Exam Preparation Review

Sustainable Finance: Reporting on Extra-Financial Data

This document provides a*cheatsheet* on reporting extra-financial data, covering key concepts,standards, and regulatory frameworks in sustainable finance.

1. Introduction: Double Materiality & ESG Reporting

• ESGReporting is crucial for:
  • Risk Management: Mitigating risks related to environmental, social, and governance issues.
  • Regulatory Compliance: Meeting new requirements like the CSRD.
• Double Materiality: Introduced by the EU Commission in 2019, itassesses two perspectives:
  • Financial Materiality: Impact of ESG risks and opportunities on the company's financial performance (investor audience).
  • Environmental and Social Materiality: Impact of the company's activities on external stakeholders (consumers, civil society, employees, investors).

2. Sustainability and Integrated Reports

• Sustainability Report:
  • Contains primarily extra-financial data.
  • Voluntary communication tool for an organization's impact (positive or negative) on ESG matters.
  • Covers: Policies (Environmental, Labor, Ethics, etc.), Metrics (Environmental, Social, Governance), Goals, Achievements, Materiality Assessment, and Compliance with standards (GRI, SASB, TCFD).
• Integrated Report (IR):
  • Combines both financial and extra-financial data.
  • Developed by the International Integrated Reporting Council (IIRC) in 2010.
  • Aims to synthesize all reporting concerns and performance indicators into a single document.
  • Communicates how a company manages long-term value creation by integrating traditional and sustainability risks.
  • Focus: Backward and forward-looking, short, medium, and long-term.
  • MainStandard: IIRC framework.

Comparison:

3. Standards of Sustainability Reporting

• Global Reporting Initiative (GRI):
  • Established in 1997, transitioned to GRI Standards in2016.
  • Provides guidance on disclosure across environmental, social, and economic factors for all stakeholders.
  • Focuses on stakeholder materiality and a company's impact on the environment and society.
  • Structure:
    • Universal Standards: Requirements for using GRI Standards, disclosures about the organization and its material topics.
    • Sector Standards: Industry-specific guidance.
    • Topic Standards: Specific information on material topics (e.g., GRI 305 for GHG emissions).
• Sustainability Accounting Standards Board (SASB):
  • Independent non-profit setting standards for disclosure of financially material sustainability information to investors.
  • Identifies ESG issues most relevant to financialperformance in 77 industries.
  • Standards are industry-specific because financial impact varies by sector.
  • Provides guidance on which issues are most material using its Materiality Map.
  • Example: For automobiles, fuel economy impacts revenue; for pharmaceuticals, counterfeit drugs impact revenue and reputation.
• International Sustainability Standards Board (ISSB):
  • Part of the IFRS Foundation, published global sustainability reporting standards on June 26th, 2023.
  • Aims to create a unified global framework for sustainability and climate disclosure.
  • Has embedded principles from other frameworks like SASB and TCFD.
  • Key Standards:
    • IFRS S1 (General Requirements): Requiresconsidering SASB Standards for identifying sustainability-related risks and opportunities beyond climate.
    • IFRS S2 (Climate-related Disclosure): Specific climate disclosures, integrating TCFD Recommendations and climate-related topics/metrics from SASB.
  • Companies can voluntarilyapply S1 and S2 from 2024.
  • The ISSB is taking over the monitoring of climate disclosures from the TCFD.

4. Reporting on Climate and Environmental Issues

• Carbon Disclosure Project (CDP):
  • Global platform for companies, cities, and states to report annually on climate change, water security, and deforestation.
  • Uses an A-F scoring system.
  • High scores indicate comprehensive data, clear governance, risk/opportunity assessment, targets, and action.
  • CDP plans to incorporate ISSB standards into its reporting system.
• Task Force on Climate-related Financial Disclosures (TCFD):
  • Influential international framework fordisclosing climate change risks and opportunities, created in 2015 by the FSB.
  • Aims to operationalize the Paris Agreement for businesses.
  • Provides voluntary, consistent climate-related financial risk disclosures.
  • Considers physical, liability, and transition risks ofclimate change.
  • Recommended Disclosures (June 2017 Report):
    • Governance: Oversight by the board and management's role.
    • Strategy: Impacts of risks/opportunities, resilience of strategy under different scenarios (e.g., $2^{\circ}C$).
    • Risk Management: Processes for identification, assessment, and management of climate-related risks.
    • Metrics and Targets: Usage of metrics (Scope 1, 2, 3 GHG emissions) and targets to manage risks/opportunities.
  • Companies should disclose: Material climate change risks, management strategy, quantitative & qualitative GHG emissions, and potential impact of climate change on business.
  • TCFD recommends disclosing: Annual GHG emissions, Weighted Average Carbon Intensity (WACI), internal price on carbon, and climate riskanalysis.
  • The ISSB will take over this role in 2024.
• Internal Carbon Pricing (ICP):
  • Voluntary tool where companies assign a monetary value totheir GHG emissions.
  • A self-imposed price factored into business decisions.
  • Recognized as a forward-looking metric for managing climate-related transition risks.

5. Reporting Standards From Regulators: The EU Case (CSRD)

• Corporate Sustainability Reporting Directive (CSRD):
  • Part of the EU's Sustainable Finance Action Plan.
  • Replaces the Non-Financial Reporting Directive (NFRD).
  • Scope: Appliesto all listed companies (including SMEs) and large companies meeting 2 of 3 criteria: +250 employees, total balance sheet >€20M, total turnover >€40M.
  • Main Features:
    • Double Materiality Analysis: Impact of company on ecosystem and vice-versa.
    • Disclosure: Reporting on 1114 data points based on materiality analysis.
    • EU Taxonomy Alignment: Calculation of revenue, CapEx, OpEx alignment with 6 EU Taxonomy objectives.
    • CarbonFootprint: Focus on Scopes 1, 2, and 3, prioritizing high-quality Scope 3 data.
  • Key Changes from NFRD:
    • Extended Scope: Expected to cover >50,000companies.
    • Audit (Assurance) Requirement: Mandatory external audit of reported information.
    • Detailed Reporting: Use of mandatory EU sustainability reporting standards (ESRS), developed by EFRAG.
    • Digital Tagging: Reported information must be machine-readable (SEAP).
    • Non-EU companies with substantial EU activity must also comply.
• European Sustainability Reporting Standards (ESRS):
  • Mandatory for large EU companies under CSRD.
  • Developed by the EFRAG.
  • Based on the double materiality principle (financial and non-financial impacts).
  • Aimed to incorporate GRI standards to the greatest extent possible.
• Omnibus I Simplification Package (CSRD):
  • Narrower Scope: Exempts firms with <1,000 employees and <€50m turnover (~80% fewer companies).
  • Streamlined ESRS: Drops sector-specific reporting, fewer required datapoints.
  • Scaled Back Assurance: Limited assurance instead of reasonable.
  • Timing Relief: Two-year deferral for companies not yet reporting (Wave 2) and listed SMEs (Wave 3).
• Materiality Matrix:
  • Standard practice, especially under GRI.
  • Identifies economic, environmental, and social aspects most relevant for stakeholders and the company.
• French Regulations:
  • Grenelle Law (2010): Energy efficiency, Duty of Vigilance, Law Against Corruption, Food Waste Law.
  • Article 173 (Energy Transition for Green Growth Law, 2016): Requires institutional investors to integrate climate change considerations into investment policies and disclose climate-related risks. Aligned with TCFD.
  • PACTE Law (2019): Companies must consider social and environmental issues, define their "purpose."
  • Article 29 (Energy Transition for Green Growth Law, 2021): Detailed guidance on climate, biodiversity, and ESG reporting for listed companies, creditinstitutions, insurers, etc.
    • Requires publishing portfolio alignment with Paris Agreement objectives and biodiversity conservation.
    • Mandates "biodiversity footprint" indicator to quantify portfolio impact on biodiversity.
    • "Comply or explain"principle for non-financial data; continuous improvement plan if unable to publish.

6. Take Aways

• Importance of ESG Reporting:
  • Risk Management
  • Regulatory Compliance (e.g., CSRD)
  • Meeting Stakeholder Demands
• Evolution of Reporting Frameworks:
  • Multiple frameworks (GRI, SASB, IIRC, TCFD, TNFD) exist.
  • Convergence: ISSB is taking over and harmonizing climate-related disclosures from TCFD.
  • Growing role of regulation (especially in the EU) in standardizing disclosure.
• Distinction between Materiality Concepts:
  • ISSB S1 Standard: Uses single materiality, focusing on information affecting prospects and investor decisions.
  • CSRD: Employs double materiality, considering financial risks and the company's impacts on people and the environment.
  • GRI: Also uses double materiality, viewing both financial and impact materiality as essential for comprehensive reporting.