In the near future, European companies will be required to disclose material information regarding the sustainability of their trading and investment activities. ESG factors (Environmental, Social and Governance) and social impacts are among the key criteria to be taken into account in investment and financial decisions.
The term ESG was first mentioned in 2006 in a UN report on the ‘Principles for Responsible Investment’.[1] In this report, 63 investment firms with a total of USD 6.5 trillion in assets under management agreed to incorporate ESG criteria into their financial statements.
Currently, Directive (EU) 2014/95/EU of the European Parliament and of the Council on non-financial reporting (NFRD) applies, which requires certain issuers to disclose sustainability-related information. This applies to companies whose securities are admitted to trading on a regulated market in Europe, which employ more than 500 people and whose net profit exceeds EUR 40 million. This Directive was transposed into national law on 1 January 2017 and incorporated into Part Eight of Act No. 563/1991 Coll. on Accounting[2], which is entitled ‘Disclosure of Non-Financial Information’.
In the near future, however, the scope of these regulations is expected to be extended to further companies, alongside the adoption of more detailed legislation in this area, which is likely to lead to significant changes. At EU level, a comprehensive legislative package has already been developed, designed to extend the existing regulations to additional companies and to clarify the content of the provisions. For example, companies will be required to determine their ESG rating; the higher the rating, the more sustainable and responsible the company is deemed to be. A high rating not only affects investors, the ability to secure more favourable loans from banks and the company’s reputation, but also the identification and management of the company’s own risks, as well as its overall competitiveness.
(Future) legislation
The following regulations have been adopted in the area of reporting on non-financial information relating to sustainability:
- Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 establishing a framework to promote sustainable investment and amending Regulation (EU) 2019/2088 (Taxonomy Regulation), effective from 12 July 2020;
- Directive (EU) 2022/2464 of the European Parliament and of the Council of 14 December 2022 amending Regulation (EU) No 537/2014, Directive 2004/109/EC, Directive 2006/43/EC and Directive 2013/34/EU as regards corporate sustainability reporting, effective from January 2023 (CSRD);
- Directive (EU) of the European Parliament and of the Council on corporate sustainability due diligence and amending Directive (EU) 2019/1937 (CSDD).
The directives, which set out new obligations, must be transposed into Czech law by 6 July 2024 at the latest. Companies that were already subject to the NFRD – the directive on ESG reporting – must prepare their first sustainability reports for the financial year starting on the 1st of January 2024.
ESG reporting
The aim of ESG reporting is to link all areas of a company’s new investment activities to the principle of sustainability. In practice, this involves, in particular, the regular review of business partners to ensure that their actions are in line with the EU’s sustainability strategy. Should this not be the case, the implementation of sustainable solutions into business practice is required. Companies are obliged to collect all information on non-financial activities that have a direct impact on their business operations.
The obligation to collect and provide information on sustainability in the prescribed form also affects many companies indirectly via their value chains. This stems from the fact that companies are obliged to provide information not only on their own activities, but also on those of their suppliers and customers.
Reporting should, in particular, consist of the preparation of a report summarising all the information collected on ESG, sustainability and the systems implemented within the company for this purpose. The aim is to minimise risks such as environmental degradation, corruption or breaches of labour law. ESG reporting serves to prevent serious corporate scandals, such as the Dieselgate case at Volkswagen AG. Furthermore, regular reporting helps companies to identify sustainability risks at an early stage and to strengthen the trust of investors and consumers.
The date by which companies must produce their first reports depends on whether they belong to a corporate group:
- From 2025: Companies falling under the NFRD 2014 (banks, insurance companies, listed companies with more than 500 employees); first report already for the 2024 financial year.
- From 2026: Large companies not falling within the scope of the NFRD (more than 250 employees and turnover exceeding EUR 40 million or balance sheet total exceeding EUR 20 million).
- From 2027: Listed companies, as well as small and medium-sized enterprises, small and non-complex credit institutions, and captives.[3]
ESG Rating
This involves the assessment of a specific company with regard to the practical implementation of the above-mentioned strategy. There are currently numerous rating agencies providing company assessments. However, these assessments are not yet standardised, as each agency largely applies its own methodologies. In the Czech Republic, non-financial assessments have so far been produced primarily by non-profit organisations, journalists and academics.
EU Taxonomy
ESG reporting is also linked to the EU Taxonomy. This strategy is regulated by a European regulation and concerns the disclosure of sustainability information in the financial services sector. It sets out general criteria for qualifying the standard of ‘environmentally sustainable’. Companies are therefore obliged to check, when entering into contracts with their contractual partners, whether the investment is sustainable.
The European regulation sets out binding criteria for identifying environmentally sustainable business activities. Companies are obliged to achieve the following environmental objectives:
- Climate protection
- Measures to adapt to climate change
- Sustainable use and protection of water and marine resources
- Transition to a circular economy
- Pollution prevention and control
- Restoring biodiversity and ecosystems
This represents a more precise definition of sustainability for a wider range of business sectors. It enables an analysis of whether a company’s technological practices are sustainable and helps to prevent greenwashing.
Greenwashing
Greenwashing refers to a communication strategy whereby a company attempts to portray its products and services to the outside world as more environmentally friendly and sustainable than they actually are. The aforementioned EU taxonomy is intended to prevent companies from misleading consumers and suppliers and, instead, to ensure greater transparency regarding environmentally sustainable production practices.
A typical example of greenwashing occurs when a company carries out a one-off, company-wide campaign to collect and clean up waste and then publishes the results of the waste separation on social media. However, this presentation is misleading, as it does not take into account all production waste. The calculation does not include total waste, including that generated by the company’s day-to-day operations.
ESG reporting in practice
The obligation to report on non-financial ESG issues will in future apply to companies that meet at least two of the following criteria:
- more than 250 employees
- a turnover of more than EUR 40 million per year, or
- the company’s assets exceed EUR 20 million
- a listed company (regardless of size, i.e. both small and medium-sized enterprises)
Each company should first conduct an audit of its business activities to determine which areas are relevant to its operations and sector (known as a materiality assessment). This analysis must be carried out in accordance with the European Sustainability Reporting Standards [4], which the European Commission adopted on 31 July 2023.
As many companies find this process overwhelming, the European Commission, in collaboration with the advisory agency EFRAG, has decided to produce a guide to the reporting standards, designed to assist companies in preparing a materiality analysis in accordance with the ESRS. At the time of writing, however, this guide was not yet available.[5]
General topics relating to ESG reporting must always be analysed, taken into account and complied with.
The acronym ESG covers three areas: environment, social aspects and corporate governance. Within these areas, the following aspects can be distinguished, for example:
Environment
- The company’s general climate targets
- Protection against water and soil pollution
- Sustainable use and protection of water resources
- Preservation of biodiversity and ecosystems
- Promotion of the circular economy and efficient use of resources
- Energy use and efficiency
- Waste management and recycling
Social aspects (SOCIAL)
- Equality and equal opportunities, decent working conditions and respect for human rights
- Workforce in the supply chain
- Affected and local communities
- Privacy and data protection
- End consumers
Corporate governance
- Corporate culture and business principles
- Management and monitoring of supplier relationships
- Prevention, detection and combating of corruption and bribery
- Documented cases of corruption and bribery
- Political engagement and lobbying activities
- Transparent payment procedures
In addition, it is necessary to take into account sector-specific issues relating to the specific industry in which the company operates.
Example of a circular economy objective:
Companies are obliged to implement a policy on resource management and the circular economy. This policy must set out how the company generates energy from renewable sources and reduces its use of non-renewable energy sources. Furthermore, the so-called inputs must be recorded, i.e., the total weight of materials used in operations, and the proportion of renewable sources within this must be stated. The weight of waste must also be recorded, measures for waste prevention and recycling must be outlined, and the environmentally sound disposal of waste must be documented.
All this information must be recorded by the company and subsequently disclosed to its suppliers and customers. Such a report must be audited and approved by an independent third party, a chartered accountant registered with the Chamber of Chartered Accountants. The audited and approved information must finally be included in the annual report, which is to be submitted to the Companies Register.
How is ESG reporting implemented within the company?
1) Analysis of the company’s status, taking into account general and sector-specific ESG issues as well as the requirements of the EU Taxonomy
- Assessment of whether and to what extent the new rules apply to the company
- Identification of all existing company activities
- Collection and compilation of information on the company’s activities for the current accounting period up to a planning horizon of more than five years
2) Systematic evaluation of the results
- Sorting of the information by area or time period, for example environment, social issues, corporate governance and intangible resources
- Analysing the information to identify the company’s risks, opportunities and objectives, and defining the company’s goals and visions for the future, such as promoting a circular economy, achieving climate neutrality or collaborating with local communities in the region
- Feedback on identified shortcomings
3) Establishment of a sustainable strategy (partial/comprehensive) that complements and supports business activities
- Elimination of corporate risks
- Securing new opportunities and possibilities for the company
- Achieving the defined company objectivesEstablishment of a timeframe for implementing the measures to achieve the objectives
- Identifying the steps the company will take to ensure that the objectives are implemented sustainably and achieved in the future
4) Continuous collection, analysis and reporting of relevant data
- Reviewing the information collected
- Regular monitoring of the plan to mitigate risks
- Monitoring progress in implementing the defined opportunities and objectives
- Reviewing the objectives and setting targets for the future
For example, questionnaires or the establishment of a discussion forum for employees can be used to collect and process relevant data.
The final sustainability report must be prepared separately by each affected company. Affected companies are:
- all large companies and all companies, with the exception of micro-enterprises, whose securities are admitted to trading on the internal market of the European Union,
- Small and medium-sized enterprises of public interest that are subject to the legal framework of the European Union and whose securities are admitted to trading on the internal market of the European Union, credit institutions, insurance companies, and undertakings classified by the state as being of public interest,
- parent companies of large groups (at group level),
- undertakings based in third countries which achieve a net turnover of more than EUR 150 million in two consecutive financial years and have a subsidiary or branch in a Member State of the European Union.
Under certain conditions, the sustainability report may also be prepared directly by the branch or subsidiary. If, despite the subsidiary’s best efforts, the parent company fails to provide all the information required to prepare the report, the subsidiary or branch shall prepare a report based on the available information and shall also include a statement that the parent company has not provided the remaining required information. However, subsidiaries and branches are exempt from the obligation to prepare their own sustainability report provided they are included in the parent company’s consolidated report, regardless of whether the parent company is based in the European Union or in a third country. The parent company’s report must, however, be made available on the website of the subsidiary or branch.
How can we help you?
Our law firm offers legal advice, particularly on ESG and related topics:
- Advising companies on the implementation and further development of ESG principles within their organisation
- Drafting bespoke ESG, diversity and inclusion policies, tailored to the company’s business model and sector
- Delivering internal training on ESG topics
- ESG advice for employers, including advice on fair remuneration, liability of statutory bodies, whistleblowing and employment law aspects
- Identifying potential problem areas within the company and preventing liability risks associated with greenwashing
- Advice on renewable energy, waste management and environmental regulations
- Supply chain and value chain management, taking into account the impact of the European Corporate Sustainability Due Diligence Directive (CSDDD)
- Legal due diligence of target companies for investors, focusing on sustainable value creation, as well as advice on ESG-related implications of M&A transactions
- Assessment of (investment) projects for potential ESG impacts
Please do not hesitate to contact us at any time should you have any queries or require further information.
[1] https://unglobalcompact.org/take-action/action/responsible-investment
[2] The amendment to this Act No. 462/2016 Coll.
[3] These are specific entities in the insurance market, usually established by large companies that are not active in the insurance sector.
[4] The Czech version is available here: https://eur-lex.europa.eu/resource.html?uri=cellar:a17f44bd-2f9c-11ee-9e98-01aa75ed71a1.0016.02/DOC_2&format=PDF
[5] So far, only the earlier version from 2022 is available; you can find it here: https://www.efrag.org/lab3#subtitle5