We have previously written on the Corporate Sustainability Reporting Directive (EU) 2022/2464 (the Reporting Directive).
Background
The Reporting Directive was published in the Official Journal of the European Union on 16 December 2022 and entered into force on 5 January 2023. It is required to be transposed into Member States' national law by 6 July 2024.
The Reporting Directive builds on the existing disclosures required under the Non-Financial Reporting Directive (2014/95/EU) (NFRD) and extends the: (i) scope of the information currently required to be reported under the NFRD; and (ii) companies to which the disclosure regime applies (it is estimated that as many as 50,000 companies will be required to report under the CSRD instead of the approximately 11,600 currently reporting under NFRD).
Key elements
The Reporting Directive will apply in a staggered way. Large public companies already reporting under the NFRD will be required to report in 2025 (covering the 2024 financial year), with other large companies (whether listed or not) required to report by 2026. Listed SMEs (excluding micro-enterprises) will be required to report from 2027 (subject to the ability to opt out for up to two years), and non-EU entities with significant activities in the EU will have to report by 2029.
A key feature of the Reporting Directive is the introduction of mandatory European sustainability reporting standards (ESRS) against which in-scope entities will be required to make public reports. This is intended to address one of the perceived shortcomings of the NFRD by making sustainability reporting more objective, thereby allowing stakeholders to compare sustainability data between disclosing entities.
The Reporting Directive has other significant aspects. A key one is that information being reported is legally required to be subject to third party assurance. This verification may initially be provided on a limited assurance basis, but eventually the standard required will be based on reasonable assurance. Notably, the Reporting Directive provides Member States with the ability to widen the net of auditors of sustainability information beyond the traditional financial accountants, so it will be interesting to see the position that Ireland adopts on this point in implementing legislation. At time of writing, the Department of Enterprise, Trade and Employment is due to provide details of Ireland’s transposition plan imminently. Reporting will be required not only on the activities of reporting entities themselves, but also on material ESG issues in their value chains. Finally, the Reporting Directive incorporates the EU's principle of 'double materiality' in terms of the disclosure requirements. This broadly means that reporting entities will be required to report on the financial impact of ESG matters on their business as well as the risks and opportunities they face relating to ESG.
ESRS
The ESRS will be adopted by means of a delegated act by the European Commission. The Commission tasked the European Financial Reporting Advisory Group (EFRAG) with preparing draft ESRS. In April 2022, EFRAG launched a consultation on the exposure drafts for the first set of sector-agnostic ESRS, setting out 13 standards relating to E, S and G matters. Following that consultation, a reduced set of 12 ESRS were submitted by EFRAG to the European Commission in November 2022. We prepared a series of articles on these drafts, available at our ESG and Sustainability Hub. More recently, a draft of the European Commission's delegated act was made the subject of public consultation in June 2023 (still open at time of writing).
The draft delegated act caused some controversy. One key change envisaged by the European Commission’s current proposal is that all standards be subject to materiality assessments by reporting entities. In other words, where reporting entities conclude that a standard is not material to their operations, they can omit disclosing against that standard (although reporting entities are required to explain their assessments). The Commission has also proposed that certain previously mandatory disclosures (for example, around biodiversity transition plans and certain social indicators such as wages for 'non-employees') should become voluntary. Additional flexibility in respect of certain disclosure requirements is also proposed. Further, it is proposed that reporting entities with fewer than 750 employees be provided with additional flexibility in their reporting. The outcome of the consultation on the delegated act is awaited with interest. We are engaged in detailed analysis on the consultation proposals.
Key considerations for reporting entities
The Reporting Directive is about just that: reporting. It does not set conduct or behaviour standards. Instead, the obligation is to report on what is or is not being done under various ESG headings.
However, the Reporting Directive presents businesses with significant challenges. First, it is necessary for entities to assess whether (and if so when) the Reporting Directive applies to them. This analysis can be complex, particularly where operations are cross-border and group structure is multinational. To the extent the Reporting Directive does apply, it will also be necessary for corporates to assess the incoming ESRS and to understand what is required of them to allow them to collect and analyse the relevant data required from their own operations and that of their value chains. It is likely that significant resource will be required to allow corporates to collect all the data required to report on a timely basis.
Sustainability affects the whole of the business and not just an ESG group function or officer. In-scope businesses will have a legal obligation to report annually in the ‘Directors' Report’ section of their annual reports against the ESRS. In addition to operational compliance, Boards of Directors will need to be satisfied that there are sufficient systems and controls in place to support the reporting standards and be satisfied that there is sufficient assurance for them to sign off on the sustainability report – alongside the annual financial reporting cycle – in a compliant manner.
Looking ahead
Further standards covering sector-specific disclosure requirements and requirements for in-scope SMEs are being prepared and are due to be consulted upon, although the Commission has indicated that it is currently focusing on finalising the proposed delegated act to adopt the ESRS. We are continuing to monitor developments relating to the Reporting Directive.
