On 21 April 2021, the EU Commission announced its proposal to extend existing sustainability reporting in a new Corporate Sustainability Reporting Directive (CSRD). The proposal, which revises the Non-Financial Reporting Directive (the “NFRD“), will extend the reach of sustainability reporting to more companies and will cover more sustainability topics.
This is part of a wider, concerted effort by the EU to legislate for greater E, S and G reporting and accountability standards, like the EU’s proposed mandatory human rights and environmental due diligence law. It is also part of a larger global trend: for example, New Zealand recently introduced a new Climate Disclosure Law (see our Blog Post on this here). Companies are increasingly embracing voluntary sustainability reporting but there are increased demands for mandatory reporting – the Global Reporting Initiative (GRI) for instance called for mandatory reporting in December last year. However companies’ standards of voluntary reporting are of variable quality and often do not address the impacts of companies’ business activities on people and the environment.
Key aspects of the proposed Sustainability Reporting Directive:
- More companies would be asked to report on sustainability, up from 11,000 previously to nearly 50,000.
- The “double materiality perspective” is further reinforced – that is companies have to report on the impact of their business activities on people and the planet across the full value chain, as well as the sustainability risks for the business itself, and to disclose the process for determining their material issues.
- Measurements of sustainability will be more consistent, reliable, and therefore comparable, for investors and other stakeholders.
- Timing is subject to change, but it is expected these measures would take effect in 2024, i.e. reporting on the financial year ending 2023.
What is the Intended Aim of the Proposals?
The EU wishes to bring corporate sustainability reporting in line with the current quality of financial reporting and disclosures. It is hoped the resulting information is reliable and easily comparable for investors and other stakeholders.
Currently, many companies are expected to disclose information under a variety of different sustainability reporting standards and frameworks. The proposal aims to simplify this reporting process for companies. They are intended to be a single, centralized reporting standard.
What Kind of Information Would Need to be Disclosed?
Under the CSRD proposal, relevant companies are expected to report on how their business activities impact people and the environment and the risks to the business of sustainability related issues such as climate change. This is known as the “double materiality perspective”, which was introduced by the NFRD and further reinforced under the CSRD. It asks companies to report on how sustainability issues (1) affect their business, and (2) affect people and the environment around them.
While the EU has been at the forefront of developing the “double materiality” principle, there are signs that the concept could be gaining traction on an international level: for example, the GRI is in the process of revising its definition of materiality to include double materiality, on the theory that understanding impacts on people and the environment “is necessary in order to identify financially material risks, opportunities, and impacts.” In the US, recent statements from SEC Commissioner Allison Herren Lee suggest that the federal securities regulator may also take an expansive view of materiality in an upcoming rule proposal on ESG disclosures, noting that “[m]any have also come to believe (incorrectly) that the SEC is legally prohibited from requiring specific disclosures unless it can demonstrate that each such disclosure is individually material to the bottom line of every public company.”
Some of the new “people” topics which entities would be explicitly required to report on include:
- Equal opportunity, including related to gender, equal pay for equal work and people with disabilities;
- Working conditions, including wages, social dialogue and collective bargaining;
- Respect for human rights broadly with a reference to core international and EU standards.
In addition, companies would be asked to disclose what steps they are taking to mitigate sustainability related impact – such as for instance climate change mitigation and adaptation.
For the first time, the proposal introduces a general EU-wide audit (assurance) requirement for reported sustainability information. This will act as a safeguard for information being accurate and reliable, helping ease concerns around greenwashing and other nefarious activity suspected as widespread by some investors and commentators. We recently reported on what the EU is doing to combat this behavior in another Blog Post, available here.
Who Will the Reporting Obligations Apply to?
The proposed reporting obligations will extend to:
- All large EU companies, meaning those that meet at least two of the following criteria:
- 250 employees;
- A balance sheet of €20 million; and/or
- €40 million in turnover; and
- All listed companies.
The EU estimate this will cover almost 50,000 companies. The EU Commission is also proposing separate, proportionate standards for SMEs, with the option for non-listed SMEs to adopt them on a voluntary basis.
When is the Proposal Likely to Apply?
The European Financial Reporting Advisory Group are working toward publishing draft sustainability reporting standards at some time during 2022. The first reporting obligations are likely to relate to activity within financial year ending 2023. Given the significant reporting standards being proposed, businesses should act now to ensure they are ready for the impending legislation.