
But it is the only one in the package that sets out an obligation to behave. The others are mainly about transparency.
Ivana Karhanová: When it sets out the obligation to behave, what can we understand by that?
David Janků: The directive focuses on due diligence, a process whereby a company or whoever is doing due diligence should identify what negative impacts may be associated with their activities. Take action or put measures in place to prevent them or, if some negative impacts have occurred, mitigate them and provide some remediation.
However, we are talking about a time horizon of several years. Therefore, the more recent regulations are the previous ones.
Ivana Karhanová: But some of those regulations, especially the sustainability-related disclosure regulation, the Sustainable Finance Disclosure Regulation, that's already in place for some companies.
David Janků: Under this regulation, it is already mandatory for financial market participants of a certain type to give their clients information about the risks associated with those investments, with those products where those clients invest.
Again, it's transparency, so the company, the financial institution, can state that there are some risks but that they're not fully tracking the impact. So there may be some basic analysis, but it must be in contractual documents for that client.
Ivana Karhanová: If I understand correctly, so far, this definition is quite vague, and that is why there will be further regulations that will refine it so that we are comparing pears with pears for all companies.
David Janků: You could say that it is interrelated in many ways. There are also what are called Regulatory Technical Standards issued in addition to the SFDR, and those set out certain indicators that firms will have to collect starting in 2023.
And that's where investors should be looking to see how many companies or how many of their portfolio investments have such and such a carbon footprint, whether there are human rights impacts associated with them, and how many of those companies have certain policies in place.
There is no obligation to increase that number, but to be transparent in collecting that data. So therefore, to enable this, companies have obligations in terms of reporting, and transparency, to be able to deliver information to their investors.
Ivana Karhanová: That means that reporting doesn't obligate them to any follow-up actions. It just obligates them to measure everybody equally. So compare apples to pears and apples to apples when they report, for example, their carbon footprint.
David Janků: Exactly. There are a lot of indicators in those standards because it's an ESG area, and there are a lot of subtopics in those individual areas. Not all topics are material or relevant to every company either.
Every company should do some kind of materiality analysis, that is, based on the impact of that topic on its financial performance or its life cycle. And also based on the outward impact on society and nature. So the company needs to determine what is a material issue for it.
In terms of the carbon footprint, that is the issue that is central to the whole reporting and the whole Green Deal system. All companies should gradually collect data for this. But in terms of sub-topics, like emissions of certain pollutants into water or a certain type of relationship with suppliers that is only for certain companies that maybe source products from conflict areas, these topics will only be important for certain companies, not all companies.
Ivana Karhanová: If I am a chemist, I can logically expect that it will be important for me to improve or reduce environmental pollution over time or compensate for my activity with something positive.
David Janků: Now, it is necessary to indicate, based on indicators in the standards, some quantities of substances that the company emits. It's not that they necessarily have to reduce that number. Still, again, the due diligence directive should cover it in the future where if a company reaches a certain size. Those impacts are of a certain severity. It should already have an obligation to act and prevent those negative impacts on the environment and society.
Ivana Karhanová: How do you perceive companies' approach to reporting in the Czech market now, because the biggest ones should already collect some data from January 2023?
David Janků: Yes, the date has moved. During the negotiations, it was that for the financial year 2023, companies should collect data, but in the end, it was postponed. So it will be for 2024 and reporting in 2025 in the first phase, affecting firms that already had obligations under the Non-Financial Reporting Directive.
This is already several years old and has been implemented in the Czech Accounting Act. These are mainly large companies with 500+ employees listed on the stock exchange and public interest entities, mainly financial institutions. They, of course, already have their processes set up much better than companies for which this topic has not been important, and now they are finding that it is somehow coming into play.
In terms of our experience of the market of our activities, my answer, which is to be expected, is that most companies are simply not ready for it. The market needs to be educated. It is certainly necessary for investors to define for themselves what information they want from the companies, the entities in which they will invest, or to which they will grant loans and credits. That education is important.
The deadlines and the negotiations have been pushed back by two or three years, and the whole process is staggered into several phases, where it comes down to the smaller companies, just so that everybody can prepare and has enough time.
Ivana Karhanová: You say that the companies themselves need to be educated. What are they most confused about?
David Janků: They grope the most on the issues the standards put the most emphasis on. And that's the area of climate change and the associated carbon footprint, calculating or mapping it because a company will never completely 100% change its entire carbon footprint because some factors are used. So that's a topic that is the biggest hurdle for those companies within those standards.
To give you an example, we also have the area of social. There it is about the actual employees. The indicators are headcount, diversity, and so on, which the company knows about and has documented somehow. It's relatively simple numbers there.
But in terms of the carbon footprint, where we use some emission factors, recalculate, and so on, and where the emissions are not only produced by the company itself, but they are also emissions associated with its activities, that is, its suppliers, transport to customers and so on.
So that's the biggest topic that those emphases put the biggest standard on and that companies will also have to navigate the best and most. But, unfortunately, there is the biggest lack of awareness of that information.
Ivana Karhanová:What you've described should have - at least I imagine it to have - three phases. The first one is that I have to be able to collect that data through that company, then pour it into some sort of conversion tool, then I get the report from that. And then the company would still have to say: OK, our goal is to optimize or improve these components of our business.
David Janků: You could say that. The first step is to map out your carbon footprint roughly after these phases you mentioned. Because once the company knows what areas are producing what emissions, it can start to set some targets, plans, and so on to gradually reduce those emissions. The big issue that the standards that accompany the CSRD focus on are the notion of a decarbonization plan or a climate transition plan.
And that's sort of a process that companies should be doing more and more in the future. It's setting some targets, reducing them by a certain percentage of the carbon footprint by 2030, and how to do it. And it should all lead to a complete decarbonization of all companies by 2050, that is, ideally, a zero carbon footprint.
Ivana Karhanová: If we take that first reporting as a baseline, I'm going to go out in 2025 with the first report for 2024. Who will be the authority to make sure that companies are meeting their obligations and complying as they should?
David Janků: That's a big topic in the reporting itself because, of course, if I take a step back and talk about the SFDR, the Financial Sector Sustainability Regulation, there's a specific regulatory authority set up, which in the Czech Republic is the CNB. It is supposed to supervise how investors and financial market participants comply with those obligations or correctly label products as green.
Some sanctions are associated with this, which are implemented in several Czech laws where the enforcement mechanism is quite clear. But in terms of reporting by all other companies under the CSRD, there will be a big element of verifying and auditing that information. Of course, some standards are being developed for the CSRD, which are for sectors across all sectors.
However, sectoral standards should also gradually emerge, which will set out or describe more specifically what the firm is supposed to be doing and what it is supposed to be reporting. A separate standard for auditors should also emerge by 2026. That is, how to verify the information that the directive sets out.
Together with this standard, it will be set up in such a way that, when the standard is in force, according to certain tracks, stages, the size of the firm, and what it has to report, it will be necessary for the firm to have the information verified based on the auditor's verification. What is unclear is what if a firm does not get an audit. What will happen? That is still a question. That is a big issue.
Ivana Karhanová: I am asking about this because all companies are obliged to upload their financial statements to the Justice.cz server.
David Janků: Yes, to the Commercial Register.
Ivana Karhanová: Exactly. But for the ones that don't do that, the real enforcement and sanctions don't work well in practice. So that's why I'm asking what is the intention here. Is it going to be for enforcement by investors and third parties, or will some authority take this on?
David Janků: Enforcement is always the biggest issue. Of course, we can set up obligations from A to Z, but as you say, enforcement is a huge issue. As I mentioned at the beginning, the whole system is supposed to work because it's supposed to create pressure from above and maybe from both sides of those companies, not just from above from the investors, because the investors themselves have to collect some data.
It's also a reputational thing, where investors will naturally want to have the strongest portfolio most aligned with sustainability themes. A big issue for companies is also what their customers and their own employees are asking for. So the pressure on companies to collect data and report transparently and credibly is coming from all sides.
Ivana Karhanová: But when you mentioned customers, the customer doesn't have much chance to know how the company is approaching the environment. Because if I take the fashion industry, for example, you will find in all brands a part of the goods that should be sustainable.
But I, as a consumer, can't tell that it is, and I can't tell if the company is more or less trying to do some greenwashing. Do you think that, along with the standards, this will be brought together on a level that will allow consumers to know better?
David Janků: Absolutely. Greenwashing, a great concept you mentioned, is closely related to the Green Deal framework. And the effort of all these regulations is just to sanction greenwashing. So when I talk about SFDR - we're talking about, for example, investments and individual investors - there's a clearly defined process for describing those characteristics to label a product as sustainable or green.
In terms of reporting standards, their main goal is just to unify everything that has been there. So far, there have been many reporting standards: the Global Reporting Initiative, the Task Force on Climate-Related Financial Disclosures, and others. There are many of them, and many of them focus on specific sub-topics.
And these new standards are aimed at precisely standardizing all information and how companies report on it. That information should then be traceable in the annual report, which will be part of the commercial register. The company should also be able to integrate information about its financial and sustainability performance. So this information should be available.
In terms of learning about a company's sustainability in business, when one buys something, that is another issue. Again, we are talking about reporting with frameworks, putting the information on paper somewhere in some system. So some consumer education would certainly be useful so that they know where to look for that information.
Ivana Karhanová: I'm referring to the fact that if you take - if I stay with the fashion industry, which is probably easy to imagine, if I have things made from, say, organic cotton, but I'm shipping them halfway across the planet from China, then the carbon footprint might be bigger because of the logistics than things that are made here but don't go that route.
David Janků: Yes, of course, this is the kind of thing that the company should ideally be described in their reports. And that's why companies push to measure their carbon footprint, to indicate where that carbon footprint is being generated.
If a customer then looks at that and compares two companies against each other, they can easily see which company is doing what. So reporting is not just about data and numbers but sets out obligations for some information transparency. This means that it is not just about the quantity of the data, what the data is, and what the numbers are, but also the quality of the information, the description of the policies, the description of the plan, and the description of the strategies.
So when the consumer then looks at the report, they should not just see a table of data that they will not be able to make sense of, but they should understand what it is, what the intentions of the company are, where it is coming from and where it is going.
Ivana Karhanová: If we move to the next stage, meaning we have the reporting done, the company has the first numbers. What should follow? Does it set goals that it wants to achieve?
David Janků: It's definitely up to the motivation of the company. Of course, if a company decides they don't want to change the data from year to year, that's entirely up to them. Even under the new standards, there is no legal obligation to set a plan. But of course, I'll say it again. There's the pressure of the market, where it will be required by investors, consumers, and associates.
As far as the supply chain is concerned, we already know that there are a lot of collaborations, and contractual terms, where the big companies choose the smaller ones just according to their efforts, for example, to decarbonize or reduce their carbon footprint. So I think the trend is clear.
Many companies are setting some kind of plans to decarbonize, and I think that will get stronger and stronger. So companies are not necessarily because they have to, but naturally, they are doing it and will do it more.
Ivana Karhanová: Would you say that the market is ready for the fact that there will be process adjustments, maybe even a change in the whole business model?
David Janků: That's a good question. I don't think it's easy to answer whether the market is ready. But, of course, the larger companies already dealing with this issue are more prepared. So many companies are already saying they are sustainable and their operations align with those standards or those obligations.
In terms of some kind of transparency, this is a completely new topic for a lot of companies, perhaps especially for SMEs, for whom the topic of sustainability has never been a major issue. However, there are also examples of small businesses, of course, for which this topic is central.
I think the Western Europe market is perhaps a little bit more ready simply because it has been more progressive for some time now, and these topics have been coming up more in the public space. The Czech market may not be so much, but I think we have a good base of companies already doing it here and organizations that are spreading awareness. So I don't think it will be that difficult.
Ivana Karhanová: If I understand this completely correctly, will we see one day that basically every product I go to buy will have a measured carbon footprint? For example, if I have the price per 100 grams, will I know the carbon footprint of yogurt, a liter of milk, or car tires?
David Janků: I don't think I can say. I don't even know if it would be ideal to know it that way. But, of course, there are many processes to calculate the carbon footprint. There are also several standards for it. So there are different methods and different emission factors.
So there's no way to say that if we had a carbon footprint for every product, we would even be able to compare them 100% if we put one next to the other. So you asked me a very tricky question.
Ivana Karhanová: Will we see advertising someday where, for example, the carbon footprint is promoted instead of price?
David Janků: We'll see. I guess we'll be surprised. I think the price will always come first, but the whole initiative is about sustainability, not just looking at the price but at everything else that goes with the product.
So if we look - for me, for example, fifty-fifty - at those two things and can prioritize a sustainable but slightly more expensive product over a cheaper product that is not sustainable, that would be a good outcome.
Ivana Karhanová: And what's your current experience? What are the most common issues that companies come to you with?
David Janků: In terms of companies that contact us, the thing that we deal with most often is data collection and the beginning of the whole ESG reporting process because it's not a two or three-month process where a company collects something quickly writes it into a report and puts it out. It's all about the availability of that data, some communication within the company, communication about what department is collecting what, who's doing what, where to keep the data, and where to send it.
These are all things that we deal with. Then, of course, there's some presentation of that data, creating a report, writing it so that it's targeted to which audience because some companies are more focused on investors with those reports, others are more focused on consumers, others have some other motivations and other audiences.
As we've discussed before, a very big topic is also carbon footprint mapping, which is a big part of that reporting, and it will get bigger and bigger. And that's something that relatively few consulting firms in the Czech Republic are dealing with yet. So that's probably a business area that will grow more and more.
Ivana Karhanová: Says David Janků, reporting consultant at Frank Bold Advisory. Thank you for coming into the studio and sometimes for hearing from us.
David Janků: Thanks for having me.