ESG regulation: the EU moves up a gear

Double materiality analysis, a carbon border adjustment mechanism, new sustainable reporting standards... What are they? And what do they mean for businesses?

In mid-June, the European Commission provided several clarifications on a series of measures aimed at accelerating the transition to a climate-neutral economy by 2050. Measures that BNP Paribas recently presented to a panel of customers and sustainable finance experts during a webinar.

The CSRD, a new, more ambitious directive

Corporate sustainability reporting is a key aspect of the European Green Deal. It is why the European NFRD (Non-financial Reporting Directive), which currently governs non-financial performance reporting for companies in Europe, will gradually be phased out, and be replaced from 1 January 2024 by a new, more ambitious directive called the “CSRD” (Corporate Sustainability Reporting Directive). The new directive covers all ESG criteria: environmental, social and governance issues.

The main innovations of the CSRD are:

• Extended scope: many more companies will fall under the reporting obligations, and in particular all companies listed on EU-regulated markets.
• Strengthened and standardised reporting requirements: based on harmonised European standards (ESRS, see below), companies will have to disclose detailed information on their risks, opportunities, and material impacts in relation to ESG criteria, following a principle of “double materiality” (see below).
• One place: sustainability reporting  must be included in a dedicated section of the management report, in a single, electronic reporting format.
• Mandatory verification of the information by an auditor or independent third party.

ESRS standards

The CSRD provides for the creation of detailed sustainability reporting standards, known as the "ESRS" (European Sustainability Reporting Standards). They are scheduled for definitive adoption in August 2023. There are 12 aspects in total, and they will enable companies to contextualise and harmonise their reporting by providing answers to four key questions:

• How does governance address sustainability issues?
• How are sustainability challenges integrated into the strategy and business model?
• How are sustainability impacts, risks, and opportunities identified and managed across the value chain?
• How are performance (KPIs) and targets measured against implemented action plans and resources?

The themes covered by these ESRS standards relate to transversal (strategy, governance, etc.), environmental (biodiversity, pollution, aquatic and marine resources, etc.) and social (respect for human rights, treatment of employees, supplier relationship management, etc.) issues.

Companies will have their work cut out for them, as there are up to 20 templates and 1,100 data entry points that potentially need to be filled in!

The double materiality principle

The main innovation of the CSRD is the concept of double materiality in reporting. This concept implies that companies need to identify major ESG issues for their operations – and the related ESRS standards – through:

• The impacts, risks, and opportunities of these challenges for the company.
• The impacts that the company may have on society and the environment.

Companies will therefore need to carry out a thorough analysis, in collaboration with their key stakeholders, to determine which ESRS standards they need to report on. Although they are not required to produce a report on each of the 12 ESRS standards, they will have to justify their choices during an audit.

To meet this double materiality requirement, BNP Paribas experts recommend that companies adopt a four-step approach:

1. Understand your company's context and activities (essential for defining your scope, your value chain, the creation of your products according to the needs of your customers).
2. Draw up a list of your key stakeholders with whom you should consult to determine which topics relating to ESRS standards are essential (or “material”) for your company.
3. Define a methodology based on quantitative and qualitative criteria.
4. Determine what is "material" for your business, based on the previous three points, and include this in your CSRD reporting.

The experts at the BNP Paribas Fortis Sustainable Business Competence Centre are at your service to assist you with your company's transition to sustainability and the related reporting tasks.

Carbon tax coming soon

The European Commission has also recently decided to introduce a Carbon Border Adjustment Mechanism at EU borders (CBAM). This means that an environmental customs duty (or “carbon tax”) will be levied on certain imports manufactured by companies outside Europe, in countries with less ambitious environmental standards. The mechanism targets the most carbon-intensive industries: cement, steel and iron, aluminium, fertilisers, and electricity.

CBAM reporting will start in October 2023, while the carbon tax will be phased in from 2026. The price of certificates will increase over the years.

We will discuss this carbon tax in more detail in another article.