Moves Made Toward a New Sustainability Reporting System in Europe: The Corporate Sustainability Reporting Directive

The EU Council and Parliament reached a provisional agreement on June 21, 2022 to adopt the CSRD,¹ which delegates responsibility for developing sustainability reporting standards to the EFRAG.² On November 22, 2022, EFRAG submitted the first set of draft sustainable reporting standards to the Commission.³ Following adoption by Parliament and Council, the CSRD took effect on January 5, 2023. EU member states will have 18 months to implement the new rules.⁴

Scope of the CSRD

The CSRD builds off the existing Non-Financial Reporting Directive (“NFRD”) framework by expanding the number of companies subject to reporting requirements and broadening what those companies must report. Introduced in 2014, the NFRD requires public interest companies with more than 500 employees to include non-financial statements as part of their annual public reporting obligations. The new CSRD will apply more broadly and cover approximately 37,300 additional companies, including non-EU parent companies.⁵ It also includes new requirements to report on resiliency strategies and value chain impacts.⁶ In contrast to the NFRD, companies subject to the CSRD will need to report not just retrospective disclosures, but forward-looking disclosures as well. Furthermore, companies will now need to consider the impacts of sustainability matters on short, medium and long-term horizons and provide both qualitative and quantitative assessments in their reporting.⁷

To ensure reliable and accurate sustainability reporting, the CSRD will also mandate the adoption of limited assurance standards for reported information by October 1, 2026,⁸ and reasonable assurance standards by October 1, 2028.⁹

Applicability of the CSRD

• The CSRD will apply to all large companies operating in the EU, whether listed on stock markets or not.
• The CSRD will also apply to listed small and medium-sized enterprises (“SMEs”). SMEs, however, will have more time to implement the new reporting system (three years after the entry into application).
• EU subsidiaries of non-EU companies will become subject to the CSRD rules if they constitute a “large undertaking,” meaning at least two of the following conditions apply: (1) the subsidiary has more than 250 employees, (2) the subsidiary has a net turnover¹⁰ of at least €40 million, or (3) the subsidiary has a balance sheet of at least €20 million.
• Beginning in 2028, the CSRD will also apply to non-EU companies with “substantial activity” (e., a turnover of at least €150 million) and a subsidiary or branch either operating in the EU with net turnover of at least €40 million or is a large or listed subsidiary.¹¹

In practice, nearly 50,000 companies in the EU will be subject to the CSRD, a marked increase from the approximately 11,700 companies currently subject to the NFRD. Non-listed SMEs can voluntarily comply with the CSRD.

Main Obligations of the CSRD

• One of the predominant changes under the CSRD is its emphasis on double materiality. Traditional notions of materiality focus on “the risks of an undertaking,” or how sustainability risks impact the company’s financial performance.¹² Double materiality accounts for “the impacts of the activities of the undertaking on people and the environment” in addition to traditional materiality.¹³ Ambiguity under the NFRD and general unfamiliarity with the concept of double materiality resulted in uncertainty as to what information should be reported. The CSRD attempts to clarify companies’ reporting obligations by integrating double materiality into the new reporting standards. EU’s double materiality standard lies in contrast to the U.S. Securities and Exchange Commission’s (“SEC”) proposed climate disclosure rules, which remain focused on traditional materiality.¹⁴
• Building upon current NFRD disclosures centered around five reporting areas (business model, policies, outcome of such policies, risks and risk management, and key performance indicators), the CSRD will require disclosures provide “sufficient detail” on an undertaking’s “resilience to risks related to sustainability matters.”¹⁵ For the most part, the additional details required will largely align with much of the information disclosed pursuant to the recommendations of the Task Force on Climate-related Financial Disclosures.¹⁶ These requirements mirror the SEC’s proposed rules, which are also based in part on the Task Force on Climate-related Financial Disclosure’s framework.¹⁷ The new requirements may result in companies needing to add significantly more information to their existing disclosures, and ensuring those disclosures align with other publications such as sustainability and ESG reports.
• The CSRD will increase the detail required with respect to due diligence requirements, ensuring consistency with instruments such as the UN Guiding Principles on Business and Human Rights and the OECD Due Diligence Guide for Responsible Business Conduct. In addition to the impacts of their own operations, companies will now need to evaluate the impacts of their activities throughout the value chain, ranging from suppliers to customers. The impacts to the supply chain must consider both the actual and potential adverse impacts, along with specifying actions taken by the company to prevent, mitigate and remediate those impacts.¹⁸

Key Takeaways

The CSRD will substantially broaden the types of disclosures required under the NFRD and the number of companies subject to mandatory reporting in the EU. Companies with “substantial activity” in the EU, including non-EU parent companies with EU subsidiaries or branches, should assess whether they will become subject to the CSRD rules and determine how to best prepare for the forthcoming rules. Additionally, companies subject to both the EU’s CSRD and the SEC’s proposed climate disclosure rule (The Enhancement and Standardization of Climate-Related Disclosures for Investors)¹⁹ should determine how to align internal controls and processes to satisfy both sets of disclosures.

¹ Press Release, Council of the Eur. Union, New rules on corporate sustainability reporting: provisional political agreement between the Council and the European Parliament (June 21, 2022, updated June 30, 2022), consilium.europa.eu/en/press/press-releases/2022/06/21/new-rules-on-sustainability-disclosure-provisional-agreement-between-council-and-european-parliament/.

² Press Release, Eur. Fin. Reporting Advisory Grp., EFRAG delivers the first set of draft ESRS to the European Commission (Nov. 23, 2022), https://www.efrag.org/Assets/Download?assetUrl=/sites/webpublishing/SiteAssets/EFRAG+Press+release+First+Set+of+draft+ESRS.pdf.

³Id.

⁴ Press release, Council of the Eur. Union, Council gives final green light to corporate sustainability reporting directive (Nov. 28, 2022), https://www.consilium.europa.eu/en/press/press-releases/2022/11/28/council-gives-final-green-light-to-corporate-sustainability-reporting-directive/.

⁵ Corporate Sustainability Reporting Directive (November 10, 2022, pg. 17); https://www.consilium.europa.eu/media/57644/st10835-xx22.pdf.

⁶ COM(2021) (November 12, 2019, pg. 43), https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52021PC0189&from=FR.

⁷ Id. at 29, 50.

⁸ Supra note 9, at 121.

⁹ Id.

¹⁰ Net turnover means the amounts derived from the sale of products and the provision of services after deducting sales rebates and value added tax and other taxes directly linked to turnover (See Article 3 of the Accounting Directive (2013/34/EU)).

¹¹ Supra note 9, at 13.

¹² Supra note 17, at 27.

¹³ Id.

¹⁴ SEC Release Nos. 33-11042, 34-94478, pgs. 63-65, https://www.sec.gov/rules/proposed/2022/33-11042.pdf.

¹⁵ Supra note 17, at 28.

¹⁶ Specifically, disclosures should include: “information about their business strategy and the resilience of the business model and strategy to risks related to sustainability matters, any plans they may have to ensure that their business model and strategy are compatible with the transition to a sustainable and climate-neutral economy; whether and how their business model and strategy take account of the interests of stakeholders; any opportunities for the undertaking arising from sustainability matters; the implementation of the aspects of the business strategy which affect, or are affected by sustainability matters; any sustainability targets set by the undertaking and the progress made towards achieving them; the role of the board and management with regard to sustainability matters; the principal actual and potential adverse impacts connected with the undertaking’s activities; and how the undertaking has identified the information that they report on.”  Id.

¹⁷ Press Release, U.S. Sec. & Exch. Comm’n, SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors (March 21, 2022), https://www.sec.gov/news/press-release/2022-46.

¹⁸ Supra note 19, at 28−29.

¹⁹ For further information, see Proposed SEC Climate Disclosures: An Overview of the Proposed Rule and What Companies Need to Do Now, V&E Insight (Apr. 11, 2022), https://www.velaw.com/insights/proposed-sec-climate-disclosures-an-overview-of-the-proposed-rule-and-what-companies-need-to-do-now/.