How is physical risk reporting changing under the CSRD?

Abstract

Over the past decade or so, the European Union has implemented transparency rules with the aim of encouraging companies to commit to mitigating their impacts on the climate system and adapting to climate risks.

Since the “climate” component of the current regulations on corporate non-financial reporting has certain shortcomings, Brussels plans to adopt new regulations by the end of 2022 new regulations, known as the “CSRD,” which stands for “Corporate Sustainability Reporting Directive.”

The CSRD would make it mandatory to take climate risks into account, so-called “physical” and “transition” indicators in corporate reporting and would expand its scope from 11,700 to 49,000 companies in the coming years. In this context, A rigorous assessment of the physical climate impacts that could affect the company’s operations must be conducted, based in particular on short-, medium-, and long-term climate projections.

Apart from their mandatory applications, the guidelines on non-financial reporting can be adopted on a voluntary basis by companies that recognize the threat that climate change poses to their value chain.

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In effect since 2018, the directive on the disclosure of non-financial information by companies, known as the NFRD^[1] (Non-Financial Reporting Directive), aims to enhance transparency and completeness social and environmental information provided by certain large European companies. These are public-interest entities (listed companies, banks, and insurance companies) with more than 500 employees: 11,700 companies are affected in the European Union.

In order to direct capital flows toward “more sustainable” economic activities, additional guidelines^[2] but non-binding on the disclosure of information related to climate were added to the NFRD in 2019.

A non-financial reporting framework deemed insufficient

Since companies subject to the NRFD are not required to disclose the climate risks to which they are exposed, The European Commission deemed the quality of the information published on this topic to be insufficient^[3].

In fact, that is what the CDSB (Climate Disclosure Standards Board) shows in its 2021 report^[4] which focuses on climate reporting by the largest publicly traded companies^[5] in the EU. In quantitative terms, among the companies that published non-financial performance reports in 2020, only 18% provided clear information on their physical resilience to various climate scenarios. And this is still Only 4% of the companies surveyed clearly describe the physical impacts of climate change on their business in the short, medium, and long term. Companies therefore discuss climate risks in their reports and identify them, but few examine them in depth.

Toward a New Reporting Framework That Better Accounts for Financial Risks

To address this shortcoming in the NFRD, the European Commission is currently developing a new reporting framework, called CSRD^[6] for the Corporate Sustainability Reporting Directive.

The significance of this directive is that compel companies to disclose information:

• On the one hand, the impact of the company’s activities on the population and the climate.
• On the other hand, regarding how various sustainability issues (climate and societal) affect the company. This is where climate, physical, and transition risks come into play, affecting the company’s operations.

This is known as “double relative importance,” better known as "double materiality" in English.

Once adopted by Brussels, the CSRD would require the affected companies to account for physical and transition risks in their reporting.

Who will be affected?

The CSRD proposal will expand, starting in 2023, the scope of these requirements to all publicly traded companies^[7], as well as to businesses^[8] exceeding at least two of the three thresholds the following:

• 20 million euros in total assets
• 40 million euros in revenue
• 250 employees

As a result, the number of companies affected by this new regulation would rise from 11,700 to 49,000 according to European Commission estimates.

What would be included in the physical risk report?

To comply with the CSRD provisions regarding physical risks^[9], a thorough evaluation climate impacts that could affect the company's operations, and the implementation of a resilience and adaptation plan must be carried out. These prerogatives stem directly from the European taxonomy^[10].

The company will therefore have to identify the most significant physical climate risks to its business in the short, medium, and long term, before implementing mitigation solutions that substantially reduce the most significant risks it has identified. As described in the European taxonomy, these adaptation solutions must in turn meet certain criteria:

• Maintaining the resilience of other stakeholders
• Promote nature-based solutions
• Aligning with regional adaptation efforts
• Monitor and measure predefined indicators to ensure that corrective actions are implemented effectively.

More information on the adaptation component of the European Taxonomy

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