Auditing ESG reports helps avoid greenwash

It is becoming more accepted that companies should not only focus on their own main goal – earning a profit – but also consider the environmental and social impact of their activities. And not just think about impacts, but evaluate and document them – large companies are now required to submit a sustainability report in conjunction with their annual financial statements.

The requirements stem from the European Union ESG directive, and were transposed into Estonian legislation through amendments to the Accounting Act that require companies to release data according to a uniform standard on environmental, social and governance factors. The reporting obligation will have a tiered rollout based on the companies’ size and influence. As the first step, large public interest entities will have to compile a sustainability report for 2024 and have it audited. That requirement will later be extended to other larger companies. 

Grant Thornton Baltic sworn auditor Anni Vaiksaar, who recently became certified as a sustainability report auditor, explains who is required to compile such a report and why, what workload can be expected, and the consequences of non-compliance. 

An ESG report seems like an onerous bureaucratic duty with benefits that are hard to grasp at first glance. After all, it should be possible for a company to behave responsibly toward the environment and society without reporting as well.

Indeed, it could be argued that if a company put the resources spent on compiling the ESG report toward actual sustainability-oriented activities, the world might ultimately be a better place. But the question comes down to: how do we know that a given company has done something, and how can we measure it and compare companies to each other? 

In some sense, it’s comparable to the change in submission of financial statements: when Estonia changed over to electronic filing in 2010, companies felt that was an additional burden and red tape, but now no one can conceive of doing it any other way.

It’s similar with ESG reporting. The European Sustainability Reporting Standards were  developed precisely to make it possible to gauge and compare how a company’s activities impact the environment, social well-being and economic sustainability. In terms of volume of work, implementation of the standard is naturally more intensive than just changing the reporting format. 

The sustainability report has to be sent to an auditor as well. Why?

An auditor’s job is to verify that the disclosed data are accurate, since that establishes credibility and helps to avoid greenwash. The auditor reviews the reporting for compliance with the prescribed framework – i.e. whether the data are comparable to those of other market participants. 

The mandatory submission of a sustainability report and audit rules out the possibility of filing the financial statements in the annual report to the Commercial Register without an auditor having approved the sustainability report first.

In what respects are sustainability report audits similar to audits of financial statements?

The main similarity lies in the fact that that the audit presupposes the existence of underlying documents – the audit trail. For a financial audit, these would be invoices and contracts, while for a sustainability report audit these documents are also used along with many others. For example, training plans showing that the company has invested into employees’ development and trained on various topics; or a CO2 footprint mitigation plan. If a company has measured its CO2 footprint and set the goal of cutting it by a certain percentage by 2030, it has also prepared a transition plan or strategy for how it intends to get there. For example, if it plans to replace internal combustion engine vehicles with EVs, it can calculate how much smaller its carbon footprint will be. Various Excel templates are available for this purpose, like the one on a website administered by the Ministry of Finance https://kestlikkusaruandlus.ee. The auditor evaluates whether the calculations were performed according to the standard and input information matches up with the underlying data. 

For now, the sustainability reporting obligation will be in effect for large enterprises, but for which ones exactly and when?

Yes, it is being rolled out first for big companies, and it will be the most challenging for them since it is a new topic. Smaller enterprises can draw on the large companies’ experience later.

Public interest entities are the first category of undertaking that will have to prepare and file sustainability reporting for 2024 to accompany their annual report. These are defined as companies with more than 500 employees whose shares are traded on a regulated securities market or which operate as a credit institution or insurance company. There are around 10 such companies in Estonia.

Next, the obligation will extend to large enterprises or corporate groups which met two of the following three indicators on two consecutive balance sheet dates: average number of employees over 250 in the given year, annual revenue over 50 million euros, and total assets over 25 million euros. These companies will have to prepare sustainability reports for 2025. 

For 2026, the obligation comes into force for publicly listed small and medium-sized enterprises if they met two of the following three criteria on two consecutive balance sheet dates: average number of employees for the given year exceeds 10, annual revenue exceeds 900,000 euros, and total assets exceeds 450,000.

According to Ministry of Finance data, there are about 300 such companies and groups in Estonia. 

Have you talked to anyone from the companies that have to submit a sustainability report this year? Are they aware of what they have to do? 

The ones I have talked to are ones that like to stay ahead of the curve and want to be prepared. They are the ones who reached out to us to make sure they are on the right track. But there are some that have not started preparing sustainability reporting. It’s not a good idea to keep on putting it off, or else they won’t be ready in time.

You mentioned that it takes a lot of time for companies to prepare sustainability reports. If you compare the time expenditure on sustainability reports with that of financial statements, what does the difference in the amount of work stem from?

Once a system has been developed, preparing sustainability reports won’t take more time than is required for preparation of financial statements. It requires the company’s information systems to be integrated in a way that the existing programs – accounting software, HR software etc. – all start outputting the required data. For example, information on how many men and women are on the payroll and what the salary differences are.

The biggest job at the outset of sustainability reports is double materiality assessment. That’s a method for determining which ESG aspects are important for the company from the financial and non-financial perspective. Double materiality assessment is at the heart of it all, because that determines what the company will report on in the first place. The assessment can take up to six months, though, because the company’s value chain needs to be mapped and that means the need to poll stakeholders, including clients and suppliers. For example, if a company manufactures something and buys inputs, it has to know how the production input was produced: whether employees were paid fair wages compared to the market average, whether child labour was used, what the CO2 emissions connected to the output was, and so forth. 

Let’s say a company recruits only women, because women ask for less pay. From the aspect of double materiality, the social impact is negative but financial impact is positive. How should the company proceed?

It can set aims for reducing the negative impact. Currently the problem is the fact that society lacks that information. But if the company has to start disclosing it, people will become more knowledgeable, making it possible to compare different companies with each other. Theoretically, the women working for the company are also among the annual report and ESG report readership, and even if they aren’t, maybe they have a friend who is, and urges them to ask for a raise, because men at another, similar company are earning more. 

In an ideal world, people could avoid buying from a certain company that has some disparities in its reporting. In real life, people count their money, and so I’m sceptical whether anyone is going to pass on buying chocolate from a company just because it’s public knowledge that they pay women 20% less than men.

Maybe not everyone is equally concerned about gender equality, but if I learn that a company exploited child labour to produce its products or that its chocolate contains more harmful chemical additives than the average, at least I am armed with information I can use to make decisions. To this point, it wasn’t possible to find out such details.

I would compare it to sales of free range and caged chicken eggs. A couple of years ago, practically no one paid any mind to the conditions in which hens were kept, but now there has been more discussion about it, people are more aware and there is a stable clientele for free range eggs. So we see that sustainable activity has become more and more important both for consumers and partners, for example due to pressure from banks or investors.