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.

While being challenging, better understanding of the value chain’s ESG performance also creates opportunities for businesses. Among others, it supports more sustainable business decisions and thereby gives companies a competitive edge and helps businesses to meet stakeholders' growing expectations towards more sustainable operations, become more competitive and avoid negative consequences associated with non-compliance with the relevant laws and regulations.

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. 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 supplementary 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 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.

The European Commission also intends to adopt further proportional standards tailored to specific types of entities, including those in the value chain.

1. Cross-cutting and topical standards - On 31 July 2023, the European Commission adopted the cross-cutting and topical ESRS. If neither the European Parliament nor the Council revokes the ESRS during the scrutiny period, then the final text of the ESRS is expected to be adopted by the EU during the Autumn of 2023 and enter into force on the 1 of January 2024. 
   
   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 are material to the company. If a topical standard is deemed material, the company must report on the disclosure requirements of that standard. However, some disclosure requirements will remain voluntary regardless of the outcome of a materiality assessment and are designated as such.

2. 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; motor vehicles; energy production and utilities; food and beverages; and textiles, accessories, footwear, and jewellery. 

   
   

3. Specific standards for listed SMEs and non-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 are to be adopted by the European Commission by 30 June 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 and has published an Issue Paper on the first text thereof. 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.

   
   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.
   
   

4. Other future standards and guidelines — EFRAG has announced its plans to release additional standards tailored to non-EU entities, even though currently there is limited to no publicly available information on the timing or content of these additional standards. 
   
   Furthermore, EFRAG intends to periodically publish additional non-binding technical guidance on the application of the ESRS. The European Commission has suggested that EFRAG prioritises the development of guidance on materiality assessment and on reporting with regard to value chains. EFRAG expects to publish draft guidance on these two issues for public consultation in the near future.

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 the upcoming, but not yet adopted Corporate Sustainability Due Diligence Directive (CSDDD).

Corporate Sustainability Due Diligence Directive (CSDDD)

On 23 February 2022, the European Commission proposed the text of CSDDD. The proposal text is currently being negotiated by the European institutions. Once the text of the CSDDD has been formally adopted by all three European institutions, Member States will have two years to transpose the Directive into their national law. 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 text (in its current) form also introduces duties for the directors and contains civil liabilities resulting from the 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 currently available texts of 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. The tool takes into account all relevant disclosure requirements from the ESRS cross-cutting standards. As for the ESRS topical standards, the tool reflects those data points and disclosure requirements that fall within the category of 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 Issue Paper on the draft 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 does not yet include: 

  • 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 and no draft text has been made available to the public yet);

  • Proposal of CSDDD, as the legal text and nature of CSDDD is still evolving and subject to numerous changes by the European institutions.

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.

• Depending on whether the ambition of a company is (i) to understand the level of its value chain entities’ ESG practices on a more general and robust level or (ii) to collect more detailed information on its value chain entities’ ESG compliance and practices for CSRD and ESRS reporting purposes, there are two types of ESG performance assessments to choose from:

  • Basic ESG assessment with a limited selection of more generic questions and requests for information concerning the company’s value chain; and

  • Extended ESG assessment with a set of more detailed questions and requests for information concerning the company’s value chain.

• 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 Esgrid evaluates 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.