The new CSRD (Corporate Sustainability Reporting Directive) establishes mandatory sustainability reporting for over fifty thousand companies in the EU and an additional ten thousand outside the Union according to strict ESRS standards for the first time in history. Croatia will have to incorporate this regulation into the Accounting Act, the Audit Act, and the Capital Market Act by July 2024. A long-anticipated regulatory storm is coming – for both companies and the financial sector. Although the new regulatory framework seems daunting and many pessimists view it merely as an administrative burden that will unnecessarily drain resources, there is an alternative perspective. The new regulation is also a good opportunity for process improvement, better market positioning, and achieving impressive financial indicators. In a changed world of limited resources where profits and infinite growth have long been the alpha and omega of business decisions, the old business as usual is no longer sustainable. Climate and social changes increasingly negatively affect the lives of many people and businesses, from droughts, floods, loss of water resources and fertile soil, lower yields to subsequent population migrations, thus managing physical and acute risks and clear transition plans must become an integral part of business strategies, both for companies and banks and the entire financial industry. Facing Reality Banks and investors face a difficult but necessary decision that they will have to divest from sectors that pose risks not only to the environment but also to long-term economic stability. However, such changes will not be simple or quick due to the time required for transition and the many interests that involve strong exposure and profitability of these sectors for the financial industry. For companies, this means facing a new reality that the previous way of measuring performance and obtaining ratings from banks based on financial indicators (e.g., EBITDA, profitability, debt, and liquidity) will no longer be sufficient as ESG risks will become an integral part of assessing their creditworthiness and will carry increasing weight, making it more difficult for them to access financing, capital, and E-funds if they do not adapt their business to the new circumstances. Due to the increasingly important role of banks in promoting sustainability and redirecting financial flows, this change is not just temporary. It is a strategic decision that has profound implications for the future success and stability of companies. Despite all the challenges, new opportunities are opening up for companies. By transforming business models, creating innovative green products and services, and strengthening interaction with stakeholders, they can better position themselves in this net-zero world. 21441 The success of these changes cannot depend solely on the will of individual companies. A synergy of various stakeholders is necessary – the state, the financial sector, and, of course, the companies themselves. That is why a strict regulatory ESG framework has been established at the EU level. This initiative ensures synchronized action, transparency, measurability, comparability, and digitalization of data on sustainable practices, thus laying the foundations for a sustainable economic ecosystem for all stakeholders. Why Regulation is Necessary For years, sustainability reporting based on the NFRD (Non-Financial Reporting Directive) has often been a mirror of superficial, well-crafted PR stories that were far from the actual practices and significant efforts companies invested in sustainability. Instead of focusing on material and key issues, many companies highlighted achievements precisely in those areas where they were already successful, creating an illusion that did not fully reflect the true picture of their activities. The consequence of this selective reporting focused on positive elements has often been not only a distorted public perception but also unrealistically high ESG ratings, which in turn undermined trust in the very concept of ESG. That is precisely why the EU has adopted a new directive, CSRD (Corporate Sustainability Reporting Directive), which replaces the NFRD and for the first time in history mandates sustainability reporting for over fifty thousand companies in the EU, which generate over 75% of the revenue of all companies in the EU, and an additional ten thousand outside the Union according to strict ESRS standards (European Sustainability Reporting Standards). Croatia will have to incorporate this regulation into the Accounting Act, the Audit Act, and the Capital Market Act by July 2024. Given that we are in an election year, it can be expected that it will be introduced into local legislation even sooner. New Reporting Rules In addition to being defined by laws, companies will have to report according to strict ESRS standards, which means that the structure of the sustainability report is strictly prescribed and it is defined what information from all three areas (E, S, G) must be reported. The sustainability report is no longer separate but becomes an integral part of the management report and must be submitted simultaneously with the submission of financial reports. The representatives responsible for it will submit it in a digital format XBRL (machine-readable format) to the central European database (EMAS). All information stated in the report must be verifiable and provable, and an important change is that the report must be audited by an auditor or an authorized third party. The application for companies that were obligated under the NFRD (those with more than five hundred employees and of public interest) begins for the financial year 2024 (about ten thousand companies in the EU and about sixty in Croatia), and from 2025, the threshold is lowered to companies that meet two of three criteria (more than 250 employees and/or 20 million euros in assets and/or 40 million euros in revenue). This means that the scope of companies gradually expands to more than fifty thousand in the European Union, or an estimated four hundred in Croatia. For these companies, adapting to mandatory reporting will be the biggest challenge as they have never faced such significant regulatory requirements before. To ensure that the entire reporting system aligns with the goals of the European Green Deal and the Paris Agreement, a classification system of environmentally sustainable economic activities has been defined that can make a real contribution to climate change, the so-called EU taxonomy, which applies to companies from January 1, 2023, and each green investment must align with its six objectives. This regulation applies to both companies and banks. Under the CSRD, companies will be required to report on the compliance of CAPEX (investment expenditures), OPEX (operational costs), and revenues with the EU taxonomy, which will require the introduction of so-called green controlling and the classification of accounting items in accordance with the EU taxonomy. 21442 Strict Accountability Check With the Corporate Sustainability Due Diligence Directive (CSDDD), whose acceptance in the European Commission is expected by the end of this year, strict rules for verification, instructions, and accountability of owners and directors of companies have been defined. The rules will be incorporated into local legal regulations in all EU countries during 2025 and will begin to be applied in 2026. This directive requires companies to prove how they collected information from key stakeholders and identified key risks and opportunities within their entire value chain, all in the fight against greenwashing. In the case of voluntary reporting in B2C business, the EU wants to further protect consumers with the Green Claims Directive, which prescribes fines of four percent of revenue for companies that falsely present sustainable products. In addition to companies having to report on sustainability, the entire financial industry must do so, for which reporting rules have been prescribed by the SFDR (Sustainability Financial Reporting Directive) under which banks, pension funds, insurance companies, and other financial institutions must report from January 1, 2023, on how they manage sustainability risks in their own portfolios and how ESG factors are integrated into their business and products. Additionally, banks must align their operations with the EU taxonomy and regulatory requirements of the EBA (European Banking Authority), where they must clearly show their existing share of green loans (green asset ratio), goals for increasing it, and an action plan on how they intend to achieve this, which is why they seek loan users who have implemented ESG strategies and sustainable investments. For this reason, banks are preparing an ESG questionnaire for clients who will need financing. In Croatia, it will be filled out with the help of HROK. Benefits for Companies Introducing a sustainability strategy as a strategic priority opens many opportunities, and an innovative approach to developing new products and services can certainly help in positioning in the new, net-zero world. Therefore, companies that start early, build their own ESG knowledge, and create their ESG team, establish processes, and systematically collect data will ensure synergistic effects that will position them as a desirable supplier, have more favorable sustainable financing, be more attractive to talent, and retain employees. This way, they will achieve impressive financial indicators and generate profits that they can reinvest and return to the community, thus creating a sustainable future (#sustainablefuture). 21443 Companies just need to start, even with small steps, and they do not need to seek perfection. They should be guided by sound economic principles, taking into account available current and future resources, and set clear rules on how they will reduce risks and what new opportunities they have on that path, as well as what kind of planet, resources, and society they leave for future generations. How to Prepare The process is not easy and is certainly not cheap. It will require investment in both people and processes, and all of this takes time and money. Therefore, reporting requires building new knowledge, a strategic approach, and team synergy. ESG is a multidisciplinary sport, which means that owners and leaders, their managers, and key employees in all departments must integrate these elements into all aspects of their business strategy and their own compensation and incentive models. The process is not easy and will certainly require many resources, primarily building new knowledge, a strategic approach, and team synergy. ESG is a multidisciplinary sport, which means that owners and leaders, their managers, and key employees in all departments must integrate sustainability elements into all segments of their business strategy and reward models.
ESG Regulation: Bureaucratic Pressure or a Great Opportunity for Growth and Development?
