What is the CSRD?
As the global community continues to grapple with the pressing issue of climate change, policymakers and stakeholders alike have increasingly turned their attention to the role of the private sector in addressing this critical challenge. To this end, the European Commission has taken bold steps to promote sustainable finance and responsible corporate behaviour with the introduction of the Sustainable Finance Package in April 2021, which includes the ambitious and comprehensive Corporate Sustainability Reporting Directive (CSRD).
The CSRD builds on the existing Non-Financial Reporting Directive (NFRD), which has required significant public interest entities to report on their sustainability performance since 2018. However, as environmental, social, and governance (ESG) reporting has gained popularity, it has become increasingly clear that the quality and comparability of such reports have been lacking. Reports have often bypassed important information and have been difficult to benchmark from company to company, leading to a lack of trust among investors and other stakeholders.
The EU’s new legislation aims to tackle these problems head-on by establishing a common reporting framework, CSRD, that ensures that businesses report reliable and comparable sustainability information in compliance with pre-defined European Sustainability Reporting Standards (ESRS). The European Commission appointed the European Financial Reporting Advisory Group (EFRAG) to prepare and draft the first set of standards. The core task of EFRAG is to provide counsel to the Commission regarding the incorporation of international financial reporting standards into EU legislation. At the end of 2022, EFRAG released the first twelve draft ESRS. The final standards are expected to be released in June 2023 after the draft standards have been reviewed by the European Parliament and Council, and other European bodies. As soon as the Parliament and Council approve of the ESRS, Member States are required to implement them into national law.
When the Non-Financial Reporting Directive set the foundation for companies to annually report on sustainability datapoints, it established the ‘double materiality’ approach, which is now a tenet of CSRD. This principle requires companies to report from two distinct viewpoints when reporting: the impact of each sustainability factor on the company (the “external” perspective) and the impact of the company on individuals, stakeholders, and the environment (the “internal” perspective).
A Storm is Coming – To who does the CSRD apply and from when?
The companies that already had to report on non-financial data, under the NFRD, were large “public interest entities”, such as listed companies, insurance firms, and banks with over 500 employees. Therefore, the NFRD’s coverage was limited. Contrary to the NFRD, only applying to roughly 11,000 companies, the CSRD applies to a wider range of companies that tick at least two of the following three conditions. A company with over 250 employees, a company with a balance sheet total of 20+ million, and a company having a net revenue over 40 million euros. Even companies outside the EU must be cognizant of the CSRD. If a company has a large or publicly listed EU subsidiary or branch with a net turnover of 40 million euros within the EU and has generated a net revenue exceeding 150 million euros in the European market in the last two fiscal years, the CSRD applies to them as well. This means that the CSRD encompasses all significant business operations that occur within the EU.
A core reason why the European Commission steers towards a more encompassing reporting directive concerning non-financial data and making more large companies accountable for their impact on people and the environment, is to cater the needs of stakeholders and investors demanding publicly accessible sustainability information from companies. By setting requirements concerning CSRD compliance, and therefore including small- and medium enterprises, the European Commission aim to create an encompassing environment in which investors can see the sustainability performance of companies. All companies required to report on CSRD must report in a pre-defined electronic format, to make it easy for stakeholders to access. These developments are also in line with the upcoming EU Taxonomy, which is a classification system to boost sustainable economic activities within the EU by making a distinction by sustainable and non-sustainable economic activities of companies to inform investors and other stakeholders.
The implementation of the EU CSRD regulation will occur in a phased approach, with the following schedule:
Extracting the Jack out of the Box – What’s in it?
It is important to note that there are already established international sustainability reporting standards that companies follow, such as the Carbon Disclosure Project (CDP) and the Global Reporting Initiative (GRI). For reporting carbon emissions, companies comply with standards established by the Greenhouse Gas Protocol. It is in the European Commission’s interest, to integrate before-mentioned standards within CSRD, to avoid overloading companies with the already excessive paperwork required to comply with the ESRS, and reward those companies with the work that they have already done.
Upon examination of the released twelve draft ESRS, it is observed that two ESRS fall under the categorisation of cross-cutting standards, while the other ten are classified as topical standards. The cross-cutting standards serve as general guidelines for mandatory disclosures, while the topical standards are more detailed. These topical standards are divided in three distinct categories of information that companies must report on: environmental, social, and governance.
The environmental category, with its five standards, necessitates companies to disclose information on topics such as climate change, pollution, water and marine resources, biodiversity and ecosystems, and resource use and circular economy. Concerning the four social standards, companies are required provide information about their own workforce, workers in their supply chain, affected communities, and consumers and end-users. The governance category demands companies to reveal information concerning business conduct. Each standard mandates specific disclosure requirements for companies. For instance, under the draft standard for climate change, a company must provide general disclosures related to climate change, metrics and targets, and impacts, risk and opportunity management, as well as standard-specific information, such as scope 1, 2, and 3 emissions.
Besides the released twelve draft ESRS, the implementation of a second set of sector-specific reporting standards, tailored to various company forms, is expected to be released soon. It should also be noted that companies obligated to report should engage in a stakeholder dialogue with their most significant stakeholders in the value chain to identify the most pertinent reporting standards that impact the chain the most.
A transparent way of disclosing information
It is clear there is a need for more transparent reporting on non-financial data, and the CSRD is definitely a step in the right direction when it comes to transparency. To make sure that the information that companies report on under the CSRD is valid, a EU-wide audit requirement is needed to make sure the data is reliable, accurate, and legitimate. The Commission aims to establish similar assurance levels for both financial and sustainability reporting. To achieve this goal, a gradual approach is being proposed. Initially, a limited assurance requirement will be implemented, which represents a significant improvement from the current situation but does not impose the more demanding reasonable assurance requirement. Currently, reasonable assurance of sustainability reporting is challenging without sustainability assurance standards. The proposal gives the Commission the possibility of creating such standards, and if they are adopted, the legal requirement will become a requirement for reasonable assurance instead of limited assurance.
Compliance to the CSRD should not only be about producing a report, but also about how this reporting can contribute to behavioural changes that lead to a more just and sustainable world. The CSRD can help identify areas where companies need to improve and can guide their efforts towards achieving a more sustainable and socially responsible business model. It will also build trust with stakeholders, including customers, investors, and communities. Ultimately, the goal for CSRD is to become a driver for positive change that benefits both companies and society.
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