CSRD and ESRS
The Corporate Sustainability Reporting Directive (CSRD) represents a significant regulatory development in the EU’s efforts to promote transparency and accountability regarding corporate sustainability. As a part of the broader European Green Deal, the CSRD aims to expand the scope and content of the Non-Financial Reporting Directive (NFRD) to improve the accuracy, comparability, and standardisation of sustainability reporting. Companies required to comply with the CSRD must adhere to the European Sustainability Reporting Standards (ESRS) developed by the European Financial Advisory Group (EFRAG), which detail the sustainability-related information companies need to disclose.
Recently, the European Commission issued 12 ‘near final’ ESRS for public feedback, representing significant changes compared to those prepared by EFRAG in November 2022. The public consultation is set to conclude on July 7th, and the final standards are anticipated to become law by late July or August 2023. The application of the ESRS, governed by the CSRD’s scope, commences from January 1st, 2024. However, each entity’s level of compliance hinges on several factors that will be discussed shortly.
The ESRS lays out detailed reporting prerequisites as prescribed by the CSRD, encompassing a broad range of sustainability matters across ESG factors. The 12 draft ESRS proposal includes two cross-cutting standards applicable to all sustainability matters, coupled with ten topical standards addressing an extensive selection of ESG issues. The revised drafts have been streamlined and modified to reduce the reporting burden, introduce additional phase-in provisions, allow voluntary disclosures, and offer more flexibility in certain disclosures.
The regulatory transformations instigated by the CSRD and ESRS necessitate that companies scrutinise their existing sustainability reporting practices to identify gaps and deficiencies, before developing strategies to fulfil the obligations of the CSRD and ESRS.
By modernising and strengthening the rules concerning ESG information that companies must report on, the CSRD expands upon the NFRD in several important ways. This expansion includes a substantial increase in the scope of reporting requirements, increasing the number of companies required to complete sustainability reports from approximately 11,600 under the NFRD to around 49,000 once the rollout is complete. While the NFRD only required compliance from large, listed EU companies with at least 500 employees, the CSRD requires compliance from large listed and non-EU companies which satisfy two of three criteria: net turnover exceeding €40 million, balance sheet of total assets greater than €20 million, and/or employing more than 250 staff. Additionally, companies with securities listed on EU-regulated markets, SMEs listed on an EU-regulated market, and non-EU companies which have at least one subsidiary generating sales of over €150 million within the EU are also bound to comply.
Another significant divergence is the adoption of ‘double materiality’, an innovative regulatory principle that makes the material assessment more complex than most companies are used to. This principle mandates companies to report not only on the environmental and social issues that affect their financial health (financial materiality) but also on the impact of the company’s activities on the environment and society (impact materiality). Although the ESRS interoperates to a limited extent with the ISSB and GRI, the unique reporting requirements of the CSRD and ESRS may prove especially complicated for multinational companies operating within the EU. Given that the potential equivalence of other standards to the CSRD requirements has not yet been made clear by the European Commission, multinational companies may be forced to navigate divergent reporting standards across diverse geographies. For example, climate disclosures enforced by the US Securities and Exchange Commission are unlikely to be deemed equivalent due to their narrow focus on environmental standards. Such disclosure requirements do not align with the comprehensive inclusion of cross-cutting, social and governance standards by the ESRS.
The CSRD is set to be introduced through a phased rollout, enabling companies sufficient time to adjust their existing reporting frameworks and processes with respect to their current capabilities. Broadly, this rollout can be separated into four key phases.
- From January 1, 2024: The CSRD will apply to companies already subject to the NFRD for fiscal year (FY) 2024, with reports due in early 2025.
- From January 1, 2025: The CSRD will apply to companies not already subject to the NFRD, but who fulfil at least two of the three criteria for large listed and non-listed EU companies for FY 2025, with reports due in early 2026.
- From January 1, 2026: The CSRD will apply to listed SMEs for FY 2026, with reports due in early 2027. However, listed SMEs may delay full compliance for financial years starting before January 1, 2028, provided they include a statement in their management report explaining compliance has been unattainable and the measures being taken to ensure future compliance.
- From January 1, 2027: The CSRD will apply to non-EU companies with at least one subsidiary generating at least €150 million in sales in the EU for the FY 2027, with reports due in early 2028.
Ultimately, while the CSRD outlines the reporting requirements and obligations, the ESRS serves as a methodological framework for reporting on sustainability issues. The ESRS is designed to form an integrated and comprehensive structure for ESG reporting that empowers stakeholders to have access to accurate and comparable information about a company’s sustainability-related impacts, risks, and opportunities. The implementation of the CSRD and ESRS will demand significant dedication and adaptation from companies, possibly requiring a substantial increase in resource allocation towards sustainability reporting. For non-EU companies subject to the CSRD, the need to synchronise their sustainability reporting with the CSRD and ESRS could serve to be particularly challenging.
Nevertheless, despite the initial hurdles of adapting to the changing regulatory landscape, there are many long-term advantages of effective compliance. Transparent and accurate sustainability reporting can greatly improve corporate reputation, thereby providing companies with a competitive edge by fostering stakeholder trust in their commitment to sustainable business growth. For multinational companies, while the evolving reporting requirements may be particularly challenging, such regulations are like to grow in global influence, and an effective early adaptation to stricter EU disclosure requirements could well prepare them for similar changes worldwide. As Europe drives towards a sustainability-defined future, the CSRD and ESRS act as important guideposts, illuminating a path towards a greener, more transparent corporate landscape. Companies that proactively prepare for the CSRD rollout will be poised to reap the significant benefits of this vision.