Corporate Sustainability Reporting Directive (CSRD) to Widen Mandatory Sustainability Reporting Requirements

On November 28, the European Council formally adopted the Corporate Sustainability Reporting Directive, following adoption by the European Parliament on 10th November this year. The CSRD is now due to be signed and published in the European Union Official Journal and will come into force 20 days after publication.

CSRD was unanimously ratified by the 27 heads of state that make up the EU’s policy-setting body, the European Council. It followed the measure’s approval by the European Parliament three weeks ago. Last week the first set of European Sustainability Reporting Standards (ESRS) were finalised by the Advisory Group on Financial Information in Europe (EFRAG), setting in stone the double materiality principle established by the CSRD.

The CSRD rules will bring non-financial companies into the EU’s sustainability reporting regime, requiring them to provide their own ESG data and metrics. Firms will be compelled to disclosure their carbon emissions and the impact of their business activities on everything from social injustice, local communities and biodiversity. CSRD will apply to large listed and private companies, included listed SMEs, more than tripling the universe of reportable firms to over 50,000.

The CSRD will require reporting of forward-looking, retrospective, qualitative and quantitative information necessary to understand an undertaking’s impacts on sustainability matters and, from the “opposite” lens, the information necessary to understand how sustainability matters affect an undertaking’s development, performance, and position (i.e., “double materiality” reporting). The principle of double materiality requires that entities look inward to evaluate how sustainability issues affect the entity and look outward to understand how the entity impacts people and the environment.

Mandatory sustainability reporting standards will undoubtedly help to provide asset managers with both a higher quality and quantity of ESG data, filling huge gaps in the current sustainability data records. The directive will significantly increase the amount of ESG information that financial institutions will be able to use to make investment and risk decisions.

The approval of CSRD is among the biggest developments in a milestone year of ESG regulatory announcements. In March the Securities and Exchanges Commission (SEC), published its first major proposal on climate-related disclosures. Also, in recent weeks the UK’s Financial Conduct Authority (FCA) has outlined its own SFDR-like sustainable reporting intentions and announced the creation of a body to examine how ESG rating companies should be regulated.

For investment product providers the CSRD is a key piece of legislation that should enable them to better comply with the Sustainable Finance Reporting Regulations (SFDR). Current rules require them to declare the ESG performance of assets in their portfolios and funds. However, many of those companies are not obliged to publicly disclose their data, forcing financial institutions to fill the gaps with estimates leading to vastly inconsistent findings.

The European Financial Reporting Advisory Group (EFRAG) will be responsible for developing draft European standards. The European Commission will adopt the final version of the standards as a delegated act, following consultations with EU member states and a number of European bodies.

How Will CSRD Regulations Be Applied

The application of the regulation will take place in four stages:

1. Reporting in 2025 on the financial year 2024 for companies already subject to the non-financial reporting directive (NFRD).
2. Reporting in 2026 on the financial year 2025 for large companies that are not currently subject to the NFRD.
3. Reporting in 2027 on the financial year 2026 for listed SMEs (except micro undertakings), small and non-complex credit institutions and captive insurance undertakings.
4. Reporting in 2029 on the financial year 2028 for third-country undertakings with net turnover above 150 million in the EU if they have at least one subsidiary or branch in the EU exceeding certain thresholds.

The CSRD requires sustainability information to be published in an entity’s management report and not a separate, standalone report. To aid in the access, review, and comparability of sustainability information, the financial statements and management reports of CSRD reporting entities will be required to be published in a digital file format. Note that U.S. entities will likely include the management report as part of the Annual Report on Form 10-K since a separate, standalone ESG report will not comply with the CSRD.

CSRD will not apply to the vast majority of companies which are small and medium-sized enterprises, these smaller businesses obviously form integral parts of many larger businesses’ supply chains. Investors will no doubt continue to build out their own ESG and Sustainability research, analysis and risk control functions to dive deeper into supply chain risks and opportunities.

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