Both the financial sector and the real economy are faced with increased regulatory requirements and expectations of various stakeholders to meet ESG criteria, which are a benchmark for sustainability and sustainable investments. A high ESG rating not only promotes corporate policy, but also serves the profit interest of investors.
Currently, in the EU only capital market-oriented companies with an average of more than 500 employees and financial institutions/insurance companies are required to report. In the future, the limit is to be lowered to 250 employees and to non-capital-market-oriented medium-sized companies.
While historically the focus was more on the concept of sustainable finance, which assumes that an appropriate alignment of private financial flows is the most effective way to achieve politically set environmental and social goals, a further thinking can now be heard, especially in Germany:
Human capital management is not only becoming increasingly important for investors, but also influences the external image of the company. Promoting this is and will continue to be a central role of HR management.
- The "E" stands for "Environmental" and refers to both sustainable awareness and sustainable corporate action with respect to environmental standards. The EU performs particularly well in a global comparison when it comes to aligning environmental target achievement through a comprehensive political sustainability agenda.
- The "S" stands for "Social" and refers to criteria such as equal opportunities, occupational safety and respect for human rights both within the companies but also with respect to the community.
- The "G" stands for "governance" and is closely related to the social topics. At its core, it is about linking the Human Capital Management (HCM) strategy with the corporate strategy and organization.
As a general rule, reporting must disclose material information, it has to be true, forward-looking, consistent and coherent. To promote this, the EU has developed various requirements.
diversity concerns, working conditions, trade union relations, worker participation, occupational health and safety, respect for human rights and supply chains.
The EU reporting framework has since been expanded by the CSRD (Corporate Sustainability Reporting Directive) that, following its approval in late November 2022, entered into force on 5 January 2023. As a result, non-capital-market-oriented corporations, i.e. large parts of the German small and medium-sized enterprises (SME) sector, are also to publish a sustainability report in the future. In addition, non-financial statements and key figures are to move into focus and thus come closer to the financial key figures.
With regard to social sustainability ("S"), criteria such as i) equal opportunities for all, including equal pay, gender equality, inclusion of people with disabilities, ii) working conditions, including adaptable employment, wages, collective bargaining, employee involvement, work-life balance, suitable working environment, and iii) respect for human rights, should be clearly highlighted.
Governance factors ("G") are also expanded to include criteria such as i) the role of administrative, management and supervisory bodies ii) corporate culture, iii) political commitment, iv) relationships with business partners, and v) internal control and risk management systems.
Through the Sustainable Finance Action Plan from 2020, there are already EU criteria for sustainable finance issues ("taxonomy"). In the future, definitions of ESG criteria are also to be created for social and governance factors as part of an EU social taxonomy. On February 28, 2022, an advisory body of the EU Commission published final recommendations for the development of a social taxonomy (Final Report on Social Taxonomy). These contain requirements for the classification of companies with regard to their social sustainability. Unfortunately, at this point mainly due to the Russian invasion in Ukraine and the energy crisis in Europe, the EU has decided to put a hold on its plans to introduce a social taxonomy during this parliamentary term.
In the area of corporate governance, the EU aims to improve an EU legal framework to encourage companies to focus on long-term and sustainable value creation as part of a Sustainable Corporate Governance Initiative. As part of the initiative, a draft Directive on Corporate Sustainability Due Diligence (CSDD) was published in February 2022. At the same time, a communication was issued on the promotion of decent work, in particular to counteract child and forced labor. It is not yet known what exactly this legal instrument will look like.1
In Germany, according to § 289d of the German Commercial Code (HGB), companies can decide at their own discretion which frameworks they use. For targeted human resources management, it makes sense to choose a framework that considers employee issues as closely as possible. The following frameworks and standards are relevant:
- International frameworks
There are international frameworks such as the core labor standards of the International Labor Organization (ILO), the OECD Guidelines for Multinational Enterprises and the UN Global Compact. The standards they contain are probably self-evident for most companies, but it is nevertheless advisable to confirm compliance with them in sustainability reports. These frameworks include, in particular, principles on freedom of association, the right to collective bargaining, the elimination of child labor and forced labor, and the prohibition of discrimination. In addition, the OECD Guidelines establish a code of conduct for foreign investments and foreign suppliers.
The Global Reporting Initiative (GRI) has developed modular, interlinked standards on environmental, economic, organizational and social aspects of corporate alignment. For human resources management, mandatory reporting requirements can be identified, such as the employer-employee relationship, diversity and equal opportunities, data security, and training and development.
EFRAG is an association under Belgian law that acts as an advisory body to the EU Commission. Both the CSRD and the recommendations on social taxonomy contain references to the sustainability reporting proposals developed by EFRAG. On 16 November 2022, EFRAG approved an updated set of its European Sustainability Reporting Standards (ESRS’) that had been published and put up for consultation in April 2022. There is a total of thirteen ESRS’ covering all three ESG pillars and being accompanied by general principles and guidance on general, strategy, governance, and materiality assessment. The EFRAG standards are expected to become the most relevant framework for ESG reporting in the EU. They are going to apply to public interest entities with more than 500 employees as of 1 January 2024, relevant for reports to be published in 2025 and onwards. The group of companies concerned is then to be successively expanded2. By tightening up the CSR Directive, the quality, consistency and comparability of the companies are to be promoted and improved.3
- Definition of ESG reporting criteria
The appropriate criteria should be identified ideally by using the new EFRAG standards and taking into account the respective industry-specific circumstances and corporate planning. These are then used to develop the target for ESG-oriented HR work.
- Gap analysis
The company’s current approach to ESG should be compared against the legal and regulatory requirements set forth in the standards and criteria that have been identified.
- Define and implement specific ESG initiatives for the HR function
It should be highlighted where there is still a need to catch up and where HR management can actively contribute to maximum target achievement. The employees' right of co-determination through employee representatives plays a prominent role here.
- Reflection of ESG initiatives in the corporate organization
ESG-oriented HR management should also be anchored in the corporate organization. This is realized, for example, through representatives in the management bodies who dedicate part of their time and responsibilities to social sustainability.
- Meaningful reporting formats
HR management optimized from an ESG perspective can only add value if it becomes a meaningful part of the sustainability report. Application guidance and reporting standards are also suggested by EFRAG. First of all, a stakeholder-centric approach should be chosen. Furthermore, the report should actually be accurate, balanced, comprehensive but also concise and strategic.
What are the actual topics that HR management should focus on when implementing its ESG strategy?
There is not one set of topics that are relevant to all companies. Much will depend on the industry and labor market a company operates in, but also specific exposures that a company is facing when it comes to human capital. However, the following are among the topics that every HR management has to look into: