Responsible Finance: How European Regulations Are Charting a Positive Course
In early 2023, the European Union (EU) adopted the Corporate Sustainability Reporting Directive (CSRD), which strengthens sustainability reporting requirements for companies and gradually expands its scope (for fiscal years 2024 through 2028).
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Pierre Chollet, University of Montpellier; Nicolas Cuzacq, University of Paris-Est Créteil Val de Marne (UPEC) and Souad Lajili Jarjir, University of Lorraine
The main objective of the CSRD is, as emphasized by the Autorité des marchés financiers (AMF), “to harmonize corporate sustainability reporting and improve the availability and quality of published environmental, social, and governance (ESG) data.” In a speech delivered in June 2022, the former chairman of the AMF stated that this directive constituted:
" The heart of the sustainable finance ecosystem."
An Ambitious Directive
The directive aims to ensure that financial institutions have access to the information they need both to meet their own reporting obligations and to conduct their business.
Institutional investors and fund managers, who are required to disclose their own sustainability information, are well aware of the current limitations: there is a lack of consensus on the definition of impact metrics, as well as on the accessibility and comparability of data.
To achieve its objective, the directive relies on three key changes regarding the disclosure of non-financial information. First, it provides that:
"Companies will be required to disclose detailed information on their risks, opportunities, and material impacts related to social, environmental, and governance issues, based on the principle of 'double materiality.'"
Thus, two perspectives are considered: risks to the company and the company’s impacts. The disclosure of this information will enable financial stakeholders to prepare their reports using a “double materiality” approach: the financial impacts of ESG criteria on portfolios and the impacts of portfolios on ESG areas.
This is consistent with the requirement, set forth in the November 27, 2019 regulation known as the “SFRD” (Sustainable Finance Disclosure Regulation), to take into account the main negative sustainability impacts associated with financial products (contribution to climate change, harm to biodiversity, water pollution, gender discrimination, etc.).
The second change is that the CSRD introduces another measure to promote transparency by establishing mandatory disclosure standards for sustainability reporting. Previously, companies enjoyed considerable freedom because the EU had limited itself to proposing voluntary guidelines. Going forward, the European Commission will select the mandatory indicators based on proposals from the European Financial Reporting Advisory Group (EFRAG), a nonprofit organization incorporated under Belgian law. This framework will need to demonstrate its resistance to lobbying and avoid creating an administrative burden for companies.
France Is a Step Ahead
Finally, the third major change is that the CSRD requires sustainability reporting information to be audited going forward. The regulation tightens the previous legal framework, as the prior directive left it up to each Member State to mandate such an audit. In this regard, France had already introduced such an audit in 2010, under the so-called Grenelle 2 law, through the role of the independent third-party organization (OTI). As a result, French companies and auditors now have extensive experience and a comparative advantage at the European Union level.
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To give European companies time to adapt to the new legislation, the auditor will initially conduct a limited audit. Then, by 2028, the EU’s goal is to transition to an audit that involves more validation testing by the auditor.
The lack of a mandatory audit was one of the fundamental flaws in the 2014 directive, as stakeholders could not compare audited reports with those that were not audited. This shortcoming could lead to a bias against virtuous companies whose weaknesses were brought to light. Corporate social responsibility (CSR) law must expose companies that are merely putting on a show.
Ultimately, the work of European lawmakers over the past few years has helped chart a course for responsible finance that aims to meet society’s new expectations regarding environmental, social, and governance standards. These objectives are far from being achieved, as we need to make it easier for companies and investors to implement these measures. Furthermore, it is important to place this work within a global and comprehensive vision to prevent the European continent from ending up like a Gallic village!
Pierre Chollet, Professor Emeritus, Montpellier Management, Montpellier Research Management (MRM), University of Montpellier; Nicolas Cuzacq, Associate Professor (HDR), Private Law and Criminal Sciences, University of Paris-Est Créteil Val de Marne (UPEC) and Souad Lajili Jarjir, Associate Professor of Management Sciences, University of Lorraine
This article is republished from The Conversation under a Creative Commons license. Readthe original article.