Overview

The Corporate Sustainability Reporting Directive (CSRD) is a measure launched on April 21st, 2021, that introduced enhanced sustainability reporting requirements for companies in the EU area. The new regulation mandates companies to disclose non-financial and sustainability-related information. The main goal of the CSRD is to provide investors, customers, and other stakeholders with accurate and comparable information regarding the environmental, social, and governance (ESG) aspects of a company's operations. While many large firms and public interest companies (such as listed firms, banks, and insurance companies) are already regulated by the Non-Financial Reporting Directive (NFRD), the CSRD provides more stringent standards for reporting the sustainability of their business. This will help provide more ESG data for investors to support the flow of funds towards sustainable projects, ensure higher levels of accountability for firms on environmental and social issues, and continue to shape international reporting frameworks. The EU has implemented a Sustainable Finance roadmap that is an ambitious and comprehensive set of measures to improve the flow of capital towards sustainable activities across the EU, which the CSRD will assist in delivering. The new regulation comes into action since "reports often omit information that investors and other stakeholders think is important" according to the European Commission.

The CSRD is a significant expansion of the NFRD, increasing the number of companies included, widening the scope and reporting requirements, mandating an external audit, and digitalizing the reporting process. The NFRD was a considerable development in creating international sustainability reporting frameworks, but the European Commission believes that it does not go far enough. The CSRD aims to address these gaps. A report by Deloitte provides a more in-depth breakdown and analysis of the implementation and changes that the CSRD proposes.

Existing Regulations

The NFRD was originally constructed to provide public accountability on social and environmental issues and provide investors with more information to drive investment to sustainable businesses. It focused on five main pillars: environmental, social and employee aspects, human rights, anti-corruption, and diversity on board of directors. It legally required more corporate disclosures on each of these, whereas previous frameworks were voluntary, making it a significant advancement in international sustainability reporting. However, issues still remain. The NFRD provided flexibility for companies to self-disclose materially relevant data, which critics argue has allowed companies to avoid essential disclosures. Many investors also feel that the data mandated in the NFRD is not actionable for future valuation. The data required is mostly backward-looking and has fewer regulations around governance disclosures or target-setting. The CSRD will expand to many more small- to midsize companies and will be building out future recommendations to take into account the more limited capacity for companies with smaller head counts.

Notable Changes

Wider Scope of Companies Included

Currently, there are only about 11,000 companies subject to the NFRD regulations. It's limited to firms with over 500 employees that are public interest companies, i.e., publicly traded companies, banks, and insurance companies.

The CSRD will increase that scope to about 50,000 companies, including SMEs who were previously excluded. CSRD reporting will be mandatory for companies that have at least two of these three attributes:

• 250 employees
• €40M in annual turnover
• €20M in total assets

The CSRD will also work with the European Financial Reporting Advisory Group (EFRAG) to build out separate reporting requirements for SMEs. This accounts for these companies having less data gathering capacity than large multinationals. Questionnaires and software are being developed to help guide companies on disclosures.

This change means that all large companies are publicly accountable for the impact they have on people and the environment, and investors will be more protected as a result of greater transparency on sustainability information.

Widening the Scope of Disclosures

Currently, the NFRD has a basic set of disclosures that cover topics including environmental, social/employee, human rights, anti-corruption, and diversity on board of directors. The CSRD aims to expand upon these by incorporating the concept of double-materiality into reporting requirements, offering more forward-looking data, and promoting increased qualitative information, particularly concerning omissions and governance. Double materiality refers to providing information on how external risks (such as flooding or extreme heat caused by climate change) affect a business and the firm's impact on those factors (e.g., GHG emissions). The CSRD also expects to see target setting and progress on historical targets. Similar to the TCFD, omissions are allowed, but a higher level of explanation is expected around why data is excluded. More descriptive information about a firm's ESG governance is expected to be a significant component of the new regulations.

The EU Commission aims to collaborate with the EFRAG and hold conferences with external organisations to ensure these new EU reporting requirements align with existing regulations, the Sustainable Finance Disclosure Regulation (SFDR)and the EU Taxonomy Regulation, as well as with existing international frameworks such as GRI, TCFD, VRF, and CDP. The new guidelines of the disclosure were designed not to deviate significantly from the existing groundwork nor to reduce duplicate reporting requirements. The overarching goal is to harmonise EU regulations around current best practices in international sustainability reporting and to create a universal code for sustainability reporting.

Audits Will Be Required

Many investors claim that NFRD reporting requirements' disclosures are not useful for investment decisions. There are considerable omissions, inconsistently labelled datasets, separate methodologies, and data often lacks context with targets in governance and strategy. The CSRD introduces an EU-wide audit regulation, similar to IFRS requirements for annual financial reports. The Commission recommends a "limited" assurance requirement, meaning audits are less rigorous and reliable, but accounts for the availability and technical capacity of current auditing organisations. This should also alleviate the financial burden on companies conducting audits while the industry matures. The aim is to increase the level of assurance over the coming years.

Reports Must Be Available Digitally

The CSRD mandates a technical upgrade to sustainability reporting, aiming to provide a single access point for sustainability disclosure data. The European Single Access Point (ESAP) has been accepted by the European Council and is designed to facilitate access to public information about EU companies and investment products.

Companies are required to submit their reports in XHTML format, adhering to the European Single Electronic Format (ESEF). They must also apply XBRL tags to all data, making it machine-accessible and more convenient for investors to use when making informed investment decisions.

Compliance of EU Reporting Standards with International Standards

The European Commission (EC) implemented the European Green Deal, approved in 2020, to transform the EU into a modern, resource-efficient, and competitive economy. This ensures net greenhouse gas emissions by 2050, economic growth independent of resource use, and a 'no one gets left behind' approach.

EU sustainability reporting standards must be consistent with the European Green Deal's actions and existing European legislative frameworks (Sustainable Finance Disclosure Regulation and the Taxonomy Regulation). Furthermore, the standards need global alignment. The European Commission supports the initiative to create a global sustainability reporting standard building on the Task Force on Climate-related Financial Disclosures' efforts.

EU sustainability reporting standards are not independent of ongoing efforts to standardise the reporting process. The EC is working with the EFRAG to ensure uniformity in European reporting standards, therefore reducing complexity and duplication of reporting requirements.

Moving Forward

The implementation of the CSRD shows clear stronger regulatory pressure on ESG reporting by the EU, holding companies accountable, and providing higher-quality information for investors interested in sustainable businesses and investment opportunities. Greenwashing is becoming increasingly difficult for companies as regulations evolve. Companies are being encouraged to become more aware of their sustainability and companies with limited sustainable practices in place will need to change as the CSRD and other regulations come into place. These evolving regions are changing the sustainability field. They are going to have a big impact on sustainability reporting in Europe particularly and it shows that the international ESG community is moving towards more standardised practices.

Need Help?

Eunoic is a technology platform that helps companies become more valuable by improving their environmental, social and governance (ESG) performance and external perception via its AI-infused cloud applications and advisory services. We can provide guidance around corporate sustainability disclosures and help analyse how your firm is seen by its outside stakeholders, such as investors, rating agencies, etc.