Series 5 Episode 2: Sustainability reporting - decoding CSRD

Transcript

Tessa Norman: Hello everyone, and welcome to the latest episode of Risk and Regulation Rundown, the podcast where we share our views and insights on hot topics in financial services risk and regulation. My name’s Tessa Norman, I'm part of PwC's Financial Services Regulatory Insights team and I'm your regular host for this podcast. In this episode we're going to be focusing on sustainability reporting, taking an in-depth look at the EU's Corporate Sustainability Reporting Directive, known as CSRD for short. This is an extensive piece of regulation which requires firms to make significant changes and firms are currently entering a critical period in their implementation plans. To talk us through how all of this is impacting firms I'm joined by two expert guests who are going to unpack CSRD for us and explain what it means in practice for the financial services sector. I'm joined by Justine Dixon, who's a senior manager in our sustainability practice, and Lucas Penfold, a senior manager who leads on ESG regulatory insights, welcome to the podcast.

Lucas Penfold: Thanks for having us.

Justine Dixon: Pleasure to be here.

Tessa: Lucas, CSRD is one of many sustainability reporting initiatives that a lot of our clients are grappling with at the moment. Can you start off by just reminding of some of the background to this directive and the key elements and key dates that firms need to be aware of?

Lucas: Yes, sure, thanks Tessa. I think people often talk about ESG regulation as being something that's very transformational for organisations. I definitely think that is the case with CSRD, it's really shifting the dial in terms of how firms are having to approach sustainability reporting and creating a lot of underpinning work to really get that reporting into shape. Definitely something that's having a big impact, I agree with your comments. I guess the first point that I'd make on this is that CSRD is a piece of EU regulation, so it's something that stems from the European Union, and is absolutely core to the EU's approach to sustainable finance and its sustainable finance framework. And also its just broader, more macro ambition around net zero transformation, it's set a target to be a carbon neutral economy by 2025, it's very clear that the EU sees CSRD as being absolutely central to this ambition. I think you mentioned this point already, Tessa, CSRD's a corporate ESG reporting regulation so it's very much focused on company level ESG reporting. And it's trying to drive better company data on ESG, both for the benefit of investors but also for wider stakeholders across society as well. It's definitely helping to improve the way that financial market participants, for example, are picking up ESG data and incorporating ESG risks and opportunities into their decision making. We do already have a reporting framework out there at an EU level and that's the Non-Financial Reporting Directive, NFRD, and CSRD is really looking to expand on NFRD with regards to ESG reporting. I'd just highlight a few key differences compared to NFRD which I think are particularly noteworthy. The first is around scope. The EU is looking to significantly broaden the scope of the regulation compared to NFRD, so it's not now just capturing EU PIEs, it's covering a much wider range of companies, so large companies, large groups listed on a regulated market, listed SMEs and so on. A much broader pool of companies that find themselves in the scope of this regulation, which is significant. Second key difference compared to NFRD is just the level of reporting that needs to be done on ESG, far more granular. There are very prescriptive templates that the EU is looking to roll out and in June, the Commission published some draft delegated acts on the reporting standards that the firms need to adhere to when they're making their disclosures in line with CSRD. And then the third point of difference is around assurance. There are much more stringent and prescriptive requirements around levels of assurance that needs to be performed on the reporting itself. So a number of different changes, pretty big changes. The first reporting will kick in from FY24, so lots of companies are going to have to really start engaging with this now to make sure they're putting the data together and making sure their reporting is done in line with the new rules.

Tessa: Thank you. It's really, really, helpful to have that overarching context of the aims behind this and how it fits in against things like NFRD, so thank you for that. And of course, as you said, this is an EU directive, but I think I'm right in saying it's got a much broader application outside of the EU. Can you just explain to us how it's going to impact UK based firms?

Lucas: Yes, that's spot on, Tessa. I mentioned the wider scope and it's definitely hitting non-EU companies, so that's definitely something that a lot of firms are having to grapple with at the moment. Essentially, if you're an EU branch or you have an EU sub, then subject to certain size and revenue criteria that are set out in the regulation, chances are that this is going to hit you. Lots of UK companies are caught as a result of that, including a lot of financial services firms. I think one observation I'd have around this is that a lot of firms, certainly in the FS sector but more broadly, probably haven't fully appreciated that there is this wider scope to the regulation, and as a result of it haven't perhaps appreciated that they're likely to be caught by this and haven't started the work to prepare. I think if you're a firm that has an EU presence of some sort, chances are that this is likely to be relevant to you, so do kick off the work to start to work through how the regulation might map into some of the different legal entities across your group and performing that scoping exercise early on, I think is an essential first step.

Tessa: Yes, great. So once firms have looked at that scoping piece and they've taken that first step, Justine, I know you've been working with a lot of our clients in this space, in what way is CSRD impacting firms in financial services? And what are some of the other challenges and other steps that firms need to be thinking about?

Justine: Sure. So, Tessa, it's important to note that currently the available standards associated with CSRD are sector agnostic, meaning that they apply to any company regardless of sector or the economy that they operate in. The actual application of these standards is very, very different for a financial services company than it is for an underlying real economy company because the value chain's really, really, different in nature. So, particularly this will impact FS firms that provide capital to a broad range of companies across the economy, that'll mean instead of having to think through a smaller number of those standards and the ESG topics they might potentially have to think about the broad range of ESG topics across all twelve standards currently available. So then associated with that, the biggest challenge probably for FS firms at the moment, as with all things sustainability reporting in FS is the collection of data. So FS companies will be very reliant on the data disclosed and reported by the underlying companies that they provide capital to, but those companies are all subject to the same reporting timelines and dates as FS companies, so there's a bit of a data time lag involved here. Thankfully, the standards give a bit of relief, a provision for that, so companies have up to three years to collect data across the value chain. But FS firms will still have to do a lot of thinking around where the biggest risks, opportunities and impacts lie within their portfolios. And I think again, thinking about the FS perspective and the data, it's a significant volume of data that FS companies have to collect, so huge, huge challenge for FS companies there. And then I think the other challenge that I would draw out applies to all companies in the scope of CSRD, and that's the concept of upskilling and organisational engagement. CSRD as we've said before, is a transformational piece of regulation and it requires our input from teams across the organisation, so more involvement from finance than before but also the finance team, in preparing those disclosures, will rely on lots of people across the organisation. So a big challenge in bringing people on that journey, helping them understand the regulation to get to a reportable point.

Tessa: Thanks Justine. In terms of those challenges what are some of the steps that firms should be taking at this stage to overcome some of those issues?

Justine: To start with the data piece, in the absence of data there are still steps that firms can and will need to be taking to assess and analyse their portfolios and understand where those material sustainability hotspots lie. So, looking at the underlying sectors that they're lending to, investing in and insuring and thinking about what this means from a sustainability perspective. There's also a piece that can be done to think prospectively around how you will collect that data in the future. So, in the underwriting, insuring, lending process how do you build in that data collection going forward at the point of providing capital? I think firms that have really sizeable portfolios will likely need to invest in systems and automation to help collect and monitor this data at scale, so I think engaging early with the board of management on the investment that's required around that will be important. And then just taking the ownership, accountability, upskilling piece. I think it's very important to establish that clear ownership and accountability early on, so who's going to be driving this response and who those key teams will be that will support that. Involvement of the finance team is going to be really, really, key, these disclosures are ultimately going to end up within the management report, so essentially the annual report, and will be subject to assurance, as Lucas mentioned, so the finance team are going to be really, really, critical in bringing that reporting rigour and skill set for this type of investor grade reporting.

Tessa: Some helpful areas there for our listeners to be thinking about in the here and now. And in addition to that, are there any other practical lessons or tips that you can share, in terms of how firms can put this into practice?

Justine: Yes, so, I think, touching on what Lucas said earlier about the scoping piece, I think determining that scoping really early on is very, very important, so which of your legal entities will be impacted and what does that mean for your reporting. So under CSRD, you can report in a number of ways, you can report at group level, you can do an artificial EU consolidation or you can report for the individual legal entities. And if you take each of those options, that will have implications for how you then go forward to do your double materiality assessment and collate your data. So I think being clear on that, very early on, is important. The next is being clear on organisational commitment to sustainability. So CSRD, it's a disclosure and transparency regulation, it doesn't tell companies what they should or should not be doing. So, I think we're finding, when we're speaking to clients and we're helping them work through the standards, having that really clear view on what your organisation is doing with sustainability, where you stand on sustainability is really important to help you, sort of, sift through the disclosures and make those decisions around what you're going to be reporting. The next, I'd say, is identifying upskilling needs across the organisation is really, really, important.

And I think the last one I'd say is to prepare for assurance as you go, so again, Lucas mentioned earlier that CSRD comes with an assurance requirement, I think documenting key judgements and decision-making, as companies are responding to the regulation, and building in those controls, as you're starting to collect new data, will be really important as well.

Tessa: Absolutely. And I think, linked into your point around strategy, I'd also say it's going to be really important for firms to think about CSRD strategically, in terms of how it fits in with other reporting frameworks and not just looking at it in isolation. Lucas, do you want to tell us a bit more about how firms are approaching that or should be approaching that and some of the other regulations that'd be helpful for firms to think about, in conjunction with CSRD?

Lucas: Yes, sure. Yes, I completely agree with that, I think, you know, clearly, as we've been getting at in this conversation, CSRD is a really important bit of regulation but it is one of many in the ESG space. Firms are having to grapple with mandatory TCFD in the UK, we've got things like SFDR, at the EU level. We've got the global ISSB standards coming out, which, by the way, will eventually become part of UK regulation, through the UK SDR, another acronym. And a sort of general observation, I'd say, on this, is that a lot of these regulations are a bit of a variation on a theme. There are, certainly, some similarities but there are also some really important differences as well. So, you know, take ISSB, for example, Justine mentioned the concept of materiality just now, the ISSB standards are viewing materiality through an enterprise value lens, whereas CSRD takes a double materiality perspective on things, so a slightly different approach. And I think, given these dynamics, we are seeing firms begin to take a more rounded view of the regulatory environment. Identifying some of those common areas and differences, both in terms of the rules themselves and what the regulation's actually requiring but also in terms of the different impacts on your business. I think what we would suggest is, where possible, try to make one change to your reporting processes or your data strategy or the governance structure that you put around ESG reporting, that's going to cater to each of these different regulations in the round, rather than thinking about each regulation in silos.

Clearly, that's going to help drive efficiencies in the way that firms are responding to these regulations and removing some compliance costs in the process as well, which I think, has to be helpful. To your point around strategy, I think Justine touched on this, I think it is very tempting for firms to view something like CSRD as a compliance exercise because it's a big bit of regulation and is putting formal rules in place, that firms need to adhere to but I do think it's really important to try to view this as a strategic opportunity for the firm. So set your overall ambition around ESG, how does that then filter down to the story you want to tell through your reporting? And then marrying that with CSRD but also some of those wider regulations that I mentioned as well, just to help, sort of, bring it all together. And I think, you know, that just helps firms land on a more coherent approach and story and, ultimately, I think that the objective with all of this stuff is, really, to try and use the reporting to drive better value for your organisation. So, I think it, certainly, helps, as you're sitting down to plan your approach to how you might respond to CSRD, it's worth having that lens in mind, as you start the work.

Tessa: For those points around strategy and value creation, in the way that firm’s approach this, are really key I think. So to finish up Justine, if you were a financial services firm and you think you're probably in scope of CSRD, what are the couple of steps that you'd really encourage firms to take on a practical level, after listening to this episode?

Justine: Yes, so, if I were to givethree top tips as to what people could go away and do after listening to this podcast, I think the first one is being really clear on how CSRD impacts your organisation. As we said earlier, depending on your legal entity structure, it could be a fairly minor impact, it could be a really extensive impact and that will depend on your legal entity structure, so I think that's number one. Number two is deciding accountability, so who's going to lead and own this in the organisation and once you've got that, who are the key people, internally, that that person is going to really rely on to be really actively involved in responding to CSRD. And I think the third, I'd say, is getting this on the agenda of board and management, if it isn't already and helping them understand, I suppose the scale of activity and the level of effort that may be required for the organisation, so, you can make sure that you've got the time carved out and the investment carved out, to respond to this appropriately, rather than it being side of desk.

Tessa: Lucas, is there anything you'd add to that?

Lucas: No, I'd agree with all of that, Justine. I guess, just to reinforce the point that I made earlier on, which is, I think, when you're designing your approach to CSRD, you know, just make sure it's flexible enough to cater for other regulations as they arise. I think I mentioned the UK SDR as a big development that's on its way in the UK space, I think definitely having your eye on that, that future emerging landscape in this space, when you're developing your response to CSRD is going to be good practice for firms.

Justine: I think, just to add to that, Lucas, that's a really important point and something we talk to clients a lot about, which is, with something like CSRD, many firms are going to have to implement new systems to deal with the data required and collect the data required to respond to it and actually when companies are implementing those systems, there's a big piece around thinking about implementing a system that is flexible and adaptable to respond to future ESG reporting needs. If you need a similar piece of data but cut in a slightly different way, for a different geography or a different piece of regulation, making sure that your systems can deal with that.

Tessa: Brilliant, thank you very much both. So that's been a really valuable discussion and it's been great to hear about all those different impacts and how firms can overcome those challenges, in terms of engagement, upskilling, accountability and data. And to our listeners, I hope you've enjoyed this episode and thank you very much for listening. As always, if you found this conversation helpful, please subscribe to future episodes and please rate and review the series as it helps other listeners to find us. If you'd like to hear more from us on risk and regulation, please look out for our regular publications on our website and we'll be back next month with our next episode.