Today, the majority of large companies produce sustainability reports covering their ESG practices. However, one major obstacle to voluntary ESG reporting is the inconsistency of the shared information Companies have the liberty to select their ESG reporting framework and decide what information to disclose, which results in difficulties for investors and other stakeholders to compare ESG risks and impacts uniformly.
The harmonization of the content of these reports is one of the main objectives of the European Commission.
This objective is to be achieved with the adoption of the Corporate Sustainability Reporting Directive (CSRD) on 28 November 2022. The EU Council gave its final approval to CSRD, and on 16 December 2022, the Directive was published in the Official Journal of the EU. Its main objective is to guarantee that companies provide dependable and comparable sustainability information necessary for investors and other stakeholders. Additionally, it aims to support companies in fulfilling the rising number of requests for sustainability information.
The directive entered into force on 5 January 2023, and it must be integrated into Member States’ national laws within 18 months. The directive will be implemented in three stages, as follows: (1) financial years starting on or after 1 January 2024 for companies already subject to the NFRD; (2) financial years starting on or after 1 January 2025 for large companies not currently subject to the NFRD; and (3) financial years starting on or after 1 January 2026 for listed SMEs, small and non-complex credit institutions, and captive insurance undertakings, but SMEs can opt out until 2028.
Companies that fall within the scope of this regulation will be obligated to reveal information concerning how sustainability-related factors, such as climate change, impact their operations, as well as information about how their business model influences sustainability factors. The reporting requirements encompass environmental, social, human rights, and governance factors. Environmental considerations include emissions linked to climate change (including Scopes 1, 2, and 3 greenhouse gas emissions), water and marine resources, circular economy, pollution, and biodiversity. The specific disclosure obligations are currently being developed for the European Commission by the European Financial Reporting Advisory Group (EFRAG), a non-profit advisory organization that released an initial draft of the first set of standards for consideration by the Commission in late November 2022.
The primary changes are in regard of:
Expanding the scope of the new regulations to all large businesses, regardless of whether they are listed or not, and removing the current 500-employee threshold. The rules will also apply to listed small and medium-sized enterprises (SMEs).
Applying the regulations to non-EU firms that earn a net turnover of over €150m in the EU and possess at least one subsidiary or branch within the EU.
It is mandatory that businesses disclose a complete set of sustainability information relevant to their operations and that such disclosures conform to the mandatory EU sustainability reporting standards that the Commission is developing.
Requiring sustainability information to undergo a minimal level of audit assurance.
Requiring businesses to produce their management reports in an electronic reporting format and to label the sustainability information.
Scope of obligations:
The entities that fall under the scope of the CSRD include:
• Large businesses, regardless of whether they are listed or not, that exceed at least two of the following criteria during the financial year: a balance sheet total of €20m, net turnover of €40m, or an average number of 250 employees.
• Non-EU companies that have significant activities in the EU market, generating €150m in annual turnover in the EU, and possessing at least one subsidiary or branch within the EU.
• Small and medium-sized enterprises (SMEs) that have securities listed on an EU-regulated market, excluding micro undertakings. This does not include SMEs with securities listed on SME growth markets or multilateral trading facilities.
CSRD in the context of the SFDR (Sustainable Financial Disclosure Regulation) and the Taxonomy Regulation
The SFDR outlines the guidelines for how financial market participants such as asset managers and financial advisers must divulge sustainability information to asset owners and end-investors. To do so, these financial market participants require sufficient information from the companies they invest in. The CSRD is designed to ensure that investee companies report the information necessary for financial market participants to fulfil their own SFDR reporting obligations. The Taxonomy Regulation establishes the framework for the EU taxonomy by specifying four conditions that must be met for an economic activity to be deemed "environmentally sustainable" (an economic activity should contribute substantially to one or more of the climate and environmental objectives, it should not significantly harm any of the other objectives, and it has to be carried out in compliance with minimum social safeguards, which are defined in the regulation; finally, it has to comply with technical screening criteria established through delegated acts by the Commission, who is empowered to draft the actual list of environmentally sustainable activities). It also mandates that companies within the scope of the NFRD publish information on the degree to which their activities align with the taxonomy's environmental sustainability criteria.
By Tsvetelina Paskova, Associate, Gugushev & Partners, PONTES