In the course of the general discourse surrounding the sustainability of companies and business models, reporting on environmental, social, and governance (ESG) aspects continues to gain importance both politically and in society at large. The EU Commission has also been concentrating more on the disclosure of meaningful, high-quality sustainability information for some time now.
Now that a compromise has been reached on a Corporate Sustainability Reporting Directive (CSRD), the previous requirements regarding the submission of non-financial data are to be expanded into comprehensive sustainability reporting in order to increase transparency in this regard. It's safe to assume that the final directive will not differ significantly from the wording of the compromise.
Table of contents
- Political compromise reached in trilateral negotiations in June 2022
- Who is affected by the CSRD?
- When will the new requirements take effect?
- Do SMEs need to follow the same regulations as large companies?
- Where will companies need to report on their sustainability?
- In what format should the sustainability report be made available?
- What is the content of the sustainability report?
- Materiality of information in sustainability reports
- What further specifications are there regarding the content of sustainability reports?
- Will sustainability reports need to be audited?
- In dialog with employees
- What do the changes mean for the practice of preparing sustainability reports?
Political compromise reached in trilateral negotiations in June 2022
Following vigorous deliberations on a wide variety of details in the conceptual design of sustainability reporting, the EU Commission, European Council, and European Parliament came to a political agreement on the regulations of the upcoming CSRD on June 21, 2022.
In particular, the new regulations are intended to amend Directive 2013/34/EU (on financial reporting) and require numerous companies to compile extensive sustainability reports.
Who is affected by the CSRD?
The wording of the compromise represents a huge expansion of the range of entities that will be required to submit sustainability reports. These obligations will apply to companies that meet the following criteria:
- All large companies with limited liability (i. e. listed companies and limited-liability partnerships) in the EU
- All large insurance companies and credit institutions in the EU (regardless of their legal form)
- All capital-market-oriented companies in the EU (except for micro-enterprises)
- Companies based outside of the EU that generate more than €150 million in annual turnover in the EU and have subsidiaries or branches in the EU
“Large companies” are to be understood as those that meet at least two of the following size criteria on two consecutive closing dates:
- Balance sheet total of at least €20 million
- At least €40 million in turnover in the 12 months prior to a given closing date
- Annual average of at least 250 employees
Adjustments will apply analogously to reporting at the group level, although certain exemptions will be possible especially in the context of parent companies and subsidiaries.
When the first draft of the CSRD was finalized in April 2021, the Accounting Standards Committee of Germany (ASCG) projected that the number of companies subject to these reporting requirements in Germany would rise from some 550 at present to around 15,000 – a nearly 30-fold increase. In the EU at large, around 50,000 are expected to be affected (up from just under 12,000).
When will the new requirements take effect?
Do SMEs need to follow the same regulations as large companies?
The directive makes things simpler for SMEs in a variety of ways. For example, capital-market-oriented SMEs can opt out of the new reporting requirements for a transitional period of two years. Such companies will, however, need to make sure their management reports contain a brief explanation of why they have not disclosed any sustainability information. The CSRD also specifies reduced requirements for SMEs in various areas of sustainability reporting.
That said, it can be assumed that the general disclosure requirements related to value creation and supply chains will result in the CSRD's reporting obligations also affecting SMEs that are not themselves subject to the CSRD (if they end up having to provide sustainability information to companies they supply to help them meet their reporting obligations, for instance).
Where will companies need to report on their sustainability?
The wording of the compromise will require companies to incorporate sustainability reports into their management reports. Instead of integrating their sustainability information fully, however, companies will need to prepare sustainability reports and include them in a separate section of their management reports.
In what format should the sustainability report be made available?
Companies subject to the CSRD are to compile their management reports in a standardized electronic format in accordance with Commission Delegated Regulation (EU) 2019/815 (the ESEF Regulation). Accordingly, the sustainability information:
- in XHTML format and
- to be labeled according to a digital categorization system (so-called taxonomy) still to be developed.
The taxonomy complements the development of an EU-wide platform for business information (the “European Single Access Point”) and thus dovetails with the Commission's previous work on digitalization.
What is the content of the sustainability report?
According to the specifications of the CSRD, a sustainability report must contain information that is needed to determine how the respective company's actions affect various aspects of sustainability and, by the same token, understand how these aspects impact the development, performance, and current situation of the company. The following six subject areas are considered aspects of sustainability:
- Environmental concerns
- Employee matters
- Social issues
- Respect for human rights
- Combating corruption and bribery
- Corporate governance factors
In addition, the CSRD will require various detailed disclosures that reference these sustainability aspects, including with regard to the following:
- Business models and strategies
- Sustainability-related goals
- Sustainability-related concepts
- Incentive systems related to sustainability
- The role of company bodies in connection with aspects of sustainability
- Due diligence exercised with regard to sustainability
- Negative effects of a company's own actions and those of entities along its value chain
- Measures to prevent, mitigate, or eliminate negative effects
- Sustainability-related risks
- Sustainability-related performance indicators
Companies may opt out of providing information related to their value chains for a transitional period of three years starting from the date the CSRD initially takes effect. To do so, they will need to detail the efforts they have undertaken to procure the data in question, explain why they were unsuccessful, and describe how they plan to gather the information in the future.
Materiality of information in sustainability reports
In line with the wording of the CSRD compromise, the materiality of sustainability information is to be judged based on the principle of double materiality. This means sustainability-related information always needs to be disclosed whenever it:
- Is necessary to understand the course of business, results, and situation of the company in question or
- Describes the impact of the company's activities on the sustainability aspects cited above
What further specifications are there regarding the content of sustainability reports?
The European Financial Reporting Advisory Group (EFRAG) has been commissioned to draw up the European Sustainability Reporting Standards (ESRS) and provide them to the EU Commission in the form of specialized recommendations on reporting. Now that the public consultation on the draft standards is complete, they will be considered for adoption as legal acts by the EU Commission, at which point they will immediately become obligatory for companies to which the CSRD applies.
The Commission is to approve an initial set of general ESRS on the fundamental areas of reporting and aspects of sustainability by June 30, 2023. A second set of ESRS (including on sector-specific topics and companies based outside of the EU) is to follow by June 30, 2024.
Will sustainability reports need to be audited?
The content of sustainability reports will need to be audited in the future. The directive will initially require an audit with limited assurance (in the sense of a review). However, plans are already in place to develop European standards for audits with reasonable assurance (similar to the examination depth that applies to management reports). The formulation of these standards is to be completed by October 2028. Sustainability reports will then be subject to audits with reasonable assurance.
Each EU member state will be able to decide whether it will require an audit by a company-internal auditor, another auditor, or an independent provider of confirmation services.
In dialog with employees
Company executives are to keep employee representatives up to speed on these matters on a suitable level and discuss the relevant sustainability information with them, along with the ways in which they intend to collect and review it. In addition, they are to share their related assessments with the administrative, executive, and supervisory bodies of their company as they deem appropriate.
What do the changes mean for the practice of preparing sustainability reports?
The new regulations on sustainability reporting go hand in hand with a tremendous increase in the importance of this new type of reporting.
In practice, companies will face a number of challenges resulting primarily from the following factors:
- The expanded scope of application of ESG reporting
- The need to make sustainability reports digitally accessible
- The redesign and expansion of the content of sustainability reports (including the applicable ESRS)
- The need to have sustainability reports reviewed by an external auditor
Once the CSRD requirements are enacted, the EU member states will need to pass corresponding national laws within a specified period. For practical purposes, it will be particularly interesting to see how national legislators make use of their options as member states and whether they pass regulations that go beyond the wording of the directive.
Companies subject to the CSRD would do well to start taking a look at the new reporting requirements early on and prepare to implement the necessary processes.
More information on reporting possibilities
Are you looking to learn more about reporting possibilities in your finance team? Then head over to our website.
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