On 28 November 2022, the Council of the European Union (“the Council”) adopted the proposed Corporate Sustainability Reporting Directive (“CSRD”), clearing the final hurdle to the CSRD entering EU law. Member states have 18 months to incorporate the CSRD’s provisions into national law following its publication in the Official Journal of the European Union.
The CSRD is the latest in a series of directives on non-financial disclosure. These were initially introduced by the 2014 Non-Financial Reporting Directive (the “NFRD”) which itself amended the 2013 Accounting Directive (the “Accounting Directive”) to require reporting on environmental and certain social matters.
The CSRD builds on the NFRD by expanding the scope of companies caught and by imposing more detailed reporting requirements on in-scope companies.
Who is caught?
The CSRD will apply to:
- all ‘large’ EU companies; and
- all companies listed on EU regulated markets (except micro undertakings).
Companies will be considered ‘large’ if they exceed at least two of the following criteria:
- balance sheet total of €20 million;
- net turnover of €40 million;
- an average of 250 employees during the financial year.
The CSRD also apply to listed SMEs. However, listed SMEs will be subject to lighter reporting requirements and will benefit from an opt-out until 2028.
Non-EU companies operating in the EU (whether listed or not) may also be caught if they meet certain thresholds. The CSRD will also catch non-EU companies that have at least one subsidiary or branch in the EU and a net turnover of more than €150 million generated in the internal market. If the non-EU company has an EU subsidiary, the CSRD will only apply if the subsidiary is either large or listed and is not a micro undertaking. If the non-EU company has an EU branch, the CSRD will only apply where the branch generates a net turnover of more than €40 million.
What do the new rules require?
One of the key features of reporting under the CSRD is that in-scope companies will have to report on a double materiality basis – i.e. both how their business impacts and is impacted by Environmental, Social and human rights, and Governance (“ESG”) issues.
Overall, the CSRD introduces extensive sustainability-related disclosures, although they vary marginally according to the type and size of in-scope entity. Matters that companies will need to report on include:
- resilience of the company or group’s business model and strategy in relation to sustainability risks;
- sustainability strategy and transition plan(s);
- how the company’s business model and strategy consider its stakeholders’ interests and its impacts on sustainability matters;
- sustainability targets and policies;
- any incentive schemes linked to sustainability matters;
- indicators relevant to its sustainability-related disclosures; and
- a description of the due diligence processes with regard to sustainability matters and actions taken to remediate or mitigate potential adverse impacts in its supply chains.
Additionally, the reports will have to be accompanied by a limited assurance opinion: this is first time we have seen a general EU-wide audit requirement for sustainability information, and this is likely to set the direction of travel that other jurisdictions may follow.
What reporting standards do in-scope companies need to report in accordance with?
This is still somewhat in flux, as the relevant EU sustainability reporting standards still need to be adopted by the European Commission – the Directive requires these to be adopted by June 2023. The European Financial Reporting Advisory Group (“EFRAG”) has submitted its first general set of European Sustainable Reporting Standards (“ESRS”) to the European Commission. EFRAG will now turn to the drafting of sector-specific ESRSs, which are required to be adopted by the European Commission by June 2024. By June 2024, the Commission will also adopt the sustainability reporting standards for non-EU companies caught by the CSRD. It is currently unclear to what extent these standards will align with or diverge from the ESRSs.
The application of the directive will be phased, with obligations starting to apply at different times depending on the type of entity:
- reporting in 2025 on the financial year 2024 for companies caught by the CSRD that are already subject to the NFRD;
- reporting in 2026 on the financial year 2025 for large companies caught by the CSRD that are not currently subject to the NFRD;
- reporting in 2027 on the financial year 2026 for listed small and medium companies (except micro undertakings); and
- reporting in 2029 on the financial year 2028 for non-EU companies with net turnover above €150 million in the EU if they have at least one subsidiary or branch in the EU exceeding the thresholds mentioned above.
- The CSRD goes some way to meeting the demands of an increasingly ESG-focused investment community which demands hard data setting out the risks and opportunities arising from sustainability issues. Arguably, the CSRD marks the beginning of a new dawn of comprehensive ESG reporting and monitoring in the EU.
- Companies who may fall within the scope of the CSRD should consider starting their analysis now and:
- Mapping out which entities will be caught by which provisions of the CSRD (as, depending on the size of the relevant entity, the reporting obligations may apply at different times) – this would likely involve engaging with financial reporting teams to assess whether relevant thresholds are met (or might be met, if business performance changes over time);
- Carrying out a gap-analysis exercise to understand what additional information and processes may be required;
- Assigning tasks to internal teams, designating responsibility for gathering information and establishing appropriate reporting lines, promoting collaboration between different EU entities where required and putting in place appropriate governance structures to oversee the new reporting obligations; and
- Whilst still at the draft stage, improving familiarity with the ESRSs to understand what additional information will need to be disclosed.
- Companies operating across multiple jurisdictions may be concerned about the risk of having to comply with similar-but-different reporting requirements. The CSRD includes an equivalence mechanism – in practice, this will mean that if the non-EU parent of an EU subsidiary reports in accordance with ‘equivalent’ reporting standards to the ESRSs (and that EU subsidiary is included within the consolidated report), certain reporting exemptions will apply. However, given the CSRD and corresponding ESRSs are already more ambitious than most other standards, it may be difficult to see which other standards will be considered ‘equivalent’. For example, the nascent ISSB standards (which the UK intends to adopt as baseline standards for sustainability reporting), do not require a double materiality approach, and therefore are unlikely to be considered ‘ESRS-equivalent’. However, there is an ongoing collaboration between ISSB and EFRAG, so it remains to be seen whether an agreement can be reached and the extent to which the two standards will be interoperable.