Frank Bold for Reflex. ESG: From alphabet soup to clear standards for business

A few years ago, only insiders knew the acronym ESG, but today it is part of the mainstream for sustainability aspects. The letters ESG stands for E - environmental, S - social, and corporate G - governance stand for everything related to sustainability, especially in business. We have ESG legislation, ESG investments, ESG reporting or ESG ratings. A group of experts from FRANK BOLD, a group of more than 100 experts whose lawyers and experts in energy and business in general co-create domestic and European legislative standards - and at the same time strive to improve the state of society and the environment in which we live - have written about various aspects of ESG, news and trends for Reflex.

The climate is changing. Climate change causes negative events such as droughts, floods and fires that can threaten your business.

Legislation is changing. In response to climate change, legislation is emerging in the EU and America that requires companies, investors, banks and public institutions to be more sustainable.

Customer preferences are changing. Consumers often no longer just look at price, but also at how a company approaches ESG.

Perceptions of sustainability are changing. A number of studies show that ESG orientation does not hinder companies' financial performance, quite the opposite.

In the West, companies have been aware of this for several years - large companies commonly include ESG in their overall business strategy and calculate climate risks in their financial planning. According to a Reuters report, the majority of corporations surveyed considered sustainability a driver and key source of future revenue as early as 2017.

Moreover, for EU companies, sustainability is the key to so-called green finance - the EU plans to spend a trillion euros on sustainability by 2030 from public money alone. Hundreds of millions more are expected from investors and banks.

To ensure that these funds are used by truly green companies or projects, the EU has developed a set of legislation that requires companies to provide sustainability data. These include:

• mandatory ESG reporting for companies (CSRD)
• mandatory ESG reporting for banks and investors (SFDR)
• classification of sustainable activities (EU Taxonomy)

Mandatory ESG reporting will apply to approximately 1,000 Czech companies from 2025. Recent data show that even the largest Czech corporations do not publish the necessary information on sustainability. Czech companies are at risk of missing the train. "An absolutely unprecedented change in the economy is coming and even a small delay in the Czech environment can have major consequences for competitiveness," explains Pavel Franc, director of the Frank Bold expert group, which is involved in the preparation of European ESG standards. "On the other hand, companies that quickly navigate sustainability-related changes can access new markets and business opportunities."

In the following texts, we will present in more detail not only ESG reporting, but also all other important ESG topics - from legislation to green finance to energy.

"Alphabet soup" defines the boundaries

TCFD, CDP, GRI nebo SASB. This is just a small list of seemingly unrelated letters that denote voluntary standards and frameworks for ESG reporting or sustainability data reporting. Only a few such initiatives existed a few decades ago. They provided guidance on what information to track for companies that wanted to integrate sustainability into their operations. Similarly, they also guided investors and banks interested in ESG on the data they should require from companies.

However, as the demand for greater corporate sustainability has grown, so has the number of voluntary standards. If all reporting initiatives were now added together, they would require companies to provide data for more than five thousand indicators. Add to that the diverse requirements of individual banks, investors, rating agencies and buyers. You get a result that has come to be known in English as "alphabet soup".

Uniform standards for ESG reporting are supposed to make order out of a jumble of letters. The EU is the furthest along in their preparation - a draft is already ready and the European Commission is expected to approve it in June. The EU standards aim to reduce the administrative burden on companies (one report should be enough instead of dozens of forms) and are a necessary piece in the puzzle of transforming Europe's economy - without transparent data from companies, it will not be possible to redirect finance into sustainability.

In addition to the European ESG standards, global ones are also being developed, but unlike in the EU, reporting according to them will not be mandatory or will depend on individual countries. The United States is also developing its own reporting standards.

The global trend is therefore to make the reporting of ESG information as meaningful and standardized as we know, for example, in the world of finance.

Benefits of ESG: Banks prefer green investments

The transformation of the economy, new ESG legislation and reporting requirements do not only mean new obligations for companies, but also opportunities. We are talking about green finance, i.e. money directed to sustainable projects or companies. They already account for an increasing proportion of total investment and it is estimated that ESG investments will dominate in Europe as early as 2025.

A few numbers to show you. For example, green bonds and loans have seen unprecedented growth. In 2021, total issuance of these financial instruments will reach $1.6 trillion, more than double the previous year's volume. Similarly, investment in ESG funds is growing - in the Eurozone alone, assets under management by ESG funds have almost tripled in the last five years. According to a recent study this year by the investor association INREV, more than 90 percent of European investors consider their commitment to reducing emissions before investing in specific funds.

For smooth access to private investment, it is therefore increasingly important for funds and companies themselves to address ESG. A focus on sustainability also ensures better access to public finance mobilised under the European Green Deal. "In addition, 'green' companies can borrow more cheaply for development and also insure themselves more cheaply, which increases their value. "Banks already favour green investments because they have to collect data on the carbon footprint of their investments from January 2023, just like investors. They therefore want to naturally green their portfolios," said David Janků, reporting consultant at Frank Bold Advisory.

What does it take for a company to qualify for these benefits? The key to everything is data. You'll need detailed sustainability information whether you're applying for a soft green loan, looking to issue a green bond, or looking to transform your investment fund into a sustainable one. ESG reporting will not just be another legislative obligation, but an essential part of the business itself.

How to report? According to Frank Bold's first comprehensive guide for businesses

If a company is new to ESG, the initial orientation to the topic can be complex and full of questions: What legislation applies to the firm, what data does it need to report, and what purpose does it all serve? To help companies, the first comprehensive guide to ESG reporting explains the content of EU sustainability reporting standards, including what is mandatory, for whom and when.

If they start working on these steps already this year, companies will have enough time to orient themselves in the topic, set up quality processes and get the necessary support from experts. Indeed, their capacities will fill up quickly as the deadline for compliance approaches.

The guide, which is the first of its kind in Europe and was developed by Frank Bold Advisory experts together with Deloitte, was created for the Prague Stock Exchange and the European Bank for Reconstruction and Development. It is intended to support large listed companies, banks and insurance companies that will be affected by ESG reporting next year, but is also useful for everyone else. Other large companies will be subject to ESG reporting in 2025 and must have data collection set up by 2024. However, ESG disclosure through supply chains also applies to medium-sized and smaller companies.

The preparation of the guide included an analysis of the readiness of the largest Czech companies for mandatory ESG reporting. It shows that most of them significantly underestimate the onset of ESG regulations and do not prepare for them. This carries the risk that these companies will not be able to react in time and take advantage of the opportunities that ESG reporting will bring, for example, so-called green financing.

Companies can download the guide free of charge, for example, on the Frank Bold Advisory website.

ESG and obligations for Czech business: what 2023 will bring

In the middle of this year, the European Commission is due to adopt ESG reporting standards, according to which nearly 50,000 European companies across sectors will report. Under these standards, companies will publish data on, for example, their emissions or employees. Although most companies will be obliged to comply from 2025, it is beneficial for companies to start reporting as soon as possible.

"Collecting data and setting up processes will take time, so it is important for companies to start preparing now," says Filip Gregor, Frank Bold's chief ESG expert. "At the same time, ESG reporting is not just about legislation. Tracking sustainability data helps companies to save on energy and materials, build better relationships with partners or get better financing."

A recent development is the March agreement on the specific framework for the European Green Bond Standard, which will enable the financing of sustainable projects.

Negative environmental or human rights impacts are the focus of the forthcoming CSDDD, which will require companies to examine these areas. It is intended to help prevent cases such as last year's case of European furniture companies sourcing products from Belarusian labour camps as part of their supply chain. Mapping the chain will make companies more resilient to crises, as demonstrated, for example, during the coronavirus pandemic.

And what's already in place as of this year? Businesses with more than five hundred employees must disclose the extent to which their behaviour is linked to sustainable activities according to the European taxonomy. Banks and investors will also have to disclose their impact on climate and human rights or the fight against corruption. For 2022, they must publicly report on their sustainability impacts by end of June 2023.

Mandatory solar panels and zero emission buildings

In March this year, MEPs backed a plan to make buildings climate neutral. The construction industry is set for major changes in the coming years - the Energy Performance of Buildings Directive, which will make it possible to build only zero-emission buildings, is likely to be finalised this summer. All new public buildings should be zero-emission buildings from 2027 and all new buildings from 2030.

The main requirement for zero-emission buildings will be very low energy consumption, primarily covered by locally produced renewable energy sources. Existing buildings (non-residential and residential) will have to undergo renovations to meet the new low energy requirements.

The EU Council and the European Parliament are also demanding that the final directive include a requirement for mandatory installation of rooftop solar systems on both new and existing buildings (based on the RepowerEU strategy). By 2030 at the latest, all new and existing public buildings should be equipped with rooftop photovoltaic systems.

How will ESG affect medium and small companies?

Greenhouse gas emissions, energy consumption, employment and anti-corruption policies or the origin of materials. This is a short list of topics that medium and small enterprises supplying large European customers should also start addressing as soon as possible. Why?

Large corporations need data from their suppliers for their own sustainability management and for mandatory ESG reporting. In the Czech Republic, this is particularly relevant for companies supplying products to the automotive industry.

Large car companies are already demanding not only emissions data from their suppliers, but also specific targets and plans for how the supplier will reduce emissions in the future. Other requirements include, for example, the use of recycled materials or the setting of a policy to prevent corruption. As a result, suppliers of some companies are already required to regularly fill in this information in their company questionnaires. "Although mandatory reporting does not directly apply to most SMEs, the transformation of the European economy will ultimately affect everyone. Very often, large car companies also have their own ESG targets, which they have to involve their suppliers to achieve," explains reporting consultant David Janků of Frank Bold Advisory.

Smaller companies that are able to provide ESG data to customers will logically gain an advantage and ensure they remain or gain a more advantageous position in the supply chain.

Greenwashing: Painting products green will end

"Carbon Neutral Flight" or "CO2 Neutral T-Shirt". Recently, we have encountered similar claims more and more often. Similarly, we can read on the oil company's website that it plans to achieve carbon neutrality. These misleading or false claims about the 'greenness' of companies or products are known as greenwashing. How are consumers, banks or authorities supposed to read green claims so that they do not fall for greenwashing?

A new EU directive, presented by the European Commission a few weeks ago, aims to help consumers navigate green claims. The proposal requires all companies labeling their products with any form of green assertion (such as 'ocean-friendly' or 'made from recycled plastics') to substantiate these claims in accordance with prescribed standards. "The proposal also includes much stricter rules for eco-labels," adds Dimitri Vergne from the European Consumer Organisation BEUC, which advocated for the new law. "New eco-labels will need to be approved by relevant authorities before entering the market, and the directive proposes strict penalties."

Several EU tools are designed to assist investors, banks, and public institutions in ensuring transparency and access to ESG data from companies, particularly the mandatory ESG reporting under the CSRD directive. This will prevent companies from claiming they will be climate-neutral by 2030 while continuing business as usual. They will be required to substantiate their claims with concrete plans and demonstrate whether they are making progress toward achieving them.

Taxonomy: The EU's Sustainability Catalogue

The European taxonomy became widely known in the Czech public primarily due to the debate over whether or not it should include nuclear energy. But what does the taxonomy actually mean for companies?

The most common misconception is that the taxonomy requires companies to take specific actions or that activities not included in the taxonomy cannot be carried out at all. The taxonomy is essentially a catalog of all activities the EU considers sustainable. It applies to everyone but, in principle, does not impose any requirements. It is important because it serves as the main guide for directing green finance. If a company wants to obtain financing for its project through a more favorable green loan or by issuing a green bond, it should focus on ensuring that the project aligns with the taxonomy. "Any activity that is to comply with the taxonomy must meet a set of specific conditions. For example, the construction of new buildings according to the taxonomy must meet specific energy efficiency, waste recycling, or emissions limits, and, among other things, must not be located on fertile agricultural land," explains David Janků, reporting consultant at Frank Bold Advisory.

So far, the EU has published criteria for activities that contribute to reducing climate change and adapting to it. This year, it is expected to release these requirements for activities that support goals related to water resources, the circular economy, pollution, and biodiversity.

Companies underestimate ESG. They risk losing financing and customers.

Society, along with entrepreneurs, is facing an unprecedented climate crisis with impacts on all aspects of our lives. The war in Ukraine has simultaneously demonstrated the risks associated with dependence on supply chains controlled by dictatorial regimes. This list of challenges and risks could go on for a long time, but what is important is that standardized rules for their monitoring and reporting have been in place in the EU for several years.

The largest corporations are already required to disclose non-financial information about their business, and over the next few years, more large companies, as well as others in the supply chains, will gradually follow suit. However, in practice, we see that businesses are not preparing for these new obligations and, aside from the associated risks, are particularly underestimating the opportunities that lie ahead. In addition to opportunities for acquiring quality risk management tools, the key benefit is access to project financing. Companies that fail to join the ESG movement risk not obtaining funds from banks and investors or doing so only under significantly worse conditions than their competitors.

"At Frank Bold, we have been focusing on companies' preparedness for a long time," says Pavel Franc, CEO of Frank Bold. "In 2020, we conducted the world's first in-depth sustainability reporting analysis of the thousand largest European corporations. Even back then, investors were particularly calling for clear information on companies' environmental protection or anti-corruption goals. And this trend has deepened since – as of this January, mandatory legislation requires banks and investors to disclose what information they must share about their investments, particularly with regard to climate change, human rights compliance, and the fight against corruption. It is only logical that when financing, they will prioritize companies and projects that have high-quality reporting on their own impacts and are transparent in this area," he adds.

In addition to pressure from investors, new generations of customers are also demanding a responsible approach to the environment and society from "their brands".

European energy is going green. What about the Czech Republic?

In response to the rapidly growing interest in renewable energy sources, the EU Council approved a temporary regulation last December that will allow for faster construction. According to this regulation, officials must approve (or deny) rooftop solar power plants within three months. Silence from the authorities means consent for plants with a capacity of up to 50 kW.

Global powers, such as the USA and China, are also addressing the transformation of energy, mainly to secure their own safety. For Europe, this effort is a much greater challenge. The first step in managing it was the adoption of the REPowerEU strategic package, aimed at reducing the EU's dependence on fossil fuels from Russia.

As part of this package, financial incentives are planned to encourage member states to prioritize renewable energy. It simplifies financing and its administration for so-called green investors, who focus on sustainable projects and renewable energy. Green financing should specifically attract investment into coal regions in the Czech Republic.

"We can see that the Czech government is responding to the current developments in the energy sector and is focusing, for example, on investment incentives for the green industry. The Ministry of Industry and Trade has already adjusted investment incentives for strategic projects and has newly included those that contribute to energy security," says lawyer Laura Otýpková from Frank Bold, who has long been working in the energy sector.

The shift away from fossil fuels is a response not only to the war but also to the ongoing climate crisis. At the end of March, European authorities agreed to reduce greenhouse gas emissions by 55% by 2030. By that time, 42.5% of energy should come from renewable sources. "We do not yet know the Czech Republic's contribution to this goal, but according to current data, it is realistic to generate 32% of energy from renewable sources," estimates Otýpková. "How can this potential be achieved? For example, by unlocking the potential of these renewable sources and facilitating investments, possibly through community energy."

The government is hesitating to unleash the potential of community energy.

Czechia managed to respond to the energy crisis, but what’s next? The amendment to the Energy and Building Act, known as Lex OZE I, simplified the construction of renewable energy sources up to 50 kW at the end of last year, which will help install solar panels on apartment buildings. However, community energy has much greater potential, and we are still waiting for it to be anchored in law. It could cover up to 80% of household consumption, but only if we start building energy sources other than just solar. We should focus on wind energy.

"Public debate often focuses on the technical limitations of renewable energy sources," says lawyer Laura Otýpková from the expert group Frank Bold. "However, there are many legislative barriers that we can quickly address. These include, for example, phased measurements, which unnecessarily increase the cost of energy production for households, legal regulation of energy storage and community energy, as well as defining go-to zones for easier installation of wind turbines."

These gradual legal steps should fit into the overall framework, allowing the state to address the energy transition in a comprehensive and strategic manner. Documents being prepared by the government focus not only on increasing the share of renewable energy sources, investments in distribution and transmission systems, and supporting community energy, but also on the financial accessibility of energy for all. However, the preparation of these plans is slow, and there is little public information about them.