ESG disclosures far from complete and comparable
The CSRD will set a common standard for ESG data disclosures, with the first deadline in 2025. Currently, ESG data disclosures are far from complete, especially related to scope 3 emissions, while comparability is weak, given that companies can use different methodologies. These issues are unlikely to be solved by the CSRD, which means that there should be close monitoring of the first data sets that will become available in 2025.
Financial markets will play a key role in the path to net zero, as investment needs are significant
Complete and comparable ESG data disclosures are necessary for investors to properly asses risk and challenges of the companies they invest in (and their impact on the environment as well)
The CSRD will set a common standard for ESG data disclosures, with the first deadline in 2025
Currently, ESG data disclosures are far from complete, especially related to scope 3 emissions…
…while comparability is weak, given that companies can use different methodologies
These issues are unlikely to be solved by the CSRD, which demands close monitoring of the first data sets that will become available in 2025
The path to net-zero by 2050 requires above all reliable data
The European Commission (EC) presented its Green Deal on 11 December 2019, with the aim to make the EU a climate-neutral continent by 2050. Financial markets will play a key role in achieving the goal, as it requires significant investments. A necessary condition in this respect is that investors have access to reliable information about ESG risks, as well as the challenges and opportunities of the companies that they invest in (for instance, via investments in green, social, and sustainability bonds). To facilitate this, several reporting initiatives have already seen the light of day, with the Corporate Sustainability Reporting Directive (CSRD) probably being the most important.
One of the ultimate goals of the CSRD is to introduce a common standard for companies’ sustainability reporting, which should enhance data comparability as well as accountability. Eventually, this will improve the trust of society and investors, which, in turn, will likely give companies better access to sustainable financing. Currently, the lack of reliable information on sustainability risks that companies face, as well as the impact that companies have on people and the environment, is seen as a major impediment to channel sufficient funds to environmentally-friendly activities. Below, we will assess current sustainable data disclosure requirements and their coverage/completeness as well as comparability.
Short history of EU sustainability disclosures regulations
In 2018, the EU set a few objectives under its “Financing Sustainable Growth” action plan, noting that: “the disclosure (…) of relevant, comparable and reliable sustainability information is a prerequisite for meeting those objectives” (see ). This fits the call from investors, regulators, and society more broadly that there is a big gap in terms of ESG information availability, which hampers investors in their decision-making process, while also limiting the accountability of firms on ESG-related matters, while regulators are also left in the dark.
As such, developing a common standard for sustainable data disclosures was (and has been ever since) topping the agenda of European policymakers, culminating in the approval of the CSRD ().
CSRD: who needs to report and when and what?
The chart on the next page shows the timeline about when and which entities need to report under the CSRD. It shows that the first reporting deadline is in 2025 (over the annual report of 2024), while by 2029 all companies that are in scope of the CSRD will need to disclose their ESG figures.
In terms of what information needs to be reported, the EC asked the European Financial Reporting Advisory Group (EFRAG), and independent and multistakeholder advisory body, to draft common standards, known as the European Sustainability Reporting Standards (ESRS). The ESRS provides, therefore, a common framework that entities rely on when reporting sustainability information. The idea behind having a common framework is that it enhances comparability and reliability of ESG information being provided by entities, while also reducing their reporting burdens (and costs).
The ESRS takes a ‘double materiality’ perspective, meaning that companies not only need to report their impact on people and the environment (impact materiality), but also how environmental and social factors will affect their own operations (financial materiality). The ESRS covers 12 reporting standards, with two of which having a general nature, five related to the environment, four to social issues, and one related to governance. What is more, companies need to report on both a sector level and an entity level, while there are three reporting areas (see below).
On the surface, the adoption of the ESRS paves the way for the much needed common standards in ESG reporting. However, although the intention was there, in practice, the ESRS-compliant data coming to the market could still lead to fragmentation amongst companies, as it is likely that they will still use different definitions or interpret questions in different ways. This embodies a risk, as it would undermine the comparability of data (that, at face value, seems comparable), which in turn harms their reliability. Below we take a closer look at these issues.
ESG data currently far from complete
We first take a look at the ESG data that is currently being disclosed by companies. We focus our analysis on a set of companies of two sectors: utilities and financials. As shown in the graphs on the next page, ESG disclosures across different pillars (E, S and G), as well as solely focused on carbon emissions, is still significantly lacking. Particularly for banks, only around 60% of the environmental and carbon-related data is being disclosed. That clearly shows that for banks, ESG disclosures is still very much focused on governance.
With the ESG data not yet touching upon all relevant information for investors, one could argue that the current data is not complete. A good example is, for instance, reporting on scope 3 emissions. While these account for the majority of banks’ emissions, a significant share of banks still does not include financed emissions within their scope 3 reporting (or does not assess their entire lending portfolio). According to the ECB, half of the EU banks do not report on scope 3 financed emissions, and 85% of those that do report, do not report it with an at least (broadly) adequate quality (see ).
ESG data also not fully comparable
Moving on, we try to investigate the comparability of current ESG data disclosures of various companies. One key aspect related to disclosures of carbon emissions is the emission factor that companies choose to calculate CO2 emissions. It now seems possible that two similar companies from a similar sector could report different carbon emissions just by using different emission factors. Indeed, a research study by Kings College (see ) shows that there are significant differences in the emission factors of two of the most used global datasets (UK-Defra and US-EPA), in which factors from the UK-Defra database are on average 10% lower than those in the US-EPA database. As shown in the chart below, when re-calculating emissions from one database to the other, companies would show a significantly different carbon footprint.
The results clearly illustrate that existing standards that specify and guide companies on their GHG emission reporting do not clearly specify the methodology that needs to be used by companies. For example the GHG Protocol Corporate Standard (which is not only the most widely used standard globally for carbon reporting, but also required to be considered by undertakings that report under the CSRD) does not prescribe which dataset of emission factors should be used. Therefore, it allows companies to also use the dataset that fits their ambitions better. The ESRS, which specifies the reporting of the CSRD (see above), requires undertakings to “consider the principals, requirements and guidance provided by the GHG Protocol Corporate Standard”, but by doing so, also does not require calculations to be coherent across peer companies.
A long way to go
Overall, it seems that there is still a long way to go before ESG disclosures from companies will be complete and comparable. The CSRD (and the common standards set out in the ESRS) is a good starting point, but still leaves room for different methodologies and assumptions that companies base their ESG data disclosures on. This is a risk in our view, as in the end, it will limit the use of this data for investors (and other stakeholders) to assess the sustainability performance of companies as well as the risks and challenges they face in this respect. Ultimately, it could undermine the aim of the EC in channelling more private sector financing into sustainable activities and the market for sustainable investments more broadly. Therefore, it will be key to monitor closely the quality of the first ESG data disclosures under the CSRD that will be published in 2025. Investors should not take the incoming data “as given”, and should still put these under the microscope before using it “blindly” for investment decisions.