The upcoming months will see a dense dialogue between the European Commission, Parliament and the Council of the EU as they will move towards the adoption of the Corporate Sustainability Reporting Directive (CSRD). The general objective of the CSRD proposal is to contribute to the general Green Deal objective of creating “a fair and prosperous society, with a modern, resource-efficient and competitive economy”. And it plans to do so by addressing the shortcomings of the current EU rules on ESG reporting (under the Non-Financial Reporting Directive, NFRD), today deemed inefficient as they often led to the publication of insufficient, and incomparable information and, in some cases, to attempts greenwashing through picking and mixing sustainability information to improve their ESG appearance and profile.
Key aspects of the CSRD
The CSRD will address current deficiencies in the EU law by clarifying and extending companies’ ESG disclosure requirements. Companies will have to report information on the resilience of their business model and strategy to risks related to their sustainability matters; on their sustainability targets and related progress in achieving them; on their sustainability policies as well as on the main sustainability risks along their value chain, the related due diligence processes implemented, and the actions undertaken to prevent, mitigate and remediate them; on the sustainability risks the undertaking is subject to and the sustainability matters it is dependent on; on the role of administrative, management and supervisory bodies with regard to sustainability. The proposal also envisages that such information shall be disclosed in a quantitative and qualitative fashion, in an “understandable, relevant, representative, verifiable, comparable” manner.
The main novelty of the CSRD is that it envisages the development of “sustainability reporting standards” to clarify the information to be disclosed. It does not come as a surprise that such standards will have to take into consideration environmental factors de facto identical to the “environmental objectives” categories laid down in the Regulation on the Sustainable Finance Taxonomy: climate change mitigation and adaptation, water and marine resources, resource use and circular economy, pollution, and biodiversity and ecosystems. Moreover, these standards will cover information about social factors such as equal opportunity and gender equality, working conditions and human rights.
Finally, the proposal defines common auditing rules to ensure the faithfulness and reliability of the reported information.
What is key is that the proposal extends the sustainability reporting obligations of the current NFRD to a much larger number of companies, including listed SMEs – which are currently exempted from this obligation under the NFRD – from around 12.000 to 50.000 companies. SMEs will be in fact subject to specific reporting standards “proportionate to the capacities and characteristics of small and medium-sized undertakings” specifying which information SMEs shall report.
Modernising the EU financial market legislative framework
The proposal is part of a wider ambitious set of legislative initiatives aimed to enhance the sustainability of financial markets in the EU – together with other legislative tools such as the Sustainable Finance Disclosure Regulation (SFDR), and the EU Regulation on the Sustainable Finance Taxonomy, to which we dedicated a separate article. In fact, there is a close connection between these different pieces of legislation.
The SFDR describes how asset managers and financial advisers should disclose sustainability information to end-investors, and to do so they will require clear and adequate information from investee companies. For that purposed, the CSRD will ensure that investee companies report relevant and trustworthy information for financial market actors to be able to abide by the SFDR. In fact, the definition of sustainability matters is aligned between the SFDR and CSRD as the “environmental, social and employee matters, respect for human rights, anti‐corruption and anti‐bribery matters”.
On the other hand, the Taxonomy Regulation sets up criteria to define whether a company can be considered “environmentally sustainable”. As mentioned above, the CSRD will define sustainability reporting standards in line with the Taxonomy Regulation’s environmental objectives and define what additional ESG information companies have to disclose.
What impact on business?
All in all, this new piece of legislation is yet another pebble in the mosaic of the EU Sustainable Finance Strategy and part of the Union’s effort to modernise the financial system and enable it to “genuinely support businesses in their transition towards sustainability in the context of recovery from the COVID-19 outbreak”.
Although the legislation is still in its initial stage, companies across the industrial landscape should not underestimate its impact on their operations and prepare for its entry into force. Although these reporting requirements may not be mandatory before January 2026, as the text stands, the European Commission will adopt the first set of reporting standards already by October 2022, meaning that their preparation will start right after the adoption and entry into force of the directive. Moreover, a second set of reporting standards will be adopted by October 2023, specifying complementary sustainability matters information and sector-specific information that companies shall report.
It is evident that in the grand design of this modernisation of the EU financial market legislative framework, companies shall not only expect increased due diligence and reporting costs, but also consider potential impacts on their operations, supply chains, and financial appeal in the eyes of financial market actors and investors. Anticipating and shaping these regulatory changes might mean one’s business success or failure.