Environmental, social, and governance (ESG) topics have been a central focus of 2022, with a growing number of regulations to address everything from environmental concerns to forced labor and human trafficking. This growing demand for sustainability has created additional challenges and risks, including threats to market access, lawsuits, brand damage, and much more.
Now, with the upcoming EU Corporate Sustainability Reporting Directive (CSRD), annual ESG reporting will become a requirement for all large companies and all companies listed on regulated markets in the EU. It will also become a requirement for non-EU entities with significant EU operations.
What Is the CSRD?
Put simply, the CSRD requires in-scope companies to publish annual reports on their ESG activities. This is an extension of the scope and reporting requirements that exist in the EU Non-Financial Reporting Directive — a framework that mandates “sizable” public-interest entities to report on their sustainability performance.
On November 28, the European Council adopted the directive, following its adoption by the European Parliament. The final step is for the proposal to be signed and published in the Official Journal of the European Union, and then it will come into force 20 days after publication. Member states will then have 18 months to implement the new rules.
Expanding Focus & Strengthening Requirements
The reporting rules under the Non-Financial Reporting Directive (NFRD) applied to “public interest entities” — listed companies, banks, and insurance companies with more than 500 employees. Only about 11,000 companies were covered under these rules.
The CSRD builds on the success of the NFRD by significantly expanding the number of in-scope companies to around 50,000. It also substantially broadens the scope of sustainability information companies need to disclose to include actual and potential adverse impacts connected with the company’s own operations, products and services, business relationships, and supply chain.
It also requires companies to digitally “tag” the reported information to improve how investors and other stakeholders can compare and use reported information. In the absence of tags and machine-readable formats, investors struggle to assess and compare reporting information given considerable variation in how data is presented.
Additionally, the CSRD introduces an audit requirement for reported sustainability information. Although this is already required within certain EU member states, this is the first time an audit requirement will apply across the EU. This will ensure the trustworthiness and reliability of reported information, helping to ward off risks of greenwashing.
What Does This Proposal Mean for Smaller Companies & Non-EU Companies?
No new reporting requirements would be added for small and medium-sized enterprises (SMEs), with the exception of SMEs that have securities listed on regulated markets. Additionally, to ease the burden on listed SMEs, they can follow simpler reporting standards than what larger companies must adhere to.
However, if listed SMEs don’t report sustainability information, they may be at risk of exclusion from investment portfolios. This risk is only expected to grow as sustainability information becomes increasingly important in the financial system.
Generally, non-EU companies with significant EU operations will also be in scope of the CSRD. An exemption would apply if a non-EU parent company includes its EU subsidiary or subsidiaries within its consolidated management report and follows a sustainability reporting standard that is determined to be equivalent to the EU standard. However, there is no such equivalence mechanism in place yet, nor timelines for it to come into effect.
Next Steps
There are additional milestones following the European Parliament and European Commission’s agreement on the CSRD proposal.
- 2025: Businesses that are already subject to the NFRD must start reporting on the 2024 financial year in 2025.
- 2026: Large undertakings not currently subject to the NFRD must start reporting on the 2025 financial year in 2026.
- 2027: Small and medium enterprises and small and non-complex credit institutions, and captive insurance undertakings, must start reporting on the 2026 financial year in 2027, with a possibility of voluntary opt-out until 2028.
- 2029: Large non-European companies that have at least one branch or subsidiary in the EU exceeding certain thresholds must start reporting on the 2028 financial year in 2029.
ESG Reporting Requirements Are Growing in the EU
On November 23, 2022, the European Financial Reporting Advisory Group (EFRAG) submitted its draft European Sustainability Reporting Standards (ESRS) to the European Commission. All companies covered by the CSRS will be required to align their corporate sustainability report with these new standards. The standards outline requirements for detailed reporting on a broad range of ESG issues, including workers in the value chain, climate change, consumers, end users, and business conduct.
The commission is now reviewing the standards and will hold another consultation before adoption. The first set of standards is expected to be adopted as a delegated act by June 30, 2023, and the second set is expected to be adopted by January 30, 2024.
Sustainability Reporting Is Global
The CSRD and the ESRS updates are examples of a larger global trend toward ESG reporting. With investors calling for reliable, comparable, and relevant ESG data from businesses, more regulations and standards are being created to meet this need.
In March 2022, the International Sustainability Standards Board (ISSB) proposed two standards in an attempt to set unified global rules:
- The General Sustainability-Related Disclosure Requirements, which set overall requirements for an entity to disclose sustainability-related financial information about all significant sustainability-related risks and opportunities
- The Specific Climate-Related Disclosure Requirements, using recommendations from the Task Force on Climate-Related Financial Disclosures (TCFD) and incorporating industry-based disclosure requirements from SASB Standards
In response to these proposals, the ISSB received over 700 responses to its General Requirements Proposal Standard and over 600 responses to its Climate Disclosure Standard. The ISSB is now assessing and discussing these responses, with the final standards expected to be issued in Q1 2023.
Once finalized, these standards will be handed over to the International Organization of Securities Commissions (IOSCO), which is an association of organizations that regulate the world’s securities and futures markets. The IOSCO will issue recommendations to members on adopting the ISSB’s new standards, and regulators will look to incorporate them, though some companies may choose to adopt the standards earlier than required.
Furthermore, the U.S. Securities and Exchange Commission (SEC) proposed rule changes in March 2022 that would require registrants to include certain climate-related disclosures in their registration statements and periodic reports.
The proposed rule changes would require a registrant to disclose information about direct greenhouse gas (GHG) emissions and indirect emissions from purchased electricity or other forms of energy.
Furthermore, registrants would be required to disclose scope three emissions — GHG emissions from upstream or downstream activities in its value chain — if they have set a GHG goal or target that includes these emissions. The proposed rules also provide safe harbor with regard to liabilities as a result of scope three emissions disclosures, along with an exemption from the scope three emissions disclosure requirement for smaller reporting companies.
This is just scratching the surface of the SEC’s proposed rule changes. However, the message is clear: ESG reporting is increasingly becoming a requirement for investors, the public, and global governments, and standards are tightening up to ensure companies are providing reliable, comparable, and relevant ESG data.
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