Why Companies Should Start Sustainability Management Now

Customers and investors are no longer solely concerned with financial metrics, but increasingly also with non-financial performance indicators. The acronym ESG has become established for this purpose. ESG stands for Environmental (environmental concerns), Social (social aspects) and Governance (corporate governance and compliance) and covers precisely these non-financial performance indicators. ESG is primarily to be understood as a framework that defines sub-areas and criteria which companies should consider when it comes to sustainability. ESG thus provides the framework for companies to analyze their ecological and social impact, promote sustainable business practices, and make non-financial performance visible and comparable to external parties. Engaging with ESG criteria should form the basis of every sustainability strategy . Consistently tracking, monitoring, and communicating ESG criteria is the main task of active sustainability management.

The EU regulations and laws that have already been implemented or are in preparation as part of the EU Green Deal also directly relate to the ESG framework. However, sustainability management is no longer just a burdensome mandatory or compliance exercise. These are merely another driver. Because the overall societal development towards greater sustainability is already influencing companies at all levels of the value chain – regardless of regulations. Above all, increasing customer demands and strategic embedding are other important factors.

All three factors are crucial for companies to successfully integrate ESG within an organization. If these three ESG factors are considered in sustainability management within the company, competitive advantages can be created and risks minimized. The following briefly examines these three factors.

The detailed second part of our blog series An Overview of the Most Important ESG Regulations in Germany you can find here. The third part of the blog series Sustainability between Customer Demands and Strategic Integration you can find here.

Key Sustainability & ESG Regulations at a Glance

In the EU, several significant ESG regulations are underway, which have emerged as a result of the Green Deal. The aim of these regulations is to strategically integrate sustainability into companies' business practices.

CSR Directive Implementation Act (CSR-RUG)

One of the most important regulations is the CSR Directive Implementation Act (CSR-RUG). This obliges companies to disclose information on non-financial aspects and thus to prepare a sustainability report. Five non-financial aspects that must be reported on are: environmental matters, employee matters, social matters, human rights and the Combating corruption and bribery. The directive aims to drive capital market-oriented companies, as well as banks and insurance companies, towards more responsible and sustainable practices. This is intended to create more transparency regarding environmental and social impacts.

The CRS-RUG has applied to capital market-oriented companies, institutions, and insurance companies with more than 500 employees since the 2017 financial year.

The Sustainable Finance Disclosure Regulation (SFDR)

The Sustainable Finance Disclosure Regulation (SFDR) requires financial product providers and financial advisors to disclose sustainability factors in the decision-making process for their financial products and to inform customers about the adverse sustainability impacts of these products. This becomes particularly important for financial products that are referred to as ESG-compliant or as “sustainable investment” are designated.

The aim of the SFDR is for financial market participants to finance their growth sustainably in the long term and to avoid greenwashing. Furthermore, there are specific requirements for companies regarding which sustainability information must be disclosed.

Since March 2021, the SFDR has primarily affected financial market participants and financial advisors who develop and offer financial products in the EU.

The EU Taxonomy

The EU Taxonomy is a classification system for sustainable economic activities established in the EU Action Plan "Sustainable Finance". The EU Taxonomy creates clear rules and regulations for the concept of sustainability, defining when a company operates sustainably or environmentally friendly. This results in reporting obligations for companies regarding sustainability.

For large capital market-oriented companies with over 500 employees, the EU Taxonomy has been applicable since January 2022.

The Non-Financial Reporting Directive (NFRD)

Since 2017, banks, insurance companies, and large capital market-oriented companies have been subject to the Non-Financial Reporting Directive (NFRD) mandated for sustainability reporting.

Also known as the Non-Financial Reporting Directive, it mandates companies with 500 or more employees to disclose non-financial information, such as the social and environmental impacts of their activities. However, since the NFRD came into force, significant weaknesses in the directive have been identified, such as the lack of clarity regarding the definition of materiality. Therefore, in 2021, the EU Commission published proposals for a revision of the NFRD and initiated the CSRD, which is intended to revise and replace the NFRD.

Corporate Sustainability Reporting Directive (CSRD)

Through the Corporate Sustainability Directive (CSRD) a uniform framework for reporting non-financial data will be established for the first time by the European Commission. The CSRD will replace the currently applicable Non-Financial Reporting Directive (NFRD), thereby creating new requirements for sustainability reporting. The directive applies to all companies with more than 250 employees and is expected to be adopted by October 31, 2022, at the latest. It is currently in draft form.

Whistleblower Protection Act (HinschG)

The Whistleblower Protection Act (HinschG) protects individuals within a company who disclose violations within that company. The respective whistleblowers will be legally protected from negative consequences within the company. Companies with at least 50 employees are affected by this ESG law, likely starting in early 2023.

Supply Chain Due Diligence Act (LksG)

The Supply Chain Act (LksG) regulates the responsibility of companies regarding the impact of their business activities on human rights within their supply chain. The law applies from January 1, 2023, to companies based in Germany with at least 3,000 employees, or companies with a branch office in Germany also employing at least 3,000 people.

The ESG Directives represent a completely new legal framework for sustainable business practices, affecting not only financial players but also the real economy. It is essential for companies to gain an overview of current and upcoming ESG regulations and to align their operations accordingly.

Customer Preferences

In addition to ESG regulations, it is evident that customer preferences are increasingly shifting towards sustainability. The trend towards greater sustainability has long been observed, especially for consumer products. Online retailers actively label products that carry a sustainability label and meet sustainability requirements. Sustainability is already a key purchasing factor in many areas, and this trend is rapidly growing.

It is becoming clear that ESG criteria will be crucial for almost every product and service. For companies, it is important to recognize this and incorporate it into their customer communication. For example, more sustainable products can open up new target groups, or costs can be saved through a circular economy.

Conversely, companies that delay adapting to sustainability for too long not only cut themselves off from new business opportunities but also risk losing customer trust. Therefore, it is crucial for companies to communicate their sustainability efforts openly and transparently to the public and to customers.

To successfully establish sustainability within a company, it is necessary to regularly seek dialogue with customers and stakeholders, and to understand and appropriately consider customer preferences and wishes.

Strategic Alignment

Integrating sustainability into the corporate strategy is essential. Considering ESG criteria should be an integral part of every risk analysis and reflected in the corporate strategy.

Through comprehensive and active sustainability management, a company's business model can be made future-proof and expanded. Especially through standardized data collection, risks can be identified early and minimized or even avoided. A holistically conceived sustainability strategy can be a decisive advantage for the company and represent a strong differentiating factor.

Conclusion

Even if a company is not yet regulated by sustainability laws today, the early implementation of an active sustainability management system and its associated processes offers many advantages:

• Improved Access to Capital Markets
• Higher Customer Growth
• Optimized Resource Utilization
• More Efficient Compliance
• ...

To successfully master the strategic challenges of sustainability management, it is beneficial to gain an overview of ESG regulations, to consider customer preferences throughout the entire process, and based on this, to establish a successful sustainability strategy within the company.