What does EU Corporate Sustainability Reporting Directive (CSRD) mean for firms in scope?

Having addressed the shortcomings in its current regulatory framework on disclosure of non-financial information, the European Union (EU) is once again at the forefront of the international race to sustainability standards and the transition to a sustainable economy. The provisional political agreement on the Corporate Sustainability Reporting Directive (CSRD) reached by the European Council and European Parliament on 21 June 2022 sets high standards in line with the European Green Deal. 

The CSRD is part of the bigger Sustainable Finance package, which enables the Green Deal by helping to channel private investment behind the transition to a climate-neutral economy. The directive amends the current Non-Financial Reporting Directive (NFRD) adopted in 2014, creating a more consistent and coherent flow of sustainability information throughout the financial value chain. It makes a very important contribution to extending the European Green Deal across all sectors and existing regulation. With the adoption of the new framework, companies will face more onerous reporting requirements with respect to sustainability issues such as environmental rights, social rights, human rights and governance factors.

The current NFRD framework, together with the Sustainable Finance Disclosure Regulation (SFDR) and the Taxonomy Regulation, are the central components of the sustainability reporting requirements underpinning the EU’s sustainable finance strategy. However, it suffers from a widening gap between the sustainability information made available by companies and the needs of the users of that information. This means that investors are unable to channel financial resources to companies with sustainable business models and activities, which grossly undermines the objectives of the European Green Deal. It also hampers stakeholders’ ability to hold companies accountable for the impact they have on people and the environment, creating an important accountability issue in the financial system.

To summarise, the CSRD extends the scope of the reporting requirements to additional companies, requires assurance of sustainability information, specifies the information that companies should report in more detail, requires them to report in line with mandatory EU sustainability reporting standards and ensures that information is disclosed in a machine-readable digital format. There is also an important change in the terminology of the framework, where “non-financial information” is replaced with “sustainability information”. It is understood that this is due to the fact that the former implies that the information in question has no financial relevance whereas it does indeed have financial relevance.

The CSRD will require sustainability reporting in a dedicated section of company management reports, improving the accessibility of such information for investors and other stakeholders. This will give asset managers who want to invest sustainably an opportunity to do so, contributing to a stable, sustainable and inclusive economic system. These requirements will apply to all large companies and all companies listed on regulated markets, including Small and Medium Enterprises (SMEs). However, during a transitional period an opt-out will be available for SMEs. In practice, this means that they will essentially be exempted from the application of the directive until 2028. 

Needless to mention, the implementation of the CSRD will also address the recent increase in demand for corporate sustainability information on the part of the investment community. The current NFRD framework falls short of the information needs of stakeholders are met. While some companies from which users want sustainability information do not report such information, others that do report such information do not report all the information that is relevant. Reported sustainability information is often neither sufficiently reliable, nor sufficiently comparable. Furthermore, it is rarely available in a machine-readable digital format.

In order to ensure the quality of reporting, the CSRD requires the reporting to be certified by an accredited person or firm. More specifically, either an independent auditor or a certifier will be required to ensure that the sustainability information provided by a company is in compliance with the certification standards that have been adopted by the EU or under national law of the third-country undertaking. In practical terms, this means that firms' sustainability reporting will be based on a reasonable assurance engagement with their independent auditor or certifier. They will be given a broad choice of independent assurance service providers for the assurance of their sustainably reporting. This is important because reliability and accuracy of the information reported would not only foster comparability across and within market sectors for investor but also allow policy-makers to monitor environmental and social trends.

The scope of the directive is considerably extended to apply to more EU and non-EU companies listed and operating in the EU regulated markets. It will apply to a “large undertaking” that is either an EU company or an EU subsidiary of a non-EU company, where a “large undertaking” is a defined as an entity that exceeds at least two of the three criteria: (i) a net turnover of €40 million, (ii) a balance sheet total of €20 million, and (iii) 250 employees on average over the financial year. The directive will also apply to all insurance undertakings and credit institutions.Subsidiaries will be exempt if the parent company includes the subsidiary in its report that complies with the CSRD.

In the case of non-EU companies, the requirement to provide a sustainability report on the environmental, social and governance (ESG) impacts will apply to companies generating a net turnover of €150 million in the EU and which have at least one subsidiary or branch in the EU. Furthermore, the reporting of non-EU companies will be required to be certified, either by an auditor in the EU or in a third country. For publishing the sustainability report of the third-country undertaking, the EU subsidiary or EU branch will be ultimately responsible.

In terms of the implementation timeline, the provisional agreement is subject to approval by the European Council and the European Parliament. The EU is expected to adopt the CSRD in October 2022. The directive will enter into force 20 days after its publication in the Official Journal of the EU. Under the CSRD, companies will start reporting from 2024 in line with mandatory EU sustainability reporting standards and alongside an external assurance of sustainability reporting.

For companies already subject to the non-financial reporting directive, the CSRD will apply from 1 January 2024. For large companies that are not currently subject to the non-financial reporting directive it will apply from 1 January 2025. SMEs listed on regulated markets, small and non-complex credit institutions and captive insurance undertakings, on the other hand, will have an additional year. Non-listed SMEs will not be required to report but can do so on a voluntary basis.