by Nada Welker | Jun 7, 2023 | ESG, strategy in change
Path to climate neutrality
Many efforts are needed on the road to carbon neutrality. Companies are under increasing pressure to address environmental, social and governance (ESG) issues and define sustainability targets. Read everything you need to know about Carbon Crediting in our recent blog article.
A decarbonisation strategy for climate protection
Beyond their ethical implications, ESG measures and, as a consequence, good ESG ratings have become a crucial competitive factor for companies.
With comprehensive sustainability reporting set to become mandatory very soon, companies are recognising the relevance of managing their environmental impact, particularly in relation to carbon emissions. According to experts, in order to achieve the 1.5-degree target for CO2 emissions proclaimed in Paris in 2015, global greenhouse gas emissions would have to be reduced by 50 per cent of current levels by 2030 and reduced to net zero by 2050.
Source: McKinsey, 2021
The harmful effects of these emissions on the global climate have led companies and organisations to re-evaluate their operations, adapt to greener practices and develop comprehensive strategies to reduce their carbon footprint, such as building renewable energy facilities. In such a decarbonisation strategy, one ideally follows the principle of Avoid – Reduce – Remove – Offset.
Source: Magility, 2022
However, there are also emissions that are difficult to reduce or even completely avoid, especially in manufacturing companies. For these companies, it is compensation instead of reduction. This is where the so-called carbon credits come into play.
Carbon Credits and Carbon Allowances
Carbon credits are used by companies to offset emissions that they cannot avoid. This so-called Voluntary Carbon Market (VCM), i.e. voluntary implementation, contrasts with Regulated Emission Trading Systems (ETS), which are used by various countries to encourage companies to reduce emissions. In the ETS, the amount of CO2 emissions allowed is limited. Companies that emit fewer emissions than allowed can sell these as so-called carbon allowances – but if they emit more than allowed, they must purchase corresponding allowances.
By purchasing carbon credits and thus financing certified climate protection projects, companies, governments, but also individuals can reduce, remove or offset their emissions. One carbon credit corresponds to the removal of one metric tonne of CO2.
Since 2005, the European compliance market has included CO2 emissions from industry, energy and aviation, the sectors with the highest current emissions in the EU. It is managed according to the “cap and trade” principle, which reduces the amount of carbon allowances available each year, thus increasing prices and creating incentives to reduce. In 2022, the total number of allowances in circulation (TNAC) was over 1.1 million, generating €38.8 billion in sales. The number of annual allowances is continuously being reduced in order to achieve further price increases.
The VCM which started in 1996 with the first so-called REDD projects (Reducing Emissions from Deforestation and Forest Destruction) has rapidly developed into a million-dollar business that could potentially be worth almost 10-40 billion dollars by 2030.
Source: Shell and BCG, 2022
Carbon Crediting Ecosystem
Currently, projects to offset CO2 are carried out by independent private project developers. Both the projects themselves and the tonnes of CO2 saved as a result are verified by external auditors. These auditors apply various standards, such as the Gold Standard or the Verra Verified Carbon Standard, to quantify and verify the savings potential of the projects. After verification, the corresponding number of credits is registered in the so-called carbon registries of the respective standards. Buyers can then purchase the credits directly from the project developers, via the registries or from other traders.
Source: Magility, 2022
What are the disadvantages of carbon crediting so far?
Since the market for carbon credits and the associated projects is not yet very strongly regulated, there is a danger that companies will only engage in emissions reduction for the sake of appearances, invest in projects that are not environmentally compatible or simply engage in greenwashing:
- Compensation measures, such as reforestation of the rainforest, are relatively short-term measures – which is exactly “only” over the lifetime of a tree. Nevertheless, in most cases such measures also create other benefits for the environment.
- In some cases, (re)afforestation does not take into account the biodiversity of the surrounding area, but focuses only on factors such as rapid tree growth. This in turn promotes the spread of monocultures.
- The prices for carbon credits were still very volatile in the past. This creates the risk that investments for future projects are set too low.
- Some companies could simply buy carbon credits for a clear conscience – and at the same time do nothing to reduce their emissions.
- In the context of impact investing, i.e. investing in sustainable projects, “additionality” is key. This means, if a project or an investment creates a reduction in emissions, this must be in addition to the emission reductions that would have been achieved even without the implementation of the project. However, assumptions about what emission reductions would have been achieved even without a specific project are often difficult, if not impossible. For example, would the solar plants in a rural area of India have been built only because of the investment through carbon credits or would they have been built anyway? Would a forest in Colombia have been reforested even without carbon crediting financing? Although the registries are trying to ensure additionality, it will probably be a while before there is real clarity on this.
What does the future hold for carbon crediting?
Under Article 6, the Paris Climate Agreement allows the carbon crediting system to offset emissions, as well as trading carbon allowances. The current Clean Development Mechanism (CDM) will be replaced by a new registration option for projects. It currently remains uncertain whether and to what extent this will affect the VCM. Although standardisation is still under development, carbon credits will undoubtedly be an important factor in reducing emissions and a considerable currency. However, to become completely carbon neutral, more than just offsetting is needed, but an intelligent and holistic decarbonisation strategy.
Article 6.4 was recently added to the Paris Agreement at COP29 to introduce a new mechanism that creates a more transparent and efficient framework for climate action and revolutionises carbon credits. You can read everything about the new carbon credits here.
At magility, we consider this decarbonisation strategy a fundamental part of our ESG management system. We help you to implement your individual strategy into your company.
When does your sustainable future start? Contact us for more information!
by Nada Welker | May 23, 2023 | ESG, Future Trends, Market development & Trends
Sustainable and responsible corporate governance is increasingly determining corporate actions in the boardrooms. A good ESG rating will have a significant impact on corporate success in the future, and the topic of ESG is receiving correspondingly strong attention in the media. Since 2017, large companies, insurance companies and banks have been obliged to report on sustainability. Based on the EU’s Non-Financial Reporting Directive (NFRD), non-financial reporting is usually included in the annual financial statements and comprises information and lists of commitments to environmental protection and nature conservation, social responsibility, human rights, dealing with corruption and ensuring diversity on supervisory boards and management floors.
However, as part of the EU Green Deal and the EU Action Plan “Financing Sustainable Growth”, the NFRD was fundamentally revised and expanded to make the presentation of information more comparable and transparent and to clarify its relevance. The draft of the new “Corporate Sustainability Reporting Directive (CSRD)”, which has been available since 2021, was adopted by the European Council on November 28, 2022.
In this article, we summarize the latest information on the new sustainability reporting, answer the most important questions and provide valuable tips on how you can prepare for the implementation of the CSRD (Corporate Sustainability Reporting Directive) in your company.
[infobox headline=”At a glance”]
- The new Corporate Sustainability Reporting Directive aims at creating comparable and reliable reporting about both financial and non-financial topics within a company
- The concept of double materiality looks both at the impact of a company’s own activities on the environment and recognizing ESG aspects that may affect the company, its strategies and activities
- In total, around 50,000 companies in the EU and 15,000 in Germany alone will be affected by the CSRD regulations in the future.
- With our ESG management System, Magility supports its customers in the implementation of the Corporate Sustainability Reporting Directive and the preparation and creation of your sustainability reporting
[/infobox]
What is the role of the CSRD?
According to the Commission, the Corporate Sustainability Reporting Directive is intended to ensure “that adequate, accessible information is available on the risks for companies in connection with sustainability aspects and on the impact of the companies themselves on people and the environment.” The goal is to create comparable and reliable reporting, with an equally weighted non-financial part added to its traditional financial-oriented part in the future. In addition, all of a company’s business relationships and supply chains will be subject to sustainability scrutiny. Until now, existing legislation on the disclosure of non-financial information has often been considered inadequate or even unreliable. The new CSRD initiative will fundamentally change the scope and nature of sustainability reporting.
In order to achieve the European Commission’s goal, companies will have to take care of two things in the future:
- The application of new ESG accounting standards, the European Sustainability Reporting Standards (ESRS), and
- the independent auditing and certification by an auditor of the reporting based on these standards.
Sustainability information must also be accessible digitally.
While the CSRD provides the formal requirements for reporting, the ESRS define the content. The ESRS take up existing regulations, such as the standards of the GRI (Global Reporting Initiative) and the SASB (Sustainability Accounting Standards Board) and the rules of the TCFD (Task force on Climate-related Financial Disclosures), but at the same time make the content clearer. New, uniform rules for the EU are thus defined, including the concept of double materiality. Specificially, this means that the impact of a company’s own activities on the environment is no longer the only factor to be considered. Equally, how ESG aspects affect the company and its strategies and activities must now also be taken into account.
Source: Magility GmbH
What are the advantages of the new reporting directive?
The advantages of this new transparency and uniformity are obvious. Stakeholders, such as investors, but also consumers, should find their own decision-making easier, for example with regard to investments or purchases that are also based on sustainability aspects. But it will also encourage and enable companies to give their ESG measures a bigger stage and thus tap into new customer groups and investors.
As non-EU companies are now also required to report for the first time, the European Commission’s initiative strengthens equal opportunities in the EU. For small and medium-sized enterprises (SMEs), this offers a major incentive to also voluntarily expand their reporting to include sustainability topics. The EU is thus laying the foundation for a global standard of sustainability reporting and wants to put an end to greenwashing.
Which companies will be subject to the new directive in the future?
As things stand at present, the audit obligation will apply to the first companies as early as 2025 (reporting year 2024), with others to follow by 2029.
Source: Magility GmbH
In total, around 50,000 companies in the EU and 15,000 in Germany alone will be affected by the CSRD regulations in the future. Compared to the current NFRD EU Directive 2014/95/EU, the new directive also changes the scope and timing of the reporting obligations. Whereas companies previously had to report on environmental protection, social responsibility, anti-corruption and bribery as well as diversity on company boards, the CSRD goes even further: in addition to the “double materiality” already mentioned, further forward-looking information including the setting of targets as well as documentation of progress will be required in the future. Information on intangible assets must also be disclosed. As a matter of principle, reporting must comply with the Sustainable Finance Disclosure Regulations (SFDR) and the EU tax directives.
How do I know what to report about?
How exactly the corporate sustainability reporting directive is now implemented is defined by the ESG accounting standards, the ESRS. The current drafts of the requirements can be found on the website of EFRAG (European Financial Reporting Advisory Group).
Source: Magility GmbH
ESRS 1 and ESRS 2, the General Information and Overarching Standards sections, describe and explain general aspects of the report that apply to all topics and areas. They specify how to report on the individual topics.
ESRS 2 examines strategy and business model in relation to sustainability, as well as corporate governance and organization and sustainability-related impacts, risks and opportunities. Finally, this section deals with concrete measures, allocation of resources, and key performance indicators.
The Environmental (ESRS E1 to E5), Social (ESRS S1 to S4) and Governance (ESRS G1) sections contain ten topic-specific standards, for example on climate change, environmental pollution, employee rights, corporate governance and business ethics. Which of these topics are relevant to a company is already determined in the analysis of dual materiality (ESRS 1). The standards set out in detail here what must be reported specifically on the individual topics.
In summary: ESRS 1 defines the how of the sustainability report, ESRS 2 and the topic-specific segments define the what, i.e. the contents of the report.
The timeline around the implementation of the CSRD at EU level
EFRAG, which submits fully developed draft standards or amendments to them to the EU for EU sustainability reporting, published the first official drafts of the new standard at the end of April 2022. On November 10, 2022, the EU Parliament adopted the reporting proposals for large capital market-oriented companies and equivalent trading partnerships, which were subsequently finalized by the European Commission. The new CSRD then officially came into force on December 19, 2022.
Source: Magility GmbH
From mid-2024, the new regulations will then also be implemented in national law at EU level. For companies, this means that the first annual reports will have to be published in accordance with the new uniform requirements for sustainability reporting as early as January 2025.
The ESRS currently still have draft status – but the standards are to be further defined and extended to sector-specific standards as early as November 2023.
Source: Magility GmbH
No time to lose: magility supports you with your sustainability reporting
The additional burden imposed by the new EU requirements is noticeable for all affected companies, but it is particularly high for small and medium-sized enterprises. They often find it difficult to track their supply and value chains and therefore cannot provide the required information in full. Despite the three-year transition period granted to SMEs, we strongly recommend dealing with the new requirements immediately and developing an implementation strategy now. On the one hand, because the conception of a new reporting already takes a lot of time from a purely technical point of view. On the other hand, companies and their management must be aware that this is a far-reaching change that cannot be anchored in the corporate culture overnight.
Magility supports you in the implementation of the Corporate Sustainability Reporting Directive and the preparation and creation of your sustainability reporting. With our ESG Management System, we help you successfully navigate through the ESRS and set your sustainability targets.
– We check if and when CSRD becomes relevant for your company
– Together we develop a viable ESG management system:
- Definition of material impacts
- Structuring of ESG measures in an ESG program
- Definition of the relevant goals – SDGs (Sustainable Development Goals)
- Agreeing on an ESG governance model
- Defining the plan for ESG reporting and audits
Sustainability is a must-have, no longer a nice-to-have! We support you in this. Contact our magility ESG experts!
