Allianz Risk Barometer 2023 -
Rank 5: Changes in legislation and regulation

In Europe, this aspiration is crystallized in the Corporate Sustainability Reporting Directive (CSRD), which was finally adopted in November 2022 and will become binding for all companies over the coming years – demanding a great deal of additional effort from them. This is because the CSRD not only targets the environmental aspect of economic activity, but also covers the entire spectrum of sustainability, including social aspects.

This brings the non-financial factors to the forefront of reporting, in line with the logic that it is precisely these factors that become financially material in the long-run. “The preservation of natural and social foundations is the basis for all economic activity, and undermining these foundations will hamper economic success sooner rather than later,” says Ludovic Subran, Chief Economist at Allianz.

Extending the reporting scope beyond the current focus on financial risks makes the disclosure of information a much more complex and challenging exercise, not least as the CSRD follows a “double materiality” approach: it requires assessing both impact directions. While the “financial materiality” is concerned with the impact of environmental, social, and governance (ESG) issues on the financial performance of assets (outside-in perspective), the “impact materiality” concentrates on the environmental and social impacts that an asset causes (inside-out perspective). Furthermore, in addition to the risk assessment, the CSRD requires a reporting of opportunities related to both sides of materiality. With the CSRD, the EU is taking the lead in sustainability reporting, in line with its claim to be a regulatory superpower.

In the coming years, the International Sustainability Standards Board (ISSB), based in Germany, will decide to what extent the European standards will also gain global acceptance. For the time being, there can be no talk of a level playing field.

In other areas, sustainability and the green transformation are likely to lead to more fragmentation for the time being. The EU has set the course for the Carbon Border Adjustment Mechanism (CBAM). Even if the logic of a CBAM can hardly be criticized – without an appropriate mechanism, there is a risk of carbon leakage and a permanent impairment of European competitiveness – it represents an additional burden on international trade flows. And this at a time when geopolitical upheavals are casting their long shadows on the progress of globalization.

“More and more new rules, standards, levies and sanctions will not bring the international flow of goods to a standstill, but they throw a spanner in the international division of labor, rendering it less efficient,” says Subran. “For companies, the new regulations go hand in hand with a considerable amount of additional work. Reporting and compliance are increasingly becoming strategic functions within companies.”

Nearly half of respondents cited cyber-security resilience as their foremost ESG concern in the Allianz Risk Barometer. For many, the war in Ukraine has heightened the risk of a large-scale cyber-attack, which can have wide ESG implications, including the failure of a business to protect its information network, the social consequences of disrupted supply chains, and damage to a company’s reputation. “Embedding cyber resilience in any enterprise risk management program or ESG framework is key,” says Denise De Bilio, ESG Director at AGCS’ risk consulting unit. “These must contain clear policies on ransomware and address the workplace impact of cyber-attacks on employees and their stress levels, as well as the risks to critical public infrastructure.”

With two in five workers reported to be considering changing jobs in the next three to six months, company working conditions also rank highly on the ESG risk list. “The pandemic shifted the social contract between employers and their people,” says De Bilio. “Companies are now expected to address a broad set of labor and employment issues, ranging from health and safety to wellbeing and diversity, while being accountable for driving societal impact, environmental stability and inclusive growth. The ‘S’ in ESG will gain momentum as companies strive to acquire and retain an environmentally and socially conscious talent pool.”

This momentum will be given greater urgency as ESG disclosure requirements are ramped up in major jurisdictions, such as with the Corporate Sustainability Reporting Directive (CSRD) in the EU.

The list of ESG issues companies face is fueling demand for skills and resources in this area yet demand far outstrips supply. A lack of consistent standards and reporting frameworks has hindered ESG knowledge gathering, training and certification. It also drives up costs. However, as ESG becomes more established, a talent pool will emerge, as will a prioritization of resources that support sustainability initiatives.

“The sustainability imperative is clear,” says De Bilio. “Integrating ESG considerations across all aspects of business has become the key performance indicator of a company’s financial health and its ability to meet increasing stakeholder expectations to support the transition to a green economy, access capital, raise financing, meet heightened regulatory and compliance requirements, and attract and retain talent.”