Mandatory Due Diligence in ESG reporting

by Agnieszka Bąk

The deadline for mandatory ESG reporting in 2024 based on the CSRD Corporate Sustainability Reporting Directive is fast approaching. Entrepreneurs awaiting the publication of ESRS standards focus on creating teams for sustainable development and finding effective reporting solutions.

In the meantime, on June 1, 2023, the European Parliament voted on the provisions regarding CSDDD, thus adopting a negotiating position on the European Commission’s proposal for a directive on due diligence issued in February 2022.

What will be the impact of adopting the CSDD directive? Why is it essential to prepare the reporting process correctly, and why is data collection crucial? We will answer these questions in the following article.

What is the Corporate Sustainability Due Diligence Directive (CSDDD)?

The Corporate Sustainability Due Diligence Directive will be another element in European law that complements the foundations of the Green Deal, EU Taxonomy, and the entire European Union policy related to sustainable development and financing.

The planned regulations will oblige companies, among others, to introduce due diligence to their policies, identify and consider their impact on human rights and the environment as part of their operations and throughout the value chain, and include climate transformation in their strategy.

The final shape of the created regulations will be known in the further stages of the proceedings. In addition to the published proposal, the negotiating positions of the European Council and the EU Parliament are available.

What are the obligations of the EU CSDDD?

The directive will introduce regulations regarding the following:

obligations of large enterprises regarding actual and potential negative impacts on human rights and the environment in the area of:
- about own business
- on the activities of subsidiaries
- about the activities of business partners
provisions on sanctions and civil liability for breach of these obligations.
requirements to adopt a plan to ensure the business model and strategy are compatible with the Paris Agreement.

What is the purpose of the CSDDD?

The CSDDD, as the name suggests, primarily introduces the obligation to apply the due diligence principle to all its corporate policies and to apply a due diligence policy, which includes, among others, a description of the entrepreneur’s approach to due diligence and rules of conduct.

The main areas of CSDD directive requirements for entrepreneurs include the following:

obligation to conduct due diligence to identify and prevent environmental and human rights risks
risk mitigation by developing and implementing policies to eliminate identified threats
transparency in due diligence processes by publishing an annual sustainability report or making information available on their website
establishing complaint handling procedures by creating reporting channels for employees and stakeholders
due diligence towards third parties – its suppliers and business partners, to identify and prevent threats to the environment and human rights, including conducting site visits, reviewing suppliers’ policies and procedures, reviewing compliance with regulations, and assessing internal management and processes

What is the role of the CSDD directive in attestation?

The CSDD directive defines the conditions for the attestation of ESG reporting by statutory auditors or audit firms. Attestation will help ensure the connectivity and consistency of financial and sustainability information.

Thanks to the ESG reporting controls, there is no room for falsification of results, commonly known as greenwashing. An entrepreneur obliged to submit annual reports will have to pay special attention to data collection and faces the choice of tools for obtaining data and then analyzing the collected data and developing the results.

How will CSDDD affect the supervision of non-financial reporting?

The CSDDD also introduces provisions governing oversight by state institutions. On the part of state institutions of the Member States, there will be an obligation to appoint equivalent supervisory authorities that will ensure:

ex officio initiation of explanatory proceedings
carrying out inspections
set a deadline for implementing remedial actions
ordering the cessation of infringements of national provisions adopted based on the directive, refraining from the repetition of the conduct in question, and taking remedial action
Imposition of a financial penalty

To whom does the CSDD directive apply?

According to the proposal of the European Commission, the provisions would cover:

large EU limited companies:

Group 1: over 500 employeesand a net turnover of over EUR 150 million
Group 2: more than 250 workersand a net turnover of over EUR 40 million, and activities in sectors with a high environmental impact, such as agriculture, forestry and fishing, textile and leather production, and mining and manufacturing mineral products. (For this group, the rules will take effect two years later than for group 1.)

non-EU companies: Third-country companies operating in the EU (turnover adjusted for groups 1 and 2, produced in the EU)

The proposed rules will not cover micro-enterprises and SMEs but provide support measures for companies that may be indirectly affected.

On the other hand, the negotiating position of the European Council presents a gradual approach to applying the provisions set out in the directive. Initially, they would apply to huge enterprises with more than 1,000 employees and a global net turnover of EUR 300 million, and for non-EU companies, respectively, EUR 300 million of net turnover generated in the EU within three years of the entry into force of the directive.

An analysis of the positions of the Council and the European Parliament indicates some key issues that will be subject to negotiation later. The first concerns the degree of exclusion of the financial sector from the provisions of the CSDDD. Other points of contention include civil liability and the obligation of due diligence for directors.

Because of the above, a compromise between the position of the Council and the submitted proposal should be expected. However, regardless of the final solution adopted, the consequences of introducing these regulations will directly or indirectly affect the majority of enterprises and financial market participants over time.

What is the timeline for the CSDDD?

The next step will be inter-institutional negotiations – so-called “trilogies”, which will start soon during the Swedish Presidency of the Council of the EU and then during the Spanish Presidency. They aim to adopt the directive before the European elections next year.

After the adoption of the CSDDD by the European Parliament, the rules will enter into force within 20 days, and EU countries will have two years to transpose regulations into national law.

The deadline seems distant, but it is worth getting acquainted with the assumptions to build a solid foundation for ESG reporting.

How are EU Taxonomy and the CSDDD connected?

This CSDD directive is intended to support the transition of the EU economy to a more climate-neutral one in line with the assumptions of the European Green Deal and the UN Sustainable Development Goals. It is essential to the EU’s environmental, social, and governance policy.

First, it relates to the applicable EU regulations on ESG reporting – the CSRD directive and the SFDR regulation, which are also connected with EU Taxonomy.

How will the introduction of CSDDD affect entrepreneurs?

The CSDDD will significantly impact the companies it covers and those that will be affected indirectly. It mainly concerns the following areas of activity:

A unified legal framework for the reporting obligation will be created to ensure legal certainty and a level playing field.
Increase customer trust and employee engagement
It will raise awareness of the negative impact of enterprises on the environment and human rights
Improve risk management and adaptability.
It will increase attractiveness for investors oriented toward sustainable development
It will influence the outcome of innovation
It will improve access to finance

The introduction of a unified system of requirements in the field of reporting obligations and the creation of regulations on the control of reports and conditions for auditors means additional challenges for entrepreneurs in terms of the quality of the reporting process.

In addition, in connection with the regulations obliging Member States to create supervisory authorities responsible for oversight in the field of reporting, failure to comply with the rules may result in financial losses and loss of reputation. To avoid this, it is worth looking for market solutions, including IT tools and consulting services, thanks to which you can create an effective ESG reporting strategy.

How to properly collect data for ESG reporting?

ESG data is a collection of information from the scope of the company’s activity and those that are difficult to access regarding the entire supply chain. The problem is this area’s huge diversity of data sources, quantity, and quality. An example is the data for Scope 3 for reporting GHG emissions, which are divided into 15 categories, each covering many specific activities. Collecting data and indicators in this area is a big challenge for entrepreneurs. Gathering data is only simple if we use the right approach and modern tools.

Initially, you should analyze your business and identify potential data sources and how they can be obtained – whether they are Excel files, suppliers’ invoices, HR software, or a database. IT tools such as Power BI or Sustainability Manager allow you to connect many data sources and, after appropriate transformation, are ready to create analyses. Their advantage is the ability to create reports and visualizations that allow for easier drawing of conclusions that are important not only in ESG reporting but also as a starting point for improving the company’s strategy in many areas. PowerApps technology, which can be integrated with the abovementioned tools, may also be an indispensable element in data acquisition.

In the next step, you should look for a solution to store the collected data – the amount of which can be a big challenge. Cloud solutions such as Dataverse may be the right way to solve this problem.

In a modern approach to data collection, artificial intelligence, in particular sentiment analysis algorithms, natural language processing (NLP), and machine learning, facilitate data acquisition from significant unstructured sources. IoT tools, however, allow you to collect data from hard-to-reach places.

What is the importance of good data quality?

Properly obtained and prepared ESG data covering a wide range of the company’s activities allow you to create a reliable report, which is not only a presentation of results but also allows you to draw conclusions for the next steps and develop the company’s strategy. The report created and audited under the assumptions of the due diligence policy will also be a business card of the entrepreneur, which will open the way to obtaining funding and arouse the interest of potential investors.

It is crucial that, in addition to meeting the legal obligation, ESG reporting allows for in-depth analysis of activities in many areas. On its basis, you can build the company’s future, considering the identified risks and opportunities related to climate risk, and be a leader in sustainable development in your industry.

If you want to deep dive into our ESG solutions or just need help understanding the ESG impact on your business and how the above tools could be adjusted to your demands do not hesitate to contact our ESG team at ESG@cloudsonmars.com