EU adopts sustainability reporting directive

The Council of the EU has formally adopted the Corporate Sustainability Reporting Directive (CSRD).

The move comes after the European Parliament’s formal adoption of the directive earlier last month. The CSRD is an ESG reporting framework that will impose mandatory reporting requirements on companies with European operations.

The CSRD replaces the Non-Financial Reporting Directive (NFRD) and also includes ESG disclosure requirements for financial market participants, with the Sustainable Finance Disclosure Regulation (SFDR), and the EU Taxonomy Regulation.

Around 12000 European companies were subject to the NFRD, those with securities listed on EU regulated markets, banks, and insurance companies with 500 or more employees. The European Commission estimates that roughly 50,000 companies will fall under the CSRD’s reporting obligations. In addition to those companies currently subject to the NFRD, this will include:

All listed companies offering securities on an EU index (except for “micro-enterprises”);

All large companies, meaning those that meet at least two of three criteria: (i) a balance sheet of €20 million, (ii) net turnover of €40 million, and (iii) 250 employees or more on average during the year – parent undertakings of “large groups” that meet two of these criteria on a consolidated basis also qualify; and

Non-EU companies, so-called “third-country undertakings,” with significant European operations – i.e., that generate a net turnover of €150 million or more in the EU and that have an EU subsidiary that is either listed on an EU regulated index or “large” under the above criteria, or an EU branch generating an annual net turnover of €40 million in the prior year.

Several other elements of the CSRD include:

Uniform Reporting Standards. The CSRD will impose uniform, comprehensive reporting standards applicable across the EU, under forthcoming European Sustainability Reporting Standards (ESRS). The ESRS will call for disclosures of numerous metrics across the ESG pillars, including things like energy and emissions data, water use, climate-related risk management strategies, circular economy, pollution, biodiversity under the “E”; working conditions, diversity, inclusion, human rights under the “S”; and business risk, strategy, and board oversight over sustainability information under the “G”. The ESRS are still under development by the European Financial Reporting Advisory Group (EFRAG).

Double Materiality. Under the CSRD, subject companies must report according to a “double materiality” perspective, wherein they must consider not just the material impacts of ESG factors to the organization but also the organization’s own impacts on the environment and social systems. This is distinct from the US Securities and Exchange Commission’s climate reporting proposed rule, which embraces a “single materiality” perspective that would require disclosure of only climate-related impacts to the reporting entity.

Third-Party Assurance. The CSRD will impose a third-party assurance, or audit, obligation on reporting entities, requiring reporting to be certified by an accredited independent auditor. Only “limited” assurance will be required to start. Subsequently, however, the CSRD provides for development of a more rigorous, “reasonable” assurance standard in 2028, if it is found to be feasible.

Reporting Mechanics. The CSRD requires that companies report ESG metrics not in a separate sustainability report, but in a dedicated section of the broader company management report, thus blending the sustainability and other financial reporting into a single document. Companies also must digitally tag sustainability information to allow the EU to maintain a singular, uniform database of CSRD disclosures, furthering the goal of increasing transparency and accessibility of sustainability disclosures.

The CSRD takes a phased approach to implementation, with different categories of companies becoming subject to the reporting requirements along a staggered timeline. Large, “public interest” undertakings already subject to the NFRD and large, listed companies with 500 or more employees will be subject starting January 1, 2024, “large” undertakings not currently subject to the NFRD will be subject beginning January 1, 2025, and “small and medium-sized undertakings” with securities listed on an EU regulated market, as well as small and non-complex credit institutions and captive insurance undertakings, will become subject January 1, 2026. Non-EU companies subject to the CSRD must comply beginning January 1, 2028. For all of these groups, initial reports under the CSRD would be required to be produced the following year.

Now that it has been formally approved, the CSRD will be signed and published in the Official Journal of the EU and will enter into force 20 days later. EU Member States will then have 18 months to transpose the CSRD into their respective national laws. More details on exactly what the mandatory reporting standards will look like will become clear over the coming months, as the EU considers and adopts a delegated act setting forth ESRS by June 30, 2023, and a second, sector-specific set of ESRS by June 30, 2024.