Proving Sustainability: Those Who Fail the Test Can Make Corrections

What seemed like a distant future until recently is soon becoming a reality for many domestic companies – ESG reporting. Companies in Croatia, particularly those listed on the stock exchange, will be required to publish non-financial (ESG) reports alongside their usual financial statements starting next year. This document will demonstrate how well a company adheres to environmental, social criteria, and good corporate governance standards. In short, it will reflect their commitment to the concept of sustainability. A small number of domestic companies already voluntarily publish such reports, as they are aware that a good ESG image significantly enhances their rating among investors, banks, and increasingly among employees and end customers themselves.

Extensive, Transparent, and Measurable

As is already known, the new European Directive on Corporate Sustainability Reporting (CSRD) came into effect in January 2023. It will affect more than fifty thousand companies in the European Union and an additional ten thousand outside it. Croatia must incorporate this regulation into the Accounting Act, the Audit Act, and the Capital Market Act by July. The application for the first obligated entities begins this year, with the first reports under CSRD to be published in 2025. However, ESG reporting is not entirely new for domestic companies: prior to CSRD, the NFRD, the Non-Financial Reporting Directive, was in effect, which was somewhat simpler and applied to a narrower circle of obligated entities. Nevertheless, the question arises as to whether domestic companies are already prepared for the implementation of CSRD. What operational and personnel prerequisites do they need for this?

Jasminka Rojko, an ESG and corporate finance consultant with many years of banking experience and owner of Rojko & Co, explains that CSRD requires obligated reporters to provide extensive information about activities related to the environment, society, and governance (ESG).

– Companies are obliged to report in a transparent and measurable manner. All data must be published in XBRL format, meaning that the sustainability report must be tagged in accordance with the strict rules of ESRS. This is necessary for all digital reports to be stored in the central database ESAP, which in itself means that they can be verified and compared – emphasizes Rojko.

How to Document Processes

According to her, companies will need to have documented processes for the first year of reporting based on which they have made calculations, or evidence of the methodology used in preparing the reports.

– For example, to calculate carbon dioxide emissions and the company’s footprint, companies apply the GHG protocol. For now, in the first years, there are no specific obligations for the verification or validation of these calculations. However, companies can use verifiers who will confirm that the calculation was made in accordance with the GHG protocol, or attach ISO 14064. Of course, they can voluntarily attach other standards such as ISO 14001, the environmental management certification, or ISO 45001, the international standard for occupational health and safety management systems. Additionally, for assessing climate risks, they will need to apply climate models that have been verified and validated by the United Nations to prepare transition plans for reducing physical and acute climate risks – emphasizes the interviewee from Lider.

Subject to Verification

It is important to note that all information included in the sustainability report will be subject to verification and confirmation by authorized auditors for the first obligated entities starting from January 1 of this year in the form of a ‘limited assurance engagement’, with a gradual plan to transition to ‘reasonable assurance engagement’. This is the highest auditing standard that, according to expectations from 2028, will require a much more detailed insight and verification of the basis for sustainability reports. In other words, it will be equated with the standard for auditing financial statements.

The first challenge for companies will be the preparation of reports, data retrieval, their verification, and publication, explain the Croatian Financial Services Supervisory Agency. This regulator will also be responsible for verifying the truthfulness of the reports to avoid the well-known greenwashing.

– All of this will require additional resources while the base of experts is still being built, both for companies and for auditors who will review corporate sustainability reports. Reports will have more control factors. The first will be those within the company, the experts who prepare them, and the management who will be responsible for these reports. After that, corporate sustainability reports will be subject to audits conducted in Croatia by specially authorized auditors. Only in the third step will regulators come into play, one of which will be Hanfa, which will control corporate sustainability reports based on a sampling principle – say Hanfa.

What If

For those who fail the verification, there will be several options for correction. Measures will be prescribed by law, which is still in development, but Hanfa expects a range from requests for the preparation of a new report, publication of corrections, to the case of the mildest omissions where corrections will be noted in the report the following year.

– The first reports will certainly be a challenge and, in addition to additional costs and expert resources, will require companies to make significant shifts in business processes to ensure that each new sustainability report is better. The first challenge will be data: does the company have it, how will it find it, and is it sure that it is correct. We are aware that the first reports will not be perfect, but they will certainly be a step in the right direction – they say from Hanfa.

At first glance, it could be said that CSRD will further complicate the already demanding preparation of financial reports.

Tangible Background

However, the entire story about ESG reporting has a very tangible background related to financial benefits for the company. This is also shown by the experiences of large global companies. One of them is Philip Morris International (PMI), which operates in a controversial tobacco business from an ESG perspective, but its approach to ESG reporting has been recognized in the global community. Namely, PMI has been included in the Dow Jones Sustainability World Index since 2023, one of the most prestigious benchmarks for sustainable business practices worldwide. Additionally, it has been in the Dow Jones Sustainability North America Composite Index for the fourth consecutive year.

As Darija Jurica Vuković, head of corporate affairs at Philip Morris Zagreb, states, the Dow Jones Sustainability World Index is awarded based on an annual corporate sustainability assessment (CSA) conducted by S&P Global.

– This index includes the top ten percent of the 2500 largest companies in the S&P Global Broad Market Index based on the assessment of their long-term environmental, social, and governance criteria. For 2023, PMI achieved 85 points out of a possible 100 on the CSA, which is a significant increase of 21 points since we began participating in the ranking in 2018. This is also the first time PMI recorded the highest score among thirteen rated companies in the tobacco industry – says Jurica Vuković.

Regarding the value that companies gain by participating in such indices, Jurica Vuković states that, in addition to the positive impact on reputation and strengthening stakeholder trust, there is a particularly increased attractiveness for investors, who increasingly value reliable sustainability ratings recognizing their direct impact on the long-term success of the company. Croatian companies can expect this as well.

Impact on Business

Jasminka Rojko states that the implementation of CSRD will significantly impact the operations of domestic obligated entities in several aspects.

– Companies will be further motivated to introduce sustainable practices and report on sustainability due to external and internal drivers. Among external drivers, in addition to regulation, significant encouragement will certainly come from their customers, suppliers, investors, and the local community, as well as the banking sector, which will increasingly focus on strict EU taxonomy rules and will require companies to provide clear and actionable transition plans, sustainable clients, and financing for sustainable investments. One of the extremely important external drivers will be the opportunity for sustainable financing under favorable conditions and the use of EU grants. We should also include other stakeholders in the financial market, such as insurance companies and investors, who will seek investments in green assets and entities with sustainability integrated into their business strategy and set goals – believes Rojko.

However, the greatest encouragement will come from internal drivers, as companies that report quality sustainability will enhance their reputation, become desirable employers, and attract new customers.

– By integrating sustainability into their business, they will find new niches for sustainable products or services related to the circular economy. These business opportunities will provide them with an advantage over competitors and contribute to business growth and profitability. Various measures of investment in energy efficiency will also contribute to results by reducing energy costs and enabling more efficient resource use. One of the most important internal drivers will certainly be the growth of the company’s resilience and ensuring long-term growth through better risk management and establishing clear processes while integrating sustainability into the business strategy – thinks Rojko.

Thus, the real sustainability of companies, and the entire economy, will not remain just a beautiful wish.