Sustainability Reporting in Europe

By Mark-Anthony Macharia and Cristina-Ioana Mihai

International News, March 2023

In its broadest sense, sustainability reporting covers the environmental, social and governance (ESG) aspects of a company's activities. The concept itself goes back years to a period when a number of stakeholders from the private sector, NGOs, and international organizations, started to push for the creation of various measures, both quantitative and qualitative, that would capture the ESG/sustainability efforts of a company.

These stakeholders tended to work independently leading to the creation of multiple standards with different objectives. The companies that chose to produce ESG reports, in turn, selected reporting standards based on their own individual objectives leading to:

• A lack of consistency with respect to sustainability reporting between companies.
• Differences in the quantity and quality of the reporting carried out.

As the investor community, regulators, and other stakeholders started taking an interest in the topic, the lack of common definitions, terminologies and standardization to support comparability emerged as a challenge.

The Start of Sustainability Reporting in Europe

While the European Union's (EU) sustainability reporting initiatives in recent years' form the most extensive regulatory package seen for a while, sustainability reporting as a regulatory requirement in the EU is not a new concept. The Non-Financial Reporting Directive (NFRD) of 2014 (upgraded in 2017–2018) officially kicked off sustainability reporting, by requiring all large public-interest entities with an average number of employees in excess of 500 to report on:

• The “outside-in” perspective: The impact of sustainability issues on their performance.
• The “inside-out” perspective: Their impact on people and the environment.

This combined outside-in and inside-out view is commonly referred to as "double materiality."

The NFRD recognized the existence of global frameworks such as the Task Force on Climate Related Financial Disclosures (TCFD) and recognized the TCFD, where available, as an appropriate implementation of the NFRD. While the NFRD kicked off the sustainability reporting journey for many companies in the EU, it did not deliver on the comparability and standardization that European regulators decided was needed in light of the ambitious EU 2050 climate-neutrality goal. Therefore, the EU agreed to review the NFRD and upgrade it into a more extensive and comprehensive framework, namely the Corporate Sustainability Reporting Directive (CSRD). The events below preceded the adoption of the CSRD.

The 2019 European Green Deal

The European Green Deal is a flagship project of the EU under the umbrella of which a wide range of regulatory proposals have emerged. At a high-level, the European Green Deal was created to deliver on the EU's commitment to both the United Nation's 2030 Agenda for Sustainable Development and the 2016 Paris Agreement on climate change.

Given the ambitious goals linked to the Green Deal, a wide range of regulatory initiatives followed its launch, covering a number of economic sectors (including energy, industrial production, transport, nature and forests) as well as social policies.

The 2020 EU Taxonomy

The EU Taxonomy was introduced to provide a common language and a clear definition of what would be considered sustainable in the European Union. As such, the taxonomy is at the center of many other regulatory initiatives that have since followed. As a start, the EU Taxonomy's focus has been on the environmental (E) element of the ESG. The social (S) and governance (G) are expected to be tackled in the coming years.

The EU Taxonomy creates a classification system of environmentally sustainable activities. It defines the following six objectives for the climate change agenda:

1. Climate change mitigation
2. Climate change adaptation
3. The sustainable use and protection of water and marine resources
4. The transition to a circular economy
5. Pollution prevention and control
6. The protection and restoration of biodiversity and ecosystems

To be classified as sustainable, the economic activities that companies undertake must:

• Contribute substantially to one or more of the six environmental objectives
• Do no significant harm to any of the environmental objectives
• Be carried out in compliance with minimum safeguards
• Comply with an established set of technical screening criteria

The conditions necessary to meet these conditions are stipulated and defined by different economic sectors which include the insurance and reinsurance industry.

As a precursor to the finalization of the CSRD at the end of 2022, the EU Taxonomy updated the NFRD to require new, taxonomy-specific reporting. Companies (including re/insurers) under the scope of the NFRD started reporting on elements of the taxonomy in 2022, covering the year 2021.

The 2021 Corporate Sustainability Reporting Directive (CSRD)

As noted above, the Corporate Sustainability Reporting Directive (CSRD) was introduced as a way of strengthening and expanding the NFRD. By removing the 500-employee threshold, the CSRD extends the scope of the NFRD from roughly 12,000 companies to around 50,000 companies in the EU. The CSRD further introduces a wide range of requirements related to ESG as well as a high level of standardization, especially with respect to the quantitative metrics. Companies will need to report on their Greenhouse Gas (GHG) emissions, their strategy and targets, the role of their board as well as the adverse impacts connected to their company and its value chain.

The CSRD allows for group reporting where similar information exists and further introduces audit requirements in the form of limited assurance. In addition, the CSRD embeds an extra-territorial element whereby subsidiaries of non-EU groups will first need to deliver subsidiary-level information and then, at a later point in time, certain group-level information.

The first set of data points expected for the first CSRD reporting will only be finalized and become law in 2023. Companies are then expected to report on them starting with their 2024 annual disclosures.

The 2022 Corporate Sustainability Due Diligence Directive (CS3D)

The Corporate Sustainability Due Diligence Directive (CS3D) is the latest piece of sustainability related regulatory development and is still under political discussion. The CS3D focuses on introducing a corporate due diligence duty, including directors' liability. The core elements of this duty are identifying, ending, preventing, mitigating and accounting for negative human rights and environmental impacts in a company’s own operations, their subsidiaries and their value chains. In addition, the CS3D introduces obligations for companies to develop their own transition plans aligned with the Paris Agreement.

Among other things, companies will be expected to:

• Integrate due diligence by including the following in their company policies:
  • a description of the company’s approach, including in the long term, to due diligence
  • a code of conduct describing rules and principles to be followed by the company’s employees and subsidiaries
  • a description of the processes put in place to implement due diligence, including the measures taken to verify compliance with the code of conduct and to extend its application to established business relationships.
• Identify actual and potential adverse human rights impacts as well as adverse environmental impacts when providing credit, loan or other financial services.
• Take steps to mitigate potential adverse impacts and bring actual adverse impacts to an end while also minimizing their extent by developing and implementing a prevention action plan with reasonable and clearly defined timelines for action and qualitative and quantitative indicators for measuring improvement.
• Establish and maintain a complaints procedure.
• Monitor the effectiveness of their due diligence policy and measures.
• Publicly communicate on due diligence.
• Designate an authorized representative established, or domiciled, in one of the EU member states in which it operates.
• Have directors:
  • Consider the short, medium and long term consequences of their decisions on sustainability matters including human rights, climate change and the environment.
  • Be responsible for putting in place and overseeing the company's due diligence actions.
  • Take steps to adapt the corporate strategy to consider the actual and potential adverse impacts.

Subject to being finalized in 2023, the CS3D's application date is expected to be in 2025 or later.

Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries, the editors, or the respective authors’ employers.

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Mark-Anthony Macharia, FSA, CERA, is head of legal entity risk management, EMEA, at Swiss Re Corporate Solutions based in the Netherlands. He can be reached at Mark_Macharia@swissre.com.

Christina-Ioana Mihai, CFA, is head of regulatory risk management, EMEA, at Swiss Re based in Zurich, Switzerland. She can be reached at CristinaIoana_Mihai@swissre.com.