The concept of ESG was first coined in 2006 in a UN report on “Principles for Sustainable Investment“.[1] In this report, 63 investment companies with assets totalling US$ 6.5 trillion agreed to reflect ESG criteria in their financial balance sheets.
Currently, the Non-Financial Reporting Directive (NFRD) (EU) 2014/95/EU is in force and requires certain issuers to disclose sustainability information. These are entities whose investment securities have been admitted to trading on a European regulated market, whose number of employees exceeds 500 persons and whose net profit is more than EUR 40 million. This directive was implemented in our legal system on 1 January 2017, in Part Eight of Act No. 563/1991 Coll. on Accounting[2] called “Disclosure of non-financial information“.
However, the extension of these rules to other entities is expected in the near future, together with the issuance of more detailed legislation in this area, which will lead to significant changes. A comprehensive package of legislation has already been developed in the EU field to extend the existing legislation to other entities and to specify the content of the rules. For example, companies will be required to calculate their ESG score, with the higher the score, the more sustainable and responsible the company. A high score will have an impact not only on other investors, on obtaining more favourable loans from banking institutions or on the company’s greater prestige, but also on the determination and management of the company’s own corporate risks and on its overall competitiveness.
(Future) legislation
In the area of ‘non-financial’ sustainability reporting, the following provisions have been adopted:
- Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 establishing a framework to facilitate sustainable investments and amending Regulation (EU) 2019/2088 (the 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 of the European Parliament and of the Council (EU) on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937 (CSDD)
The directives setting out the new obligations should be transposed into the Czech legal system by 06.07.2024 at the latest. However, companies that were already obliged to report on ESG under the NFRD are obliged to prepare their first sustainability reports for the accounting period from 1.1.2024.
ESG reporting
ESG reporting aims to link all areas of new investment in companies to sustainability. In practice, this specifically means regularly reviewing the other partners with which the company works and, in particular, monitoring whether partners are not acting in contradiction with the EU’s sustainability strategy. If this is the case, the introduction of sustainable solutions into business practice needs to be initiated. Companies should collect all information on the non-financial activities of the company that have a direct impact on their own operations.
The obligation to process and provide sustainability information in some way will also affect many companies indirectly, through so-called value chains. This stems precisely from the fact that companies are obliged to provide information not only about themselves, but also about their suppliers and customers.
Reporting should consist in particular of a report containing all the information found regarding ESG, sustainability and the system that will be set up in the company for this purpose. The aim is to eliminate risks such as environmental damage, corruption, breaches of labour law, etc. ESG reporting should ensure that major scandals such as Volkswagen’s Dieselgate do not occur. Furthermore, regular reporting should make it easier for companies to identify sustainability risks and lead them to increase investor and consumer confidence.
When companies will have to process their first reports depends on which group they fall into:
- From 2025
- Entities covered by the 2014 NFRD (banks, insurance companies, publicly traded companies with 500+ employees); first report already for 2024 (!)
- From 2026
- Large companies outside the scope of the NFRD (250+ employees and turnover >40 million euros or balance sheet total >20 million euros)
- From 2027
- Listed and small and medium-sized enterprises, small and not very complex credit institutions and captives [3]
ESG rating
This is an assessment of how a particular company puts the above strategy into practice. There are now many different rating agencies that provide ratings of companies, but their ratings are not yet unified and each agency uses its own methodology. In the Czech Republic, non-financial ratings have so far been carried out mainly by non-profit organisations, journalists and academics.
EU Taxonomy
The EU taxonomy is also related to ESG reporting. This strategy is regulated in a European regulation and concerns the disclosure of sustainability-related information in the financial services sector. It sets out the general criteria for qualifying the “environmentally sustainable” standard. Companies will thus have to assess whether or not an investment is sustainable when entering into contracts with their counterparties.
The European regulation sets clear criteria for identifying environmentally sustainable business activities. Companies will have to achieve these environmental targets:
- prevent climate change
- adapt to climate change
- sustainably use and protect water and marine resources
- switch to a circular economy
- introduce pollution prevention and control
- restore biodiversity and ecosystems.
This is a more precise definition of sustainability for more business areas. It provides an analysis of whether a company’s technological practices are sustainable and prevent greenwashing.
Greenwashing
Greenwashing is a communication strategy by which a company tries to portray its products and services as more environmentally friendly and sustainable than they actually are. It is the above taxonomy that should prevent companies from further misleading their consumers and suppliers and, on the contrary, should achieve greater transparency of information regarding green production.
An example of typical greenwashing could be a situation where a company organises a company-wide one-day event to collect and clean up waste. It then posts the results of the waste sorting on its social media channels. However, this result is misleading as it does not take into account all the waste from production. This is because the calculation does not take into account total waste, i.e. including waste from the company’s day-to-day operations.
ESG reporting in practice
The obligation to report non-financially on ESG topics will newly apply to companies that meet at least 2 of the following conditions:
- more than 250 employees
- company turnover of more than EUR 40 million/year or
- the company’s assets exceed EUR 20 million
- a listed company on the stock exchange (regardless of size, i.e. small and medium-sized companies).
First of all, every company should do a simple audit of its company, which areas are relevant to it according to its activity and business sector (the so-called mandatory materiality assessment). This analysis should be carried out in accordance with the European Sustainability Reporting Standards[4] , adopted by the European Commission on 31 July 2023.
In view of the fact that many companies are not familiar with this process, the European Commission, together with the advisory agency EFRAG, has decided to prepare a manual of reporting standards to help companies develop materiality analysis (ESRS standards). However, this guide was not available at the time of writing. [5]
However, the general themes of ESG reporting must always be analysed, taken into account and followed (!).
The acronym ESG combines three areas – the environment, the social area and the societal area, in the sense of leadership. Under these areas one can imagine, for example:
Environment (ENVIROMENT)
- The company’s overall climate goals
- Water and soil pollution
- Water resources
- Biodiversity and ecosystems
- Circular economy and resource use
- Use of energy
- Waste quantity and recycling
Social area (SOCIAL)
- Equal rights and opportunities, working conditions and respect for human rights
- Workers in the supply chain
- Affected communities
- Privacy and data protection
- End customer
Social area (GOVERNANCE)
- Company culture and business conduct principles
- Supplier Relationship Management
- Prevention and detection of corruption and bribery
- Confirmed cases of corruption and bribery
- Political engagement and lobbying
- Payment procedures
It is also necessary to take into account the so-called sectoral topics, which relate to the specific business sector in which the company operates.
An example of a circular economy objective:
Companies will be required to implement policies for resource management and circular economy principles. This policy will need to discuss how the company will commit to implementing renewable energy sourcing and how it will eliminate other energy sources. It will also need to measure ‘inputs’ – the total weight of inputs to the company’s operations and state in what proportion renewable sources will be used to do so. It will also need to weigh the weight of waste, looking at how well the company is able to recycle it, and how it manages its waste environmentally.
The company will be obliged to collect and subsequently disclose all such data to its suppliers and customers. Such a report will then have to be approved by an independent third party (an auditor registered with the Chamber of Auditors) and the approved information will eventually be included in the annual report that is filed in the Commercial Register.
How to do ESG reporting in your company?
1. Analysis of the state of your company according to general and sectoral ESG topics and the EU taxonomy
- whether and to what extent the new rules apply to you
- identification of all existing activities in the company
- collecting information on your company’s activities (for the current accounting period up to a future horizon of more than five years)
2. Systematic review of results
- sorting information by area or time (environmental, social, corporate governance, intangible resources)
- Analysing information (identifying risks, opportunities and the company’s objectives) and identifying what the company’s goals and vision for the future are (e.g. promoting a circular economy, achieving zero neutrality or working with local communities in the surrounding area)
- feedback on identified deficiencies
3. Setting a sustainable strategy (partial/comprehensive) complementing and supporting business activities
- elimination of company risks
- securing new opportunities for the company
- achieving the set objectives
- setting a timeframe by which the company will achieve everything
- what steps the company will take to ensure that the target is sustainable and achieved in the future
4. Continuous data processing, evaluation, reporting
- checking the information found
- regular monitoring of the risk removal plan
- monitoring the achievement of set opportunities and objectives
- reviewing objectives and creating new ones for the future
For example, questionnaire surveys, setting up an employee discussion forum, etc., may be appropriate for data processing.
The final sustainability report should be prepared by each company concerned separately. These companies are:
- All large companies, and all companies except micro companies, whose securities are admitted to trading on an EU market,
- Small and medium-sized enterprises that are public-interest entities governed by EU law and whose securities are admitted to trading on an EU market, credit institutions, insurance companies and such enterprises designated as public-interest entities by the State,
- Parent enterprises of large groups (at group level)
- Third-country enterprises having a net turnover exceeding EUR 150 million (for each of two consecutive accounting periods) and having a subsidiary or branch in the territory of a Member State of the European Union
However, it may also be submitted directly by a branch or subsidiary in certain circumstances. In the event that the parent company fails to provide all the information necessary to process the report despite the efforts of the subsidiary, the subsidiary/branch shall issue a report containing all available information and a statement that the parent company has not provided the remaining information requested. However, subsidiaries/subsidiaries are exempted from the obligation to report on sustainability if they are included in the consolidated management report of the parent (whether EU or third country). However, the parent company’s report must be made available on the website of the subsidiary or branch.
How can we help you?
Our law firm is able to provide you with legal advice on ESG and related matters, in particular:
- advising clients on the implementation and development of ESG principles in their business and society
- Developing ESG or diversity and inclusion policies specific to the client’s business and industry
- in-house training on ESG topics
- ESG advice for employers, e.g. advice on fair remuneration, statutory body liability, whistleblowing, employment law, etc.
- identification of problematic aspects in business and prevention of liability for “greenwashing”
- renewable energy, waste management and environmental regulation
- supply/value chain management and the impact of the proposed European Corporate Sustainability Due Diligence Directive (CSDDD)
- legal due diligence of target companies for investors with a focus on sustainable value creation and advice on the ESG implications of M&A transactions
- review of (investment) projects for potential ESG impacts
If you have any questions, please do not hesitate to contact us at any time.
[1] https://unglobalcompact.org/take-action/action/responsible-investment
[2] Amendment to this Act No. 462/2016 Coll.
[3] These are specific insurance market entities, usually established by large companies not active in the insurance industry.
[4] Available in Czech here: https://eur-lex.europa.eu/resource.html?uri=cellar:a17f44bd-2f9c-11ee-9e98-01aa75ed71a1.0016.02/DOC_2&format=PDF
[5] For now, an older version from 2022 is available here: https://www.efrag.org/lab3#subtitle5
