Mairead McGuinness, Commissioner for Financial Services, Financial Stability and Capital Markets Union, said: “Sustainability reporting will now be on an equal footing with financial reporting. The Corporate Sustainability Reporting Directive will help drive the transition to a sustainable economic system built on innovation and investment opportunities. It will enable companies to communicate and manage their sustainability performance more efficiently. Citizens will be able to measure the success of companies not just in financial terms but also assess how they impact people and the environment.”
The final legislative text of the agreed version is not yet available but the Commission's statement includes references to some material updates to the proposal. We expect the text of the agreed draft of the CSRD to be published during the coming weeks. This note sets out key points in respect of this agreement on CSRD.
As previously discussed, the CSRD will impose the requirement to make environmental, social and governance related disclosures on the broad range of companies to which it will apply. These will include non-listed large companies, as well as listed small or medium-sized enterprises (SMEs) (excluding micro-enterprises), and significantly, non-EU companies with significant activities in the EU will also be required to report.
The CSRD is intended to result in the reporting of transparent and reliable corporate sustainability information by relevant companies that can be accessed and compared by investors and other stakeholders. The application of one unified set of standards is also intended to achieve streamlining of reporting by companies to which it applies.
The CSRD aligns with the European Commission's commitment to advancing its European Green Deal which aims to improve the flow of money to activities that are sustainable. The CSRD follows on from the European Commission's consultation on the Non-Financial Reporting Directive (2014/95/EU) (NFRD) in February 2020. The CSRD will substantially amend the existing requirements of the NFRD. The NFRD was transposed into Irish law by the European Union (Disclosure of Non-Financial and Diversity Information by certain large undertakings and groups) Regulations 2017, which requires 'applicable companies' to make certain non-financial disclosures, with additional disclosures required for 'large traded companies'. In the Commission's view, the NFRD has not resulted in sufficient information being made available and does not apply to a sufficiently broad range of entities.
At the heart of the CSRD is the introduction of mandatory European sustainability reporting standards, which the European Financial Reporting Advisory Group (EFRAG) is currently developing. The CSRD will amend the NFRD as well as the Audit Directive (2014/56/EU amending 2006/43/EC) and the Transparency Directive (2001/34/EC) and relevant regulations.
Who will the CSRD apply to?
The CSRD will require a broad range of companies to report sustainability information. Under the CSRD, reporting obligations will apply to:
- all large companies whether listed or not
- SMEs with securities listed on an EU regulated market (excluding micro-enterprises)
- non-EU companies with at least one subsidiary or branch in the EU and that generate a net turnover of €150m or more in the EU will be required to report under the CSRD
For the purposes of the CSRD, a large company is one which meets at least two of the following criteria: a balance sheet of more than €20m; and/or net turnover of more than €40m; and/or an average of more than 250 employees during the financial year. Again, for the purposes of the CSRD an SME is an entity which meets at least two of the following criteria: a balance sheet of between €4m and €20m; and/or net turnover of between €8m and €40m; and/or an average of between 50 and 250 employees during the financial year.
The requirement for non-EU companies to report is a change from the European Commission's proposed draft of the CSRD and is regarded as significantly positive by the European Parliament. This more closely aligns the CSRD with the proposal for a Corporate Sustainability Due Diligence Directive which we have commented on previously.
What will entities be required to report?
Detailed reporting requirements are not yet available, but there are indications of what reporting companies can expect. EFRAG issued a public consultation on its first draft European Sustainability Reporting Standards (ESRS) which will be open until 8 August 2022. This sets out a framework of required reporting which will include three layers: sector-agnostic requirements; sector-specific requirements and entity-specific requirements and three reporting areas, strategy, implementation and performance measurement. The ESRS are intended to cover the sustainability risks to reporting companies as well as the impacts the reporting companies have on society and the environment, keeping the 'double materiality' reporting introduced by the NFRD. The ESRS will require reporting across all three ESG topics: environmental factors, social factors, as well as governance factors.
EFRAG has committed to submit the first draft set of ESRS for review by the European Commission by November 2022. The Commission has stated that it will issue sector-agnostic reporting standards in 2023 with sector-specific standards to be issued in 2024. It is intended that standards applicable to SMEs will be proportionate, and that non-listed SMEs may choose to adopt the ESRS voluntarily.
Reporting companies will be required to prepare their reports in a single report included with financial reporting which is in digital machine-readable format and in which the sustainability information is electronically tagged, with the expectation that this information can be fed into a single European access point in line with the European Commission's 2020 capital markets union action plan.
How will standards be monitored?
The CSRD will require that reports are certified by an accredited independent auditor or certifier on an assurance basis, who will be tasked with ensuring that information reported complies with the relevant standards. Member States will be permitted to allow firms other than existing auditors to provide these assurances.
When will the requirements apply?
The requirements of the CSRD will apply in three phases:
- from 1 January 2024, companies already subject to the NFRD will be required to apply the rules, with first reports due in 2025
- from 1 January 2025, large companies that are not already subject to the NFRD will be required to apply the rules, with first reports due in 2026
- finally, listed SMEs, small and non-complex credit institutions and captive insurance undertakings will be required to apply the rules from 1 January 2026 with first reports due in 2027. An opt-out "will be possible for SMEs during a transitional period meaning that they will be exempted from the application of the [CSRD] until 2028".
The political agreement reached by the European Parliament and the Council is now subject to formal approval. Member States will have 18 months in which to implement the Directive into national law. This means that it could be late 2023 or early 2024 before we see Irish implementing legislation. This will be a tight turnaround for the first companies that must report in 2025 (for financial years starting on or after 1 January 2024) so relevant companies should ensure that they continue to carefully monitor developments in this area.