Posted: 02/12/2022
Governments and organisations globally recognise that businesses of the future must operate in a more responsible and sustainable way than ever before. On 6 November 2022, heads of state and other climate stakeholders gathered in Egypt for COP27, the twenty-seventh conference of the Parties of the United Nations Framework Convention on Climate Change, which focuses on implementation of the Paris Agreement and negotiating global actions on climate change. However, sustainable working practices extend beyond the environment and include the prevention of other issues such as human rights and forced labour.
The European Union has taken a great leap forward in bringing such sustainable practices into the focus of companies located or active in the EU through the introduction of two directives namely, the Corporate Sustainability Reporting Directive (CSRD) and the Corporate Sustainability Due Diligence Directive (CSDDD). These instruments - both currently in proposal form - will affect how companies manage and report on their efforts to achieve sustainability.
This article outlines the scope, key obligations and timelines for enforceability of the CSRD and what this might mean for companies falling within the scope of the directive.
The CSRD extends the scope of the EU sustainability framework, meaning that companies in the UK with EU subsidiaries may now be subject to sustainability reporting obligations. Companies with such EU subsidiaries or who do business in the EU should review their operations closely to assess whether such obligations will be mandatory.
The CSRD was adopted by the European Parliament on 10 November 2022 and the proposal will now move on to the Council, with formal adoption expected to take place later in December. The directive expands the scope of the current EU sustainability reporting framework under the Non-Financial Reporting Directive (NFRD) to encompass a much wider range of companies and to require reporting on more issues in greater depth.
As well as companies within the scope of the CSRD itself, such reporting obligations will affect companies in the wider supply chain who may be called on to provide the data needed for the sustainability reports of their customers.
The CSRD aims to ensure that sustainability reporting is more accessible, reliable and comparable in order to facilitate greater value and utility for the end users of sustainability reporting. According to the CSRD proposal, the primary users of sustainability information reported by companies are investors, NGOs and social partners.
Investors use this information to better understand the risks and opportunities afforded by sustainability issues, as well as the impact of potential investment opportunities on people and the environment. NGOs and other organisations, on the other hand, use sustainability information to hold undertakings to account for their human and environmental impact.
The key concepts to be introduced or advanced by the CSRD fall within the following categories identified in the CSRD Proposal:
The CSRD will have a much broader scope than the existing framework. The CSRD will apply to all 'large' EU companies and EU subsidiaries of non-EU parent companies that exceed the limits of two or more of the following criteria: an average number of employees during the financial year of 250, a net turnover of €40 million, or a balance sheet total of €20 million.
For non-European companies the requirements of the CSRD will apply to all companies with at least one subsidiary or branch in the EU and that generate net turnover of €150 million in the EU. It will be the responsibility of the subsidiary or branch to publish the CSRD report for the non-EU undertaking.
The CSRD will also apply to SMEs listed on regulated markets but SME reporting standards will be tailored to the capacities and resources of such companies. An opt-out will also be available for SMEs during the transitional period of the CRSD that will exempt them from the scope of the CSRD until 2028. The proposal also entirely exempts listed micro-companies from mandatory reporting obligations and does not include SMEs listed on SME growth markets or multilateral trading facilities.
An important pillar in ensuring that reporting is comparable and reliable is the introduction of the requirement that companies’ sustainability reports are audited. The CSRD will require accredited independent auditors or certifiers to review and certify sustainability reports to ensure they are compliant with the objectives and sustainability reporting standards of the CSRD and the EU.
This will also include an audit of the process used by the company to identify the information contained in the report. Non-EU companies with qualifying subsidiaries or branches will also be subject to the auditing requirement either by an EU or local auditor.
Improving the standard and reach of sustainability reporting is one of the central objectives of the CSRD. This is evident even from the changes to definitions where terms like 'sustainability matters' and 'sustainability reporting' have been introduced, in contrast to the previous NFRD framework that relied on the term 'non-financial information' to capture sustainability information that was considered particularly vague by stakeholders.
The CSRD outlines in greater detail the nature of the reporting that companies should provide and the information that should be disclosed. Under the CSRD, companies will be required to provide information on their strategy, targets, governance (including at both the board and management level), adverse impacts connected to the company and its value chain, intangibles, and also how they have identified the information that they report.
Within the above areas, the CSRD also outlines the kind of information that should be disclosed. The proposal highlights that companies should report qualitative and quantitative information, forward-looking and retrospective information, and information that covers short, medium and long-term time horizons.
One aspect of the previous framework that was identified as substandard was stakeholder access to reliable information. To combat this, companies within the scope of the CSRD are required to include compliant sustainability information within a separate section of the management report. This removes the option under the previous framework for member states to allow companies to report sustainability information in a separate report distinct from the management report.
Additionally, the CSRD proposal introduces the idea of digitally-tagged sustainability reporting information. This concept aims to increase digital accessibility to sustainability information in order to enhance its utility and application in advancing digital technologies.
It is not yet known what kind of non-compliance with the CSRD will trigger sanctions or what those sanctions may be. The existing framework allows member states to implement their own sanctions. For example, non-compliance with the NFRD in Germany will result in a fine of the higher of €10 million or 5% of the total annual turnover of the company or twice the amount of the profits gained or losses avoided because of the breach. Whereas, in France, fines are not imposed unless an interested third party requests a disclosure that cannot be provided by the relevant company.
As mentioned above, the European Parliament formally adopted the CSRD on 10 November 2022. The Council will also then formally adopt the CSRD and it will be published in the Official Journal of the EU. It will enter into force 20 days after publication and its provision will have to be integrated into member states’ national laws after 18 months. The CSRD will be implemented in the following stages:
Importantly, the CSRD enhances and builds on the NFRD in bringing sustainability reporting under organised and cohesive standards. In doing so, the CSRD highlights the importance of reliable sustainability reporting and emphasises its increasing parity with traditional financial reporting in today’s corporate world. The knock-on effect of this sustainability push is that stakeholders are provided with better information to use and exploit, thus improving the value and utility of sustainability information in the wider marketplace.
As the reporting standards - and the CSRD itself - have not yet been finalised or released, companies may be unable to identify specific aspects of its operations that require reporting. However, companies can and should identify whether they fall within the scope of the CSRD and begin to implement processes for the identification and capture of information that is likely to be required by the CSRD.
Companies in the UK with EU subsidiaries or that do business in the EU should consider now how the CSRD will affect their operations and their sustainability reporting obligations.
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