Sustainability reporting is a part of the European Green Deal initiative aiming to transform the EU to be the first climate-neutral continent. Its objective is to help various stakeholders – including investors, NGOs, and customers – and evaluate companies’ sustainability performance. Since 2018, all EU Public Interest Entities with over 500 employees have been required to publish yearly non-financial information according to the Non-Financial Reporting Directive (NFRD). Under NFRD, companies must publish information related to the following:
- environmental matters,
- social matters and treatment of employees,
- respect for human rights,
- anti-corruption and bribery,
- and diversity on company boards.
However, NFRD has been criticized for its inability to enforce quality reporting that provides a clear understanding of environmental and social performance, development, impact, and position due to a lack of coherence and comparability. Many companies failed to report strategic and financial risks of sustainability matters on the businesses themselves. They also omitted material environmental and climate information for their sector. Thus, making it difficult for investors to incorporate sustainability information in their decision-making. To overcome these issues, the European Commission proposed the Corporate Sustainability Reporting Directive (CSRD) which came into force on 5 January 2023. CSRD builds on the existing NFRD regulations and adds several important points.
What CSRD will change?
- Double Materiality: CSRD strengthens the rules of environmental and social information by implementing the concept of double materiality. Double materiality includes sustainability issues that affect the company, as well as business impact on the environment and people.
- Scope: the new directive broadens the scope from 11,700 to 50,000 companies under compliance, including SMEs and non-listed large companies.
- Reporting standards: companies subject to CSRD must report according to European Sustainability Reporting Standards (ESRS) developed by the European Financial Reporting Advisory Group (EFRAG). This is a big step for ensuring coherence and comparability of non-financial reporting but at the same time poses new challenges for companies in gathering quality information, for example how to rely on third-party data.
- Assurance: CSRD makes it mandatory to audit sustainability information by an independent auditor to ensure compliance with new rules. In six years, companies will no longer be able to perform limited assurance, as reasonable assurance will be required.
- EU taxonomy: CSRD obliges companies to inform about their EU taxonomy-aligned economic activities. These include the alignment of their turnover, capital expenses, and operational expenses with all six environmental objectives of EU taxonomy.
The first-time application of CSRD is planned as follows:
2024 – Public Interest Entities with over 500 employees (for the fiscal year 2023)
2025 – All large companies that meet at least two of the three criteria: more than 250 employees; more than €40 million turnover; more than €20 million in total assets
2026 – SMEs listed on capital markets not falling under the criteria of large companies
2028 – Non-EU parent companies with a net turnover of at least €150 million in each of the past two consecutive year
CSRD gives hope that sustainability reporting will evolve and that it will fulfil its aim of increasing transparency on sustainability matters. With the development of ESRS, the reporting quality may significantly improve thanks to the standardization of reporting standards. It will make sustainability reports much easier to evaluate and compare. Nevertheless, the framework still poses many challenges with regard to double materiality assessment and information gathering. Even though some firms have already reported their sustainability data for years, many will have to adapt their processes to collect necessary data quickly. Double materiality imposes reporting on both the impact of sustainability matters on business and business impact on the society and environment. This type of data not only involves financial assessments but often requires scientific knowledge. As many corporations implement appropriate tools and processes for data gathering, this may not be the case for smaller suppliers who themselves may not be obliged to provide sustainability reports. Therefore, the biggest challenge is gathering quality third-party data which is crucial for calculating sustainability information along the whole supply chain, such as Scope 3 of greenhouse gas emissions (indirect emissions within the supply chain).
The rising number of companies under compliance will likely increase the need for sustainability consultants and reporting “specialists”. The market has already responded to these challenges with an increase in sustainability consultancies and even through a growing number of sustainability students. Corporate reporting will definitely create new opportunities for those with sustainability reporting knowledge and experience.
Sources:
- A European Green Deal
- Corporate sustainability reporting
- Delivering the European Green Deal
- Falling short?
- The Corporate Sustainability Reporting Directive – Latest insights
- What the New EU Corporate Sustainability Reporting Directive (CSRD) Means for US Businesses