Aug 11, 2024
Why evaluating value chain ESG performance is necessary and important
Understanding and monitoring the level of environmental, social and governance (ESG) compliance and performance, both within an organisation’s own operations and across its whole upstream and downstream value chain, including its products and services, its business relationships and its supply chain, is gradually shifting for businesses operating within the European Union (EU) from being voluntary towards being a mandatory requirement. This shift takes place as the sustainability-related EU legislation is toughening and phasing in new standards for the in-scope companies to investigate, report and act on sustainability impacts that reach beyond their organisation.
As the EU ESG regulatory landscape becomes increasingly more complex, collecting and analysing value chain ESG performance data can create considerable challenges. Anyone who has tried to collect relevant data outside of their organisation for their own sustainability reporting purposes knows that this is a difficult and resource-consuming task. Esgrid’s value chain ESG performance assessment platform is designed to help companies operating within the EU (and either being subject to the EU ESG reporting requirements or simply wishing to improve their value chain ESG performance) to face these challenges and keep abreast with evolving requirements and standards.
Relevant current and upcoming EU legislation
The regulatory landscape establishing sustainability-related reporting and due diligence requirements has been rapidly evolving during the past few years, with the EU introducing several new initiatives mandating companies in the EU to disclose non-financial information concerning their sustainability performance, both for their internal operations and throughout their value chain(s).
As of today, the key EU legislation setting the requirements for sustainability reporting for value chain(s) is as follows:
Corporate Sustainability Reporting Directive (CSRD)
CSRD, adopted in late 2022 and effective from 5 January 2023 in support of the European Green Deal, replaces and extends the existing EU ESG reporting framework introduced in 2014 by the Non-Financial Reporting Directive (NFRD) and extends the scope of companies required to disclose sustainability information. The scope of CSRD extends to all large companies based in the EU and all companies listed on the EU regulated markets (except for listed micro-enterprises), including EU subsidiaries of non-EU parent companies as well as some financial market participants. In addition, certain companies that are not within the scope of the CSRD themselves, but operate within the in-scope companies’ upstream or downstream value chains, may be affected through their customer and supplier relationships, since CSRD-scoped companies must also report on ESG aspects of their value chain(s). For example, a non-listed SME supplier to a large listed EU company may be asked to provide ESG data to its customer so that the customer can make the appropriate CSRD disclosures. The CSRD includes a three-year grace period specifically for value chain disclosures, during which companies may omit such data and instead disclose their efforts to obtain this information, the reasons for its omission, and future plans to obtain such data.
The provisions of CSRD are currently being transposed into each Member State's national law, which will determine the full scope and extent of the sustainability reporting requirements in each Member State of the EU.
European Sustainability Reporting Standards (ESRS)
The exact disclosure requirements, reporting standards and data points, which CSRD-scoped undertakings must follow and align their sustainability reporting with, are further specified in the set of European Sustainability Reporting Standards (ESRS) adopted by the European Commission as delegated acts in accordance with CSRD. Drafted by the European Financial Reporting Advisory Group (EFRAG), the standards are intended to provide a common framework and guidance for reporting by the companies within the scope of the CSRD in order to ensure that the information reported is consistent, relevant, comparable, reliable, and easy to access.
There are three main categories of ESRS:
Cross-cutting standards, which explain the fundamental concepts, methodology and general requirements for ESG reporting.
Topical standards, which are structured into topics and sub-topics covering the full range of environmental, social and governance issues irrespective of the sector.
Sector-specific standards, which are applicable to all undertakings within a sector and cover issues that are not (sufficiently) covered by the topical standards.
On 31 July 2023, the European Commission adopted the first, cross-cutting and topical ESRS, which are applicable from the start of 2024 (Delegated Regulation 2023/2772). The first adopted ESRS are sector-agnostic and contain 12 standards: 2 cross-cutting standards (ESRS 1 and ESRS 2) and 10 topical standards covering various ESG matters such as climate change, pollution, workforce-related matters, and business conduct (ESRS E1 to ESRS E5, ESRS S1 to ESRS S4 and ESRS G1). All in-scope companies must comply with the general requirements of ESRS 1 and the general disclosure requirements of ESRS 2 regardless of materiality. After doing so, a company should then conduct a materiality assessment for the 10 topical standards to determine which topics and sub-topics are material to the company. If a topic or a sub-topic is deemed material, the company must report according to the disclosure requirements of the relevant standard.
In addition to the already adopted ESRS, EFRAG and the European Commission are working on additional reporting standards:
Sector-specific ESRS standards - additional standards that will affect certain industries with additional industry-specific reporting requirements are currently being developed by EFRAG. The sectors are as follows: oil and gas; coal, quarries, and mining; road transport; agriculture, farming, and fisheries; financial institutions; motor vehicles; energy production and utilities; food and beverages; and textiles, accessories, footwear, and jewellery. As of now, the date for their adoption has been postponed to end of June 2026.
Specific standards for listed SMEs - in accordance with CSRD, a more flexible reporting regime is intended for listed SMEs and EFRAG is currently developing the draft versions of the relevant proportional standards for listed SMEs that will be less demanding than the full set of ESRS. Listed SMEs are not required to report sustainability information until financial year 2026, with the possibility of an additional two-year opt-out after that. Pursuant to the CSRD, the relevant ESRS for listed SMEs were to be adopted by the European Commission by 30 June 2024. However, at this time (August 2024), EFRAG has received feedback on the public consultation of its initial (exposure) drafts of the listed SME ESRS and has announced that it expects draft standards to be finalised at the end of December 2024.
Furthermore, as some non-listed SMEs, which are not subject to any sustainability reporting requirements under the CSRD, may nevertheless receive requests for sustainability information from customers, banks, investors or other stakeholders. EFRAG is therefore also developing simpler, voluntary standards for use by non-listed SMEs. These voluntary standards should enable non-listed SMEs to respond to requests for sustainability information in an efficient and proportionate manner, and so facilitate their participation in the transition to a sustainable economy. Thus, these voluntary standards will provide a robust minimum reporting framework (e.g. examples of data points) to obtain ESG-related data from SMEs in the value chain. The first (exposure) draft of these standards were published together with the ESRS for listed SMEs and the next draft taking into account the feedback received is expected in February 2025.
In addition, the CSRD states that the standards for listed SMEs will legally cap the information which ESRS can require large undertakings to obtain from SMEs in their value chains. Accordingly, once adopted, the ESRS for listed SMEs will provide the maximum disclosure requirements determining the scope of information to be requested from the reporting undertaking’s value chain entities.
Other future standards and guidelines — additional standards applicable to non-EU entities with branches or subsidiaries in EU are also in development and expected to be released together with the sector-specific standards, in June 2026.
Furthermore, EFRAG intends to periodically publish additional non-binding technical guidance on the application of the ESRS. The first three of such guidance: on reporting on value chain, on double materiality assessment and on datapoints required under the adopted ESRS regulation were finalised and published in May 2024.
In addition to the sustainability-related reporting regime under the CSRD and ESRS, certain large undertakings will soon be obligated to conduct due diligence to address environmental and social concerns within their value chain(s) in accordance with Corporate Sustainability Due Diligence Directive (CSDDD).
Corporate Sustainability Due Diligence Directive (CSDDD)
On 13 June 2024, after month-long hard negotiations between the European Parliament, the EU Council and the European Commission, and significant reduction of initial draft’s scope and requirements, the text of CSDDD was adopted. Member States will have until 26 July 2026 to transpose the Directive into their national law, which will then be phased in (based on the size of companies and whether they are EU-based or not) from 2027 to 2029. The CSDDD would require in-scope EU and non-EU companies to carry out due diligence on human rights and environmental impacts of their own operations, their subsidiaries, and their entire value chains (e.g., direct and indirect suppliers), prevent, mitigate, or bring to an end any identified adverse impacts; monitor the effectiveness of their due diligence policies and measures; and publicly communicate what they are doing on due diligence. The CSDDD’s also requires Member States to ensure that companies are held liable (civil liability) in cases of failure to comply with the obligations of the CSDDD.
In a nutshell, the CSRD (along with ESRS) establishes a reporting framework to encourage undertakings to disclose their sustainability activities related to their operations and value chain(s). On the other hand, the CSDDD is aiming to be primarily concerned with enforcing undertakings to implement mandatory due diligence measures to monitor and address negative impacts within their supply chains in relation to safeguarding human rights and preserving the environment.
Esgrid’s value chain ESG performance assessment methodology
How Esgrid collects value chain ESG performance data
Esgrid has developed its value chain ESG performance assessment platform based on a thorough legal analysis of the EU's currently applicable sustainability-related legislation, as well as currently available drafts of the relevant EU legislative initiatives. The relevant legal analysis has been conducted with the help of highly qualified legal experts, COBALT Law Firm. The methodology is constantly being updated and enhanced keeping pace with the evolving EU regulatory framework and applicable standards.
The following principles underpin Esgrid's approach:
Esgrid's platform is developed based on the ESRS cross-cutting standards and topical standards. The tool is tailored to collect and assess data on ESG performance of entities in the value chain and accordingly reflects these disclosure requirements arising from the existing ESRS standards that are applicable to or concern entities in the value chain. As for the ESRS topical standards, the tool includes issues and data points that have been considered material pursuant to the selection made by a company based on its double materiality assessment. The double materiality assessment for the purposes of making the relevant selection of material data points and disclosure requirements is carried out by the company, whereas Esgrid can provide supportive suggestions based on internationally recognised materiality standards such as SASB Standards that identify the sustainability related issues most relevant to investor decision making in 77 industries. Additionally, Esgrid's platform takes into account a general baseline approach for the scope of SME reporting obligations, as is currently reflected in the EFRAG’s exposure draft of EU Voluntary Sustainability Reporting Standard for Non-listed SMEs (VSRS).
Esgrid's platform provides, in a condensed, simple and easy-to-comprehend manner, ESRS standards based questions and data requests addressed to value chain entities that enable companies, first of all, to collect main data on ESG performance of the relevant entities in the value chain for their own ESG reporting purposes, secondly to conduct basic checks of the adequacy of the answers through relevant document requests, and thirdly to make a high-level assessment of sustainability information on its value chain in the cross-cutting areas and in other specific topics that are selected as material.
Due to the evolving regulatory landscape, Esgrid’s platform is not yet fully aligned with:
Sector-specific ESRS standards (as of today, the EFRAG working group is still developing drafts of these standards and no draft text has been made available to the public yet);
ESRS for listed SMEs (again, as of today, the EFRAG working group is still developing drafts of these standards);
CSDDD as this regulation is not yet applicable.
Our legal team is constantly monitoring the latest regulatory changes and implementing them into the ESG practices assessment system to ensure that the tool remains up to date with the applicable legal requirements.
Based on the submitted responses and collected ESG data, Esgrid´s platform will highlight the areas where the assessed value chain entity’s ESG performance does not raise red flags and also the areas that need improvement and will provide high-level guidelines for actions to be taken. This information will be available for both assessing and assessed companies to promote a dialogue for ESG-related awareness and improvements.
How does Esgrid evaluate the ESG performance of the value chain entities?
ESG performance of each value chain entity is evaluated based on the responses given during ESG assessment pursuant to the following methodology:
Positive answers indicating the existence of established ESG practices referred to in the relevant questions are evaluated with 1 point for each relevant question.
The expression of time-bound intention or commitment to establish sustainability practices referred to in the relevant questions are evaluated 0.5 points for each relevant question.
Missing, unclear or negative answers not sufficiently confirming the existence of established ESG practices or express time-bound intention or commitment to establish sustainability practices referred to in the relevant questions are evaluated with 0 points for each relevant question.
When evaluating the responses, Esgrid only considers the substance of each response. Esrgid does not assume any obligation or liability to verify the accuracy of any of the responses given by value chain entities. Furthermore, where the entities are requested to upload documents evidencing or supporting their responses, Esgrid only carries out a sanity check that the title and substance of the document uploaded by the entity is generally in line with the document requested, but does not assume any obligation or liability to verify the authenticity, validity or quality of the content of any of the relevant documents.
For the purpose of producing an Assessment Summary of the ESG performance of a value chain entity, Esgrid aggregates the total performance level for each assessed ESG topic by summarizing performance levels of relevant questions within each assessed ESG topic.
The Assessment Summary is provided as a graph to both assessing and assessed companies.
The Assessment Summary generated by Esgrid’s platform shows the level of maturity of sustainability practices of value chain entity in each ESG topic as follows:
0%-25%: Low (indicated with a red colour in the graph)
25%-75%: Medium (indicated with a yellow colour in the graph)
75%-100%: High (indicated with a green color in the graph)
The Assessment Summary provides high-level automated recommendations for developing missing ESG impact management processes to value chain entities as a supportive tool for improvement of sustainability practices.
For companies assessing their value chain’s ESG performance, Esgrid aggregates the level of maturity of ESG performance level across all assessed value chain entities and presents it as a graph on the Assessment Insights page. Esgrid also indicates the share of the value chain entities that demonstrate well-established ESG impact management processes. The companies assessing their value chain’s ESG performance also may access the responses and documents provided by its value chain entities and the Assessment Summary produced for each value chain entity.
DISCLAIMER
The output produced by Esgrid is not intended for public disclosure or for distribution by subscription or other means within the purposes of Proposal for a Regulation of the European Parliament and of the Council on the transparency and integrity of environmental, social and governance (ESG) rating activities.
Esgrid does not, and is not authorised or licenced to, issue or provide any ESG ratings, scores, and/or opinions that can be publicly used or distributed. Esgrid provides its outputs pursuant to an individual order and provided exclusively to the person who placed the order.