Series 5 Episode 9: Deadlines, data and double materiality - in the thick of CSRD

Transcript

Tessa Norman: 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. I'm your regular host, Tessa Norman, and in this episode we're discussing sustainability reporting, taking a deep dive into the EU's Corporate Sustainability Reporting Directive known as CSRD for short. I'm delighted to be joined by two expert guests who are joining us to share their insights, director Esther Rawling and senior manager Lucas Penfold, both who join us from PwC's sustainability practice. We're going to be talking about how firms can overcome the practical challenges of implementing the regime, how CSRD fits into the broader sustainability reporting landscape and what firms can except from the broader policy and regulatory agenda in the year ahead. Welcome to the podcast.

Esther Rawling: Thanks for having me, Tessa.

Lucas Penfold: Hi, Tessa.

Tessa: So regular listeners might remember that we discussed the CSRD regime in an episode last year back in June, but eight months is a long time in financial services regulation and a lot has changed since then. Lucas, do you want to kick off by giving us a bit of a refresher on CSRD and how it impacts firms?

Lucas: Yes, sure. Thanks Tessa, you're right, we've seen quite a few developments in this space since we last spoke back in June last year on the topic. I think the most significant change is that we've had the final adopted delegated act for the sector agnostic ESRS standards, and that was really acting as a pretty big trigger for activity across the FS sector. Just thinking a little bit around, I suppose, what the standards are, what these are trying to do is set out some specific data points that firms are going to have to be reporting against, across a range of different sustainability topics, whether it's environmental issues like climate change, biodiversity, pollution, through to social topics, governance topics as well. There are twelve different standards in total, although I think a really important principle in CSRD is that firms only need to be reporting on the topics that are material for their organisation. CSRD applies a double materiality lens to materiality, so it's considering the impacts that the organisation has on sustainability factors, so impact on the environment, impact on society, but also thinking about how sustainability factors are impacting on the organisation. Thinking about the risks and the opportunities it creates for a business, I think accessing materiality is clearly a critical component of any CSRD implementation programme.

The scope of CSRD is very broad, we're seeing a lot of financial services clients find themselves caught by this regulation if they have any sort of activity in the EU, whether it's listed securities on an EU exchange, maybe they'll exceed some of the turnover and balance sheet thresholds that are set out in the regulation. Or it might be that you have a non-EU parent that has significant activity in the European Union. There are a number of different ways that organisations are finding themselves in scope, which means it's really quite a far reaching regulation in terms of the firms that it's catching. There are various reporting deadlines that firms are going to have to consider. Just to call out a couple, something we're seeing at the moment, many of our FS clients are going to need to be reporting in FY25 on FY24 data because many of them are already in the scope of NFRD which is the predecessor to CSRD, another ESG related acronym there. But this means that essentially you're going to have to be gathering that data now, this year, for reporting next year. So, it's really something that firms are having to engage with today. There is also another key date we're seeing come up a lot in conversations with clients is the FY29 reporting deadline. That's something that applies to any non-EU firm that is in scope of the regulation. So even that, it might seem like a few years off, but what we're seeing and what we're hearing is that there is just a lot of upfront steps that firms are going to need to be working through, whether it's thinking about materiality, gathering the data and really making the changes to their different frameworks to make that reporting. So not to underestimate just quite how much work goes into pulling together that information for reporting, even though it might seem on the face of it a few years off yet.

Tessa: So, for those firms who are already gathering that data as you mentioned, Lucas, Esther, do you want to give us a bit of a sense of what that means in practical terms and tell us a bit more as well about where firms are at in the implementation journey?

Esther: Yes, Tessa. Just to pick up on a couple of points that Lucas mentioned, so, he said basically the first set of firms are in scope now for reporting on FY25 and if you are in this bucket of firms and you haven't started then I suggest this moves to the top of your to-do list and you really focus and start prioritising. In terms of data, another point that Lucas mentioned, don't be lulled into that false sense of security that you're reporting in 2025 for 2024. There are a huge number of data points where you need to start collecting those at the start of the financial year. Thinking about this well in advance. So, 1st January you should have thought about it, but if you haven't you need to start moving on that quickly, but it just takes time and to the point around the group that comes in in 2029, just thinking about the fact that you'll need to gather a bunch of data at the start of 2028, so you can't leave it until 2028 to start. You really need to start your planning towards the end of FY27. The other thing that I'm seeing is that most firms are well on their way in terms of the ones that are in scope, they have kicked off some sort of CSRD programme at the end of last year. So, again, if you're not then please do focus on that. Most banks are either in the thick of their double materiality assessment or they've completed their double materiality and are now turning to that data challenge, and in most instances because CSRD applies at the entity level there will be a number of data points especially around climate where firms would not have been disclosing this information at the entity level just yet. Being able to identify where either you've got missing data at the entity level or where you do have the data but you need to figure out how to disaggregate it is going to be really key.

Tessa: And for those banks who are in the thick of implementation, as I think you put it, what are some of the pain points that you're seeing, and some of the issues that they're really grappling with at the moment?

Esther: I think the first issue that I see is because CSRD is such a broad regulation and it touches so many different functions, getting the right individuals around the table and assigning ownership is really key because there are a number of disclosures where you will find you need inputs across several functions. So identifying who is actually going to be on the hook for what is really, really key. So, being able to define those roles and responsibilities quite early on can be a bit of a struggle. The next area is where you've got legal entity versus group disclosures. So, for global groups getting this dynamic is really important especially where the parent doesn't come into scope until later on. For example, where there are policy and process gaps, being able to do those at the highest level so that you disseminate them and you only basically do this once versus taking a more tactical approach where you do it at a legal entity level and then you need to revisit it at group, it's just not efficient from a resource perspective, but also there is a risk of different territories applying the rules in a different way. So managing that dynamic and then also on that group versus legal entity point as well, because your CSRD disclosures are so far reaching and they're actually really in depth in terms of what they require firms to disclose, being thoughtful of where things are being disclosed at the subsidiary level ahead of the group is really key, and thinking about how that could potentially impact the group especially when you've got various users of the disclosures including regulators. For example, if you were a US headquarter bank and you make certain disclosures in the EU subsidiary, you know, how might the SEC view that disclosure? Just being thoughtful of those kinds of things is really important.

Tessa: How can firms overcome some of those challenges that you've talked through?

Esther: I think basically don't underestimate the effort that is required, it's easy to just think that this is just another disclosure, you'll muddle through it, but it really does require a lot of effort. Buy-in at the more senior stakeholder levels of the organisation is really key because some of the decisions around methodologies, around disclosures, around regulatory risks that you may want to run, having people on side to make those decisions quickly is going to be really important. Education is important because it's easy to take for granted that people within the sustainability space may know about CSRD and may be fairly comfortable with what it involves, but when it impacts functions like corporate services and HR and other functions that may not be as comfortable with the disclosures, then going in with your right level of education so they understand what is required is really important, and engagement, engagement across all the functions again is really key. And the last thing I will end on here is, just defining that ownership of brand so people know what they are on the hook for, or they know where their hand-off s are, or where they need to input into something, is also really important.

Tessa: I think that point about stretching across, such a broad range of the organisation is really interesting and something that we're seeing in other evolving regulatory regimes, diversity and inclusion is one that springs to mind as well. That's really interesting. And Lucas, how does that compare to what you're seeing amongst some of our other clients, so particularly thinking about clients in the asset and wealth management space or insurance firms?

Lucas: Yes, a lot of common themes there I would say are cropping up across asset managers and insurance, but I think generally my observation would be that asset managers and insurers are a little bit further behind. Many firms that I've been speaking to recently in those sectors, I think are starting to mobilise a CSRD programme now, so they're, kind of, getting it up and running. Whereas, you know, as we've heard from Esther, I think banks are possibly a little bit further along, but clearly there will be some exceptions and some firms in asset management and insurance sectors are a little bit further along as well. Some are in the middle of legal entity scoping and double materiality assessments for example. I think there is a point around a segment of the FS sector having to move forward a little bit quicker than perhaps they have been to date. Just more broadly just thinking about some of the challenges that I've been observing in the asset management and insurance sectors, I think there are three that spring to mind. I think the first is around the complexity that goes into the scoping exercise. This is a complex regulation and there are lots of quirks as to how different firms are finding themselves caught by the regulations. For example, if I think about the asset management sector, some are finding that certain fund structures are potentially in scope and that brings with them lots of reporting obligations which perhaps they haven't previously been used to to this extent.

I know certainly, our private equity clients, for example, they're also having to think about, 'Okay, well, how are their portfolio companies impacted by all of this too, and do they have a role in supporting the portfolio companies, meeting their own obligations under CSRD?' I think there's a lot of complexity around application and scoping. I think the second point I'd pull out is around value chain and the value chain boundaries that you put around the DMA exercise, particularly again if you think about the coverage of the portfolio, expanding beyond the own operations when thinking about materiality and running through the DMA can be quite complex. There are associated value chain considerations around the portfolio, that just adds further complexity to the exercise, so, that's something that we're hearing more and more about in these sectors. And then the third point I think is around data, and it links with that point around value chain and portfolio coverage as well, just a lot of data points that potentially need to be reported on. So, to my earlier point around the purpose of the DMA exercise is to really focus in on what is material to your business and what really matters and using that to drive what you'll report. I think the potential volume of data that you need to be collecting and reporting against just demonstrates just how important getting that DMA exercise is for firms that operate in the asset management insurance sectors as well. That's something we're hearing quite a lot about as well.

Tessa: It sounds like there are lots of complexities and really technical issues there that firms are having to work through, but I imagine it's also important that firms don't lose sight of the higher level view and the bigger picture, because CSRD of course is just one of a number of sustainability reporting initiatives that many firms are going to have to implement. I mean, how are you seeing firms manage that interplay with some of the other regulatory initiatives?

Lucas: Yes, good question, Tessa. I agree, taking a step back from CSRD there is a very busy agenda around sustainability reporting. CSRD is clearly a major part of this and arguably the key priority for firms today, but it is part of a much wider landscape that firms are going to need to be engaging with. So, the ISSB standards is a clear example. This is a major initiative, it's a global piece. You've then got questions around, you know, how that is going to be adopted locally in different countries. So, if you're an FS firm with a broad global footprint, which many of our clients are, potentially you are going to need to be implementing the ISSB standards in a different way across some of the different entities across your group structure depending on where they are based. Definitely a lot of complexity here. In the UK we know that the intention is to implement the ISSB standards as part of an economy wide SDR framework and there is a process that has been established to essentially bring the ISSB standards into the UK framework. The aim is to arrive at a UK version of the standards by June this year, 2024, and that will be the trigger for incorporating the standards into formal regulation, and we already know the FCA wants to move quickly with the rules for listed companies potentially applying them as soon as January 2025. A lot of different moving parts here and CSRD is set within a much broader context.

I think one observation I would make is that there are a lot of overlaps between CSRD and ISSB and other SR regs like TCFD for example, and that's then maybe even more complex, I think for FS firms who are also having to grapple with product level requirements as well. Think about regulations like SFDR which have been particularly prominent in the asset management sector in recent years. So it's going to be really important that firms take a step back, consider some of the overlaps in the different materiality assessments that they need to perform under these different regulations, where there are overlaps and differences in disclosures and data points, really to take that broader holistic view to try and drive efficiencies in the way that you're responding to these different reporting initiatives rather than having to repeat the same or a similar exercise multiple times for different regulations. There is definitely an efficiency point here, and I think increasingly we're seeing firms apply a value creation lens to all of this and how they are responding to this agenda as well, rather than purely seeing it as a compliance exercise. For example, I was having a conversation with a client just the other day around using the CSRD double materiality assessment really to try and think about managing potential value erosion in their business through enhancing the risk management frameworks within their business, but also using it as an exercise to try and identify new activities, new markets they can operate in, new product opportunities and so on to really apply that value creation lens too. I think increasingly we're seeing firms see that strategic value flow through from responding to the different regulatory initiatives.

Tessa: And Esther, is there anything that you'd add to that in terms of how you're seeing clients manage and respond to this?

Esther: Just before I address that question, just to Lucas' last point, that was spot on because I think the focus to date has been on managing risk and I think clients have focused less on the opportunities and the impact side of things and I think, and CSRD I think is maybe one of the catalysts here because it's now forcing clients to think through the DMA about the impacts and opportunities. Then you've got that value creation bit coming out as clients are starting to think about it more thoughtfully and a bit deeper. So, you know, I think that's spot on there. In terms of the point around regulatory divergence and even regulatory convergence because you've got some overlap, definitely an area that clients are focused on and see as a concern and chatting with clients more recently I'm starting to see clients starting to think about their disclosure strategies. So, looking at the regulatory landscape over the next three to five year time horizon, and thinking about the wider implications for the organisation. But also thinking about, you know, when they're addressing CSRD now by looking out to that time horizon they are possibly considering things that they may need to address any how in three years just to the extent that you could more efficiently address it now, and let's think about that. And then also thinking about where the disclosures go and how that impacts, for example, the control framework that they need around the disclosures, etc, because with CSRD as an example, you've got limited assurance in the first year, gradually building up to full assurance, making sure that you've got the robustness around the disclosures in the same way that you've got financial disclosures is really key. I think having that more strategic approach to sustainability disclosures is definitely an approach that we see clients thinking more and more about.

Tessa: And given the importance of that horizon scanning piece and the need to look further ahead, Lucas, if we think about some of those other initiatives you mentioned, what are some of the key dates and developments that we expect over the next twelve months or so that firms should really be looking out for?

Lucas: Yes, 2024 is definitely going to be another busy year for developments in the reporting space in sustainability. I'd call out just a few things, one of which I've alluded to already I think, but I mentioned the expectation that we'll see more clarity on how the UK is going to be adopting the ISSB standards by the end of June/July, and then there will be a subsequent FCA consultation on embedding that within rules for listed companies. That's certainly something that a lot of our FS clients will need to closely follow. We're hoping to also hear more details about how the standards are going to be incorporated into other areas of the regulatory framework, so, for example, the Companies Act, which again will be relevant to FS clients. The second point I would just highlight is the Transition Plan Taskforce work, the TPT framework was finalised at the end of 2023 and there was some sector guidance that were consulted on for essentially how to apply the TPT framework across different sectors including banking, asset management and asset owners, and actually PwC drafted the banking sector guidance. We expect that is something that will conclude in 2024 and really the expectation is that is going to be a catalyst for a much greater focus on transition planning and disclosure around transition planning across the FS sector this year. And then the final point I'd highlight is something to keep an eye out for is the SDR proposals for asset managers. We've got final rules in places for the asset management sector, and they finalise back in November 2023, and we're expecting a further consultation imminently on how the regime will apply to portfolio management services. That's something that was excluded from the final rules from November last year, but that's an area that is clearly going to have implications for a lot of different FS firms that are perform in that activity.

Tessa: And given that a lot of that change is driven by government initiatives and impetus as well as changes driven by regulators, do you see any changes in that sort of pace of reform as we look further head? You know, in our last month's episode we heard from Lord Gavin Barwell about the potentially more fractured and uncertain political landscape for this year and beyond and how that is leading to greater divergence in policy areas such as climate, and do you see that political landscape having an impact on the progress of some of those sustainability initiatives?

Lucas: Yes, thanks Tessa. I think the big question here is whether we'll see a change of government following the upcoming election this year, and if we do see a Labour government, if the polls turn out to be accurate, we can expect to see a significant focus I think on sustainability. Labour has recently just dropped it's £28 billion green investment package which was an initiative focused at driving more sustainable growth in the economy. There has been quite a lot of debate around how achievable this would have been given the current fiscal headroom. So, in a sense perhaps unsurprising that it back tracked on this commitment. Labour has however just recently published a financial services strategy and a key priority as part of its effort on financial services is around ensuring that the UK financial services sector remains a global hub for sustainable finance. There's a really strong commitment to the whole green finance agenda. For example, we saw a commitment to implementing the SDR framework, TPT, it's clear that Labour remains committed to establishing a UK green taxonomy, and it was also talking a lot about new areas of focus on things like green mortgages, green housing stock and so on. So, I think really clear that Labour is going to be very focused on this. Clearly there is going to be some uncertainty about the outcome of the election but we're operating in an environment where I think both the Conservatives and Labour have made strong commitments to sustainable finance. I don't expect this agenda to be disappearing any time soon. I think it is very much here to stay.

Tessa: And what is your view on that pace of change, Esther?

Esther: Yes, I completely agree with Lucas on this one. I think it's tempting to be lulled into a false sense of security that with the political landscape and the environment moving that things might get delayed, and you could be tempted to put some of the stuff on the back burner. But it's just not going away, and I think we can see that the regulation coming down the pipeline is just getting-, it's more demanding in terms of what is required of firms. I would suggest that, keep pace in terms of with what you need to do in terms of thinking about what regulations you need to implement in terms of how you address it, and just know that it is not going away. So, don't be tempted to say, 'I'll put that off for next year.' I think staying focused on what you need to achieve given that we know all the ambitions of the UK in terms of being a sustainability centre of excellence and the wider commitments globally around net zero, etc, I would suggest staying the course and keeping the pace of implementation.

Tessa: We've covered a lot of ground there. It's been fascinating. Thank you both so much. It's been great to hear about those broader policy and political challenges and agenda as well as the more practical issues for firms. To round off our discussion I think let's bring it back to the more granular level where we started, and I'd like to ask you both for one final piece of practical advice that you'd give to firms who are looking at CSRD and what it means for them? Esther, I'll start with you.

Esther: I think the first thing that I would think about is, one, first of all understanding when you're in scope, and once you understand that then begin planning and understanding what you need to do and by when, and also, sorry, I can't limit this to one, but I'll give one more. Just make sure that you engage all the right stakeholders early and they understand why this is important and what is going to be required of them. Thank you, Tessa.

Tessa: And Lucas?

Lucas: I'll keep it short. I think there was a point I raised earlier, and Esther touched on it too, approach this strategically, so look to create value for your organisation rather than purely seeing it as a compliance exercise.

Tessa: Brilliant. Great to finish with some practical takeaways for our listeners. Thank you and thanks for joining the podcast. And to our listeners, I really hope you've enjoyed this conversation and thank you for listening. As always you can subscribe to future episodes and please rate and review this 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 link to that in the show notes. Please join us next month for our next episode.