On Friday, December 22 2023, the first set of European Sustainability Reporting Standards (“ESRS”) was published in the Official Journal of the European Union. Now that everything is set for the first reporting exercise under the CSRD, affecting initially large Public Interest Entities, it is a good time to reflect on the purpose of CSRD, and how this purpose has shaped the new environmental, social, and governance (“ESG”) reporting requirements for European companies.
The origin and purpose of CSRD
The EU Green Deal was launched in 2020, designed to foster the sustainable transformation of the Union’s economy to reach the net zero target by 2050. Since then, the necessity of reorienting capital flows towards sustainable activities has been the origin of various legislative decisions, including the Sustainable Finance Disclosure Regulation (“SFDR”) and the EU Taxonomy Regulation. The CSRD is the final piece of that puzzle.
The diagnosis was clear: there was an information gap between what was available in the public domain and what was needed, in terms of both quantity and quality of sustainability information, along with undesirable methodological gap. As outlined in various previous documents and the CSRD’s statement of motives, stakeholders - mainly investors - manifested an increasing need for corporates’ ESG information availability and trustworthiness to inform their investment decision-making.
Thus, the CSRD was launched to help bridge the gap. When we look at the main ESG reporting requirements introduced by CSRD, it becomes evident how this purpose has shaped the Directive.
Increasing the quantity of sustainability information available
First, it is imperative to guarantee that enough information about corporate sustainability is provided and accessible to the public by a large pool of companies. To meet this objective, two main CSRD requirements have been established:
1) Increasing the number of companies in the scope of ESG reporting obligations: from 11,000 to almost 50,000 entities
The previous Non-Financial Reporting Directive (“NFRD”) which regulated ESG reporting, mandated just large, public interest entities to publish sustainability reports. Under CSRD, obligations expand to include large private companies, listed small and medium-sized enterprises (“SME”), and other financial undertakings. Moreover, non-EU companies, when surpassing certain revenue requirements, will also be subject to CRSD-compliant ESG reporting -not only their European subsidiaries but the whole group or company.
2) Mandating sustainability reports to be publicly available
As mandated by CSRD, sustainability reports must be a part of the management report included in the annual financial statements (thus, they must be published at the same time). Moreover, regardless of whether the company is public or private, sustainability reports must be made accessible through the companies’ website and the recently created European Single Access Point (“ESAP”).
Improving the quality of sustainability information available
Secondly, the challenge is ensuring that the information to be published is trustworthy and material to inform stakeholders’ decision-making:
3) Making sure information included in the sustainability report is relevant, using a double materiality perspective
The CSRD implements the mandatory performance of a double materiality assessment, which includes materiality from an impact perspective (inside-out) and a risk and opportunities perspective (outside-in). This double materiality exercise is set to cover the information needs of investors, as well as other relevant stakeholders such as employees and representatives, regulators, business partners, or the general public.
Furthermore, the risk and opportunity perspective of double materiality is intended to enhance companies’ assessment of ESG-related risks and their financial impacts, a practice that has not yet become commonplace.
4) Guaranteeing that information is complete and comparable, through the mandatory use of the ESRS and the publication of EU Taxonomy disclosures
Among the main concerns of corporate sustainability information users was the high degree of heterogeneity between sustainability reports, caused by the fact that the previous Directive did not mandate the use of any specific standard. To enhance comparability, the EU mandated the design and publication of the ESRS. EU sustainability reporting standards are mandatory for companies falling within the scope of CSRD and set extensive, detailed, and specific rules on how to report information and compute key performance indicators (“KPI”) to ensure completeness and comparability.
Moreover, the CSRD mandates the inclusion of EU Taxonomy disclosures in the sustainability reports, expanding the original scope of the Taxonomy (only large, Public Interest Entities and large financial institutions).
5) Ensuring that published information is accurate and traceable, through the imposition of third-party verification.
Sustainability reports must be verified by an independent third party, with a limited assurance level. Reasonable assurance (the assurance level with which the financial statements are audited) is not mandatory yet, but the EU will study its implementation from 2028 onwards. Companies may designate the same auditor or audit firm for their financial statements and their sustainability report, or different ones, at their discretion. The Audit Commission of the Board of Directors must oversee this process.
What is next?
A large pool of new companies will face the obligation of publishing sustainability reports under CSRD from 2025 onwards. The task is challenging and demanding for them, and even those companies already subject to NFRD will face an increasing burden to comply with the new reporting rules.
