CSRD is shifting ESG activities from "nice to have" to "must"
November marks some major changes in European sustainability reporting - the Corporate Sustainability Reporting Directive (CSRD) approved a few weeks ago, along with the finalised and approved first part of European Sustainability Reporting Standards (ESRS), are the big milestones in the EU Green Deal and its commitment to become the first environment-neutral continent. If corporations are reporting or have started collecting their environmental and social data already, companies new to the ESG game have a vague understanding of when, how and if it will influence them or, more importantly, will the burden of requirements bring the expected impact. That is why the approval of CSRD, stamped by the European Parliament last week, is a crucial step in moving ESG beyond compliance and ensuring every company will have a role to play in reaching European sustainability goals.
Why is it important?
First of all, CSRD will bring more structure and consistency in the ESG reporting. NFRD, the currently active directive, had only non-binding guidelines for disclosures, which created confusion. Therefore companies have been using a variety of reporting frameworks (GRI, CDP, CDSB, TCFD, SASB etc), which made the reports difficult to compare and evaluate. CSRD, along with the sustainability accounting and reporting standards that should be finally approved within the next few months and EU Taxonomy, will create a consistent and coherent flow of sustainability information throughout the financial value chain and will align the process.
Another reason is accountability of the reporting companies. Today ESG is seen as a requirement for the largest companies or heaviest polluters. Although sustainability is taking headlines in corporate communication already, only a handful of companies have an ambitious ESG strategy, clear KPIs and implementation plans. This is where CSRD is critical - reported as part of the management report, which is part of the annual report, it will prevent large companies from using sustainability as a buzzword and ensure accurate, data-based implementation and reporting of ESG activities.
Last but maybe the most importantly, CSRD will extend the scope of the reporting companies. In addition to the large publicly listed companies, it will grow from 11.000 to nearly 50.000 companies, including the listed SMEs. By 2026 only the listed micro companies and non-listed SMEs will fall outside of the scope, but be encouraged to apply the provisions voluntarily.
Financial institutions positively welcome the new directive as it will enable more coherent sustainability assessment of their portfolio. Additional explanations for non-listed banks and small and medium sized credit institutions are yet to be announced.
Whom, when and how? - a quick checklist
After nearly 1,5 years of negotiations, CSDR was approved on November 10th, 2022. First reports under the new regulation will become active in 2025, while all CSRD milestones will be implemented until 2029.
● In 2025 large publicly listed companies, currently reporting under NFRD, will have to report on 2024 activities using the CSRD framework.
● In 2026 all large companies will have to report on 2025 data. Large company is the one that meets at least two of the following criteria:
○ 250 or more employees
○ net turnover > €40 million
○ total assets of at least €20 million
● In 2027 all remaining publicly listed companies, including SMEs, non-complex credit institutions and insurance companies, will have to report on 2026 (with a further possibility of voluntary opt-out until 2028).
Major changes in the sustainability reporting
Several major changes will strengthen the current NFRD requirements (that will be replaced by CSRD and will stop being active) and define a new concept of sustainability activities. It will improve the quality of ESG reporting, but might raise questions for both, currently regulated large companies and newly compliant smaller enterprises. Therefore companies are strongly encouraged not to wait until the deadline and implement their ESG practice now.
● Double materiality - concept already introduced by EU Taxonomy, defines the activities that are material to the business. It states that not only climate’s impact on financial risks of the company (financial materiality), but also the company's impact on planet and people (environmental and social materiality) is a subject to reporting. Mapping the materiality landscape, assessing existing and potential risks, engaging with identified stakeholders, and documenting the results are the crucial steps for evaluating both, “Outside-In” and “Inside-Out” perspectives.
Not only climate’s impact on financial risks of the company (financial materiality), but also the company's impact on planet and people (environmental and social materiality) is a subject to reporting.
● Reporting standards - CSRD will provide mandatory sustainability reporting standards for large companies and separate, proportionate standards for the SMEs. It will align with the already existing Sustainable Finance Disclosure Regulation and the EU Taxonomy.
● Accurate environmental reporting is another major improvement. Reporting criteria are defined by EFRAG, European Financial Reporting Advisory Group. Although the full guideline for European sustainability reporting standards (ESRS) will be completed in 2023, initial standards follow the requirements of the EU Taxonomy and require companies to report on the following environmental criteria:
○ Climate change mitigation and adaptation;
○ Pollution prevention and control;
○ Resource use and the circular economy;
○ Protection of biodiversity and ecosystems;
○ Water and marine resources.
● Supply chain assessment - if the official number of companies that will be a subject to CSRD by 2029 is 50.000, the actual number could be even bigger. CSRD will straighten the requirements for supply chain assessment, therefore even the smaller companies not falling under the official requirements might be required to present their impact data to their business partners, who are reporting companies under CSRD assessing their supply chain (tier 1 suppliers).
● External auditing - as of now official auditing of sustainability information was a choice, but under CSRD it will become a requirement. Following the logic of financial reporting, sustainability information will have to be approved by external auditors.
Start the preparation now
For some companies, the deadline for the compulsory reporting seems to be a future problem, but actually it isn’t. Double materiality evaluation, ESG data collection and assessment, process and controls design, official assurance of reported information and targets is a long and relatively new process. Even without the official reporting in the planning just yet, companies should start taking the preparation steps (to avoid risks of last minute rush):
Identify and map the aspects of double materiality that are priorities to the company's stakeholders.
Set the habit of collecting the ESG data, which will be used as a baseline in the future reporting and help to define the ESG targets.
Define the areas of company's sustainability ambition, which will later be turned into tangible KPIs.
Train employees and hire a sustainability professional, who will own the topic from scratch, thus be able to turn ESG from risk to an opportunity.
Early adoption of CSRD and public disclosure could help to strengthen company’s reputation and market image.
The authors of the Article
Indre Blauzdžiūnaitė, Linkedin
Saulius Bakas, Linkedin