Most companies are struggling to comply with the European Union’s requirements for sustainability reporting, which aim to bring environmental, social, and governance (ESG) disclosure to the next level. Indeed, a recent report by EFRAG revealed that nearly 80% of companies find it difficult to gather the necessary data to adhere fully to the new reporting standards.

Rather than treat these regulations as a compliance burden, boards of directors should see them as a chance to refocus their company on critical ESG goals. Instead of filing a report that covers all aspects of the company’s sustainability practices, boards should narrow their focus and report only those that are materially relevant and strategic. This targeted approach can turn sustainability reporting into a meaningful, forward-looking exercise that not only meets regulators’ requirements but also benefits the organization in the long term.

Focusing on What Matters

Of all the new regulations, the European Union’s Corporate Sustainability Reporting Directive (CSRD), which is supported by the European Sustainability Reporting Standards (ESRS), represents a significant step toward greater transparency in response to rising stakeholder expectations. (See “Understanding CSRD and ESRS.”)

Even though an initial category of EU entities—including large listed companies, banks, and insurers—must apply the new rules for the 2024 fiscal year, we are still finding that many boards are inadequately prepared for CSRD and ESRS. For example, some remain largely unaware that EU firms must now report on ESG issues across their entire supply chain, often requiring sustainability data and adaptation from non-EU suppliers to meet their compliance obligations.

Even more worrying, some boards are under the mistaken impression that they have already confronted and integrated the complexities of sustainability reporting. “Complacent boards who think they are finished with CSRD and ESRS,” a director said to us recently, “are either overseeing an unusually straightforward company or have simply not grasped what the regulations demand.”

Such misunderstanding carries substantial risk. The CSRD and ESRS reinforce board accountability, requiring that directors actively oversee the preparation of sustainability reports, ensure their accuracy, and carefully manage the approval process. Moreover, boards must sign a statement of responsibility confirming that the company’s sustainability impacts, risks, and opportunities are appropriately integrated into its financial disclosures, forecasts, and forward-looking statements. Any inaccuracies, it should be stressed, can lead to legal and reputational risks. To mitigate these risks, boards must establish robust processes for preparing ESG reports and verifying the data.

The good news, however, is that CSRD and ESRS do not require companies to report on every aspect of their sustainability practices, provided that they use a materiality-based approach. This approach involves reporting only on issues that are material from a financial perspective (how ESG factors influence the company’s financial performance and long-term viability) and from an impact perspective (how the company’s activities affect people and the planet). Companies can thus choose to focus their reporting on the ESG topics that are most relevant to their business and stakeholders.

This focus on materiality-based reporting may conflict with more conservative views that call for an all-encompassing disclosure. But we are not the only advocates for a more targeted approach. It should be noted that regulators strongly recommend such prioritization, and EFRAG affirmed it in their guidance from May 2024: “Relevance is the criterion to identify the information to be disclosed.”

Making CSRD and ESRS Strategic

To achieve CSRD and ESRS compliance, a board could simply instruct the sustainability team to get on with it. However, we propose a more strategic approach that not only ensures compliance with new regulations but also anticipates how ESG will come to influence both the nature and scale of a company’s value.

Our research, in partnership with Heidrick & Struggles and the INSEAD Corporate Governance Centre, reveals that only 35% of board members fully understand how ESG can affect a company’s value, and an even smaller proportion (12%) actively scan for emerging ESG-related risks and opportunities. But by adopting the materiality-based approach, organizations will be focused on what is strategically relevant and, therefore, better equipped to cope with future uncertainties and capitalize on potential growth opportunities.

One way to test a company’s ESG strategy, and flesh out its thinking in the medium term (five to ten years), is to use comprehensive and imaginative dynamic scenario planning. This involves exploring a variety of possible events and outcomes, as well as their related challenges and opportunities—similar to these climate scenarios we have recently developed.

Plausible but exaggerated future scenarios can be used as a springboard to assess potential ESG impacts and risks, identify opportunities, and tailor strategies to the various business environments that may emerge. In this way, companies can pinpoint the capabilities required to thrive in a particular situation and the specific actions they would take should a certain scenario materialize. No-regrets moves, big-bet strategies, and contingency plans can all be determined in advance, together with the early-warning indicators that would trigger their selection. This proactive approach would thus generate corporate strategies that boost resilience and are aligned with the company’s values and goals.

A more informed perspective can also help to avoid the pitfall of overreporting, often viewed as a means to sidestep the perceived risk of omitting certain disclosures and reassure the board that the company is in compliance. In addition, through scenario planning, the ESG issues most material to the company will emerge naturally, focusing attention on which topics to report on and which to exclude. The board’s involvement throughout this process fosters internal alignment, enabling it to answer stakeholder questions on the selected strategy or support the management team when obstacles are encountered.

Taking the materiality-based approach also makes more efficient use of ESG budgets and maximizes the return on investment. Instead of diluting resources across a wide variety of topics, companies can concentrate their efforts on areas where they can deliver the most value.

Striking the Right Balance

At the Aspen ESG Summit 2024, organized by the Aspen Institute’s Business and Society Program, a participant noted: “This year, I seem to have an unlimited budget for ESG reporting, yet no funds are left for strategic ESG initiatives.”

Taking the materiality-based approach strikes a balance between reporting requirements and thinking strategically, making the process both more manageable and more impactful. Indeed, we don’t view CSRD and ESRS as just another regulatory challenge. On the contrary, by taking this forward-looking approach and resisting the pressure to overreport, and integrating sustainability with corporate strategy, CSRD and ESRS provide boards with an invaluable opportunity to enhance the company’s strategic direction and long-term value.