EU closes the gap between sustainability and financial reporting

The gap between sustainability reporting and financial reporting is closing fast. The European Union (EU) is leading the change. Its new rules (launching 2022 and 2023) will treat sustainability and business risks and opportunities as one-and-the-same.

Australian and New Zealand businesses take note: the EU’s new rules for company disclosure and reporting, and for ‘green’ investment, will affect you too.

Why this matters

The EU’s 27 member states have embarked on an ambitious sustainability programme: the European Green Deal. The Green Deal’s aims include becoming the world’s first climate-neutral continent by 2030, without offsetting emissions overseas.

Transitioning to a climate-neutral Europe means ‘business as usual’ is no longer an option. The changes ahead require a huge investment in sustainable infrastructure, goods and services (estimated at NZ$800b per year). They bring with them new financial risks and opportunities. Whether you’re an investor (government agency, global pension fund, or ‘Ma-and-Pa’) or a business requiring investment, being equipped with reliable, consistent information is key to managing these risks and opportunities.

The information needed to transition to a climate-neutral Europe

If you’re a European investor, you’ll want to know you’re funding products and projects that support the Paris climate agreement. You’ll want to manage your risks by divesting carbon-intensive activities like fossil-fuel related mining, and chase opportunities by funding businesses built on circular economy practices. You’ll certainly want to identify and avoid ‘greenwash’ activities.

If you’re a company in or trading with Europe, you’ll need to provide investors with information to help them make sustainable investment decisions. (Your customers are likely to be asking for this information too.)

Enter the EU with its new rules for company reporting, disclosures and investment tools.

Three building blocks

  1. Defining ‘green’. The EU has developed a legislated ‘taxonomy’ (classification) of sustainable business activities (below).
  2. Disclosure. The EU will require companies to disclose climate risks and their impact (below). The aim: to provide the information financial markets need to maintain stability and price climate risk.
  3. Investment tools. The EU will define and enforce standards for sustainable investment tools like ‘green’ bonds. The aim: to discourage ‘greenwash’ investing.

Six environmental objectives

The EU taxonomy establishes six environmental objectives:

  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

Defining ‘green’: what’s a sustainable business activity?

There are four hurdles to cross. To be labelled 'sustainable' an economic activity must:

  1. Contribute substantially to one of the six environmental objectives
  2. Do no significant harm on the other five objectives
  3. Meet minimum social safeguards (e.g. support safe work practices)
  4. Meet technical criteria (e.g. promote strong governance).

The EU taxonomy covers activities which contribute 80% of the trading bloc’s greenhouse gases: electricity, transport, forestry, building, information and communication technologies (ICT), and manufacturing. Agricultural activities will be added shortly. 

Disclosure: what will the EU require?

Traditional reporting approaches risk from the ‘outside in’: it requires businesses to disclose the risks they face from external sources. This ‘single materiality’ approach underpins Task Force on Climate-related Financial Disclosures (TCFD) reporting.

The EU goes further. They will adopt an ‘outside in and inside out’ approach (‘double materiality’). This approach discloses the risks businesses face from external sources, plus the risks their operations pose for people and the planet.

Reporting: what will the EU require?

Goodbye glossy, stand-alone sustainability reports! Sustainability reporting of the future will sit alongside financial reporting in a single document. It will be audited by an independent expert and legally enforceable. It will also be easy to access, in an electronic format which can be ‘read’ by software.

What’s happening when?

These new rules apply to European financial services organisations from 2022. From 2023 they will cover all EU-listed companies and non-listed companies employing 250+ people.

New Zealand is moving to similar regulations from 2023.

What this means for Australian and New Zealand businesses

The impacts of the EU’s programme (the ‘Brussels Effect’) will be felt widely Downunder, for several reasons.

Firstly, the EU is home to many of the world’s largest global businesses. Many, including Siemens, Bayer, and L’Oréal, have subsidiaries in Australia and New Zealand. Australian and New Zealand businesses including Fonterra, Brambles and Mainfreight have operations in the EU too.

Are you a subsidiary of a company headquartered in the EU? Then expect to contribute local sustainability data for your company’s reporting.

Secondly, the EU trading bloc plays a huge role in global financial markets. Some financial services giants including Rabobank and Zurich Insurance service this part of the world too.

Are you chasing EU capital to run your business? Then you’ll need to disclose your sustainability risks and opportunities.

Thirdly, with global supply chains more interconnected than ever, the EU’s programme will affect businesses across the globe. European trade matters to Australia and New Zealand, and it’s likely to increase. (New Zealand is currently negotiating a free trade agreement with Europe.)

Do you sell goods or services to European buyers? To help them manage their financial risks (read: climate risks) you’ll need to show you’re managing yours too.

How to prepare for the changes ahead

  1. Benchmark your operations against the EU’s taxonomy of sustainable activities. Are your activities included?
  2. Recognise that your sustainability risks and opportunities are business risks and opportunities. Failing to reduce carbon emissions may reduce your market share. Using renewable materials may improve your brand reputation.
  3. Get serious about reporting these risks and opportunities – and managing them.