CSRD: shakeup of the EU's sustainability reporting rules
The EU’s new Corporate Sustainability Reporting Directive (CSRD) entered into force on 5 January 2023.
What is happening?
The EU’s new Corporate Sustainability Reporting Directive (CSRD) entered into force on 5 January 2023. It will require certain EU and non-EU companies to report on a wide range of sustainability matters in line with detailed EU Sustainability Reporting Standards (ESRS). Those are currently being drafted and are expected to be finalised in June 2023. Reporting will be phased in with large and listed EU companies required to report from FY 2024, and certain non-EU companies (including certain UK companies) required to report from FY 2028. The reporting requirements are likely to be extensive, spanning a wide range of environmental issues including ‘scope 3’ greenhouse gas emissions across companies’ full value chain. This move echoes similar developments in the UK where more extensive sustainability reporting is likely to become mandatory. Businesses should take stock now to ensure they are ready to report when required (either directly to regulators or indirectly to others in their supply chains).
Why does it matter?
The CSRD sustainability reporting requirements
The CSRD builds on the EU’s existing sustainability reporting regime under the Non-Financial Reporting Directive, introducing more detailed reporting requirements for in-scope companies. The CSRD requires companies to disclose information based on a ‘double-materiality’ principle: disclosures must explain both how sustainability matters (eg climate change) impact the company, and also how the company’s activities impact sustainability matters (eg pollution and plastic waste).
Under the CSRD companies will also need to disclose information about: (1) how sustainability considerations are implemented into the business; (2) how material sustainability risks and opportunities are identified and managed; (3) the resilience of the company’s business model and strategy towards sustainability risks; and (4) the company’s due diligence processes (including those relating to its supply chain) for assessing sustainability matters.
Companies will need to provide information about their net zero strategies (which must ensure their business model is aligned with the 1.5°c target under the Paris Agreement 2015) as well as any other sustainability targets.
EU Sustainability Reporting Standards (ESRS)
The final ESRS (expected in June 2023) will set out further detail about the sustainability disclosures required under the CSRD. According to the draft ESRS, which were submitted to the European Commission last November, disclosures will be required across a very broad range of ESG issues. These include climate change, pollution, biodiversity loss, waste/resource use, workers, consumers, affected communities and general business conduct. Significantly, in-scope companies will also need to report on ‘scope 3’ greenhouse gas emissions across their full value chains. The final ESRS are expected to be published in June 2023. Sector-specific standards requiring additional disclosures by companies in ‘high impact’ sectors (such as food/ beverages and textiles) are due in the coming months.
A modified set of reporting standards will apply to non-EU companies that are caught by the CSRD (see below), with the exception of non-EU companies listed on an EU-regulated market (which will be expected to comply with the full standards). The modified standards are expected to be finalised in June 2024.
Which companies will be caught?
The CSRD will apply to large EU companies (whether listed or not) and listed EU SMEs. In due course, it will also apply to non-EU companies (including UK companies) with substantial revenues in the EU and an EU branch or subsidiary. Specifically, non-EU companies will be caught if they have: (1) an annual turnover (in the EU) in excess of €150m for each of the last two financial years; and (2) at least one EU branch (with an annual turnover of more than €40m), one large EU subsidiary, or one subsidiary listed on EU-regulated markets. The CSRD reporting requirements are expected to apply to non-EU companies in respect of financial years on or after 1 January 2028.
Direction of travel
The CSRD is part of a wider package of regulatory initiatives being proposed in the EU as part of the European Green Deal. Together, these initiatives will introduce significant new due diligence, compliance and disclosure requirements on companies operating in, or trading with, the EU. In particular, the CSRD has close synergies with the EU’s proposed Corporate Sustainability Due Diligence Directive (CSDD) which, once enacted, is expected to introduce mandatory due diligence requirements on certain EU and non-EU companies requiring them to identify, prevent and mitigate adverse environmental and human rights impacts in their supply chains. In effect, the due diligence obligations under the CSDD are intended to strengthen companies’ reporting under CSRD.
These initiatives also reflect similar developments in the UK under the Government’s proposed ‘Sustainability Disclosure Requirements’ (SDR) regime. Under this regime, certain UK companies will be required to make sustainability disclosures (including in relation to scope 3 emissions) in line with standards currently being finalised by the International Sustainability Standards Board (ISSB). The ISSB’s first two standards are expected to be finalised imminently – the Government will then likely consult on their adoption in the UK.
What action should you consider?
The direction of travel in both the EU and the UK is clear: companies will increasingly be expected to report on a range of ESG matters, including in relation to their supply chains. Whilst any new reporting requirements are likely to target the largest companies first, they will likely trickle down to others over time.
Retailers and consumer brands (particularly those in ‘high impact’ sectors such as food/ beverages and textiles), should check whether they (or any of their subsidiaries) will be caught by the CSRD and, if so, should review the draft ESRS standards now to prepare for compliance. Embedding the necessary processes (both internally and with suppliers) may take time.
Businesses that are not directly caught by the CSRD, but that trade with companies that are, should also get familiar with the requirements as they are likely to see an uptick in sustainability reporting/ audit requests from these trading partners in the near future.
Even where businesses are not caught by the directive, there are significant benefits of tracking and reporting sustainability information. First, getting a clear picture of the climate and sustainability risks to the business will give it time to adapt its strategy and implement measures to manage those risks. This is crucial to ensuring the longterm viability of the business. Second, it will win the business favour with both shareholders and consumers by showing that it takes its sustainability and climate responsibilities seriously. This may also help the business attract equity investment and expand into the rapidly growing ‘green’ consumer market in the short and medium term.
Businesses may want to consider the following actions:
- ensuring the board and executive management are briefed on the CSRD reporting obligations and relevant timelines
- assessing internal resourcing, hiring staff and/or setting up a central team which will be responsible for managing the sustainability reporting process. This includes coordinating input from around the business (eg from strategy, finance, risk, investor relations and senior management), liaising with suppliers, outside advisors and preparing the relevant disclosures
- reviewing the business’ current reporting systems/processes to consider whether any updates are required
- understanding the business’ existing technologies to assist with data collation and segmentation. Think about the most intelligent use of those systems before introducing any new technologies
- mapping the business’ supply chain and identifying key actors from whom you will need to request sustainability data
- setting up initial conversations with suppliers to understand what data they have access to, how it is stored, how it can be transferred to you and in what format etc
- reviewing the business’ supply contracts to ensure they include relevant reporting requirements, standards and enforcement mechanisms, and considering what additional, specialist support (eg technical and legal) might be required to support the business to comply with its obligations under CSRD.