CSRD: EU revolutionizing corporate sustainability accountability and decisions
Introduction
The EU Corporate Sustainability Reporting Directive (CSRD), many years in the making, is revolutionary. CSRD will replace the questionable smorgasbords of stand alone inserts on corporate sustainability profiles. It does so by requiring firms to provide detailed framed descriptions on integrating sustainability into all facets of corporate decision-making.
This includes Scope 3 considerations on suppliers and end-users.
Most important, CSRD will become an international gold standard since all firms with significant business in the EU most submit CSRD reports.
In total, CSRD obliges disclosures on 13 different areas.
With CSRD, sustainability will be at the forefront in recording past and planning future endeavours.
Because it is highly complex to systemize descriptions of sustainability for every aspect of company activities and decision-making, the reporting process will be phased in and will organically evolve.
Beyond doubt, CSRD is a radical departure from ESG, which, for many companies, has become a public relations exercise.
CSRD overview
The Corporate Sustainability Reporting Directive (CSRD) became effective January 5, 2023. It replaces the Non-Financial Reporting Directive (NFRD). EU Members States had until by July 2024 to integrate CSRD into their laws.
CSRD goes much beyond NFRD by requiring the integration of risks, targets opportunities and due diligence, relative to environment and people, in corporate strategies and business models. This includes global financial activities and short- and medium term data to guide decision making.
Consequently, CRSD assists investors, civil society organizations consumers and other stakeholders assess and compare the sustainability performance of firms, based on standardized reporting.
These common standards pre-empt adhering to multiple voluntary criteria common to ESG. The voluntary ESG boundless characteristics typically result in gaps in accountability. This is especially so since ESG offers little or nothing on comparing annual sustainability performances.
Firms falling under the umbrella of CSRD are large companies previously subject to the NFRD; other listed companies; listed small and medium size enterprises; large private European firms; and non-European corporations with significant business in the EU.
Companies outside the EU with significant business in the EU that must comply with CSRD stipulations are those having securities listed in a EU market; a huge EU subsidiary; and a large connection to an EU group such as a holding company, or a EU parent group.
CSRD reporting
The essential information must cover quantitative, qualitative descriptions on 1) sustainability themes such as climate change; pollution; biodiversity and ecosystems; water waste and marine resources; plus resources use and circular economy; 2) social challenges including working conditions of a firm’s own workforce and workers in the value-chain, diversity, consumers/end users and community impacts; and 3) governance related to human rights and business ethics, all integrating Scope 3.
The technical reporting rules known as the European Sustainability Reporting Standards (ESRS) became law in December 2023.
Apart from general disclosures, all ESRS standards necessitate a materiality assessment. Should such assessments not apply, an explanation must be provided. Also, some reporting components are voluntary.
The draft ESRS standards were originally conceived by the European Commission with the technical advice of the group previously known as the European Financial Reporting Advisory Group (EFRSG). The EFRSG was a multi-stakeholder independent body including investors, companies, auditors, civil society, trade unions, academics and national standard-setters.
A hefty multi-stage series of EFRSG consultations followed and terminated in June 2023 with a 4-week public consultation.
Refinements of the EFRSG became the blueprint point of departure for an organic continuing process for improvements and clarifications that, among other things, optimize interoperability with International Sustainability Standards Board (ISSB) standards and the Global Reporting Initiative. This facilitates matters for those companies that wish to comply with one and/or the other. The EU aims for a seamless global compatibility and comparability framework on sustainability reporting.
Accordingly, not only will the evaluation criteria become an evolving/living universal foundation for rating the sustainability of companies, but they will also guide firms on how to improve their practices and standings.
A company has the option of having its draft CSRD report audited by a third party. Material so collected must appear in annual reports and are subject to audit.
Penalties for non-compliance are determined by EU Member States.
Scope 3 inclusion sets CSRD apart
Scope 3 emissions dive into the entire value chain of a firm, from suppliers to end-users, typically representing the majority of emissions associated with a company.
The most flagrant example of the importance of including Scope 3 in corporate sustainability descriptions is that of fossil fuels, the dominant global warming sources. It is estimated that 75% of total emissions, and 90% of a fossil fuel firm’s emissions, are attributable to the burning of these fuels.
Across all categories of firms, Scope 3 represents an average of 70% of company-specific emissions.
By including Scope 3 in a firm’s sustainability statements, at the very least, creates an incentive for companies to put emissions reduction pressure on suppliers and/or change certain suppliers.
Year-by-year reporting comparisons helps guide corporate investment choices.
Phased-in start timelines
Recognizing that extensive sustainability reporting could be especially burdensome for firms with less than 750 employees, the ESRS makes way for a phased-in reporting process.
The first phase of CSRD reports will begin in 2025, based on 2024 corporate performances. This phase covers firms listed on an EU-regulated market that have more than 500 employees.
Large companies with less employees, listed as well as non-EU listed, must submit their first report in 2026, for the financial year 2025. Such companies must meet two of the following criteria: over 250 employees, €50 million ($55 million) in turnover, €25 million ($28 million) in total assets.
Listed and non-EU listed small and medium size enterprises (SMEs), along with small and non-complex credit institutions, and captive insurance undertakings, will have the obligation to submit their CSRD reports in 2027, with respect to the 2026 fiscal year. Plus they will have a 2-year opt-out option after that.
SME reporting standards are more supple and will be capped. Draft versions of these less demanding standards are underway.
For non-listed SMEs that may have to submit sustainability information to banks, investors, customers and other stakeholders, the EFRSG conceived a simpler voluntary guide.
Non-EU companies with net revenues over €150 million ($165 million) annually earned in the EU; have a branch with either a turnover exceeding €40 million ($44 million); or a subsidiary that is a large company or a listed SME, will have to report on the sustainability impacts at the group level of that non-EU company, starting with the financial year 2028. The first sustainability statement is to be published in 2029. There will be different standards for such cases.
For EU firms not listed, such as an EU subsidiary of a non-EU headquartered company, reporting is obligatory for firms having two of the following characteristics in their profiles for two consecutive fiscal years. These characteristics are 1) total assets €25 million ($28 million) as of December 2023; 2) net revenue €50 million ($55 million) as of December 2023; and an average of 250 employees.
The takeaway
The CSRD will be an effective international corporate sustainability crusader because it applies to all large companies and SMEs doing business in the EU. Since the overwhelming majority of multinational large firms and SMEs with international markets conduct significant business in the EU, the CSRD impacts are world-wide.
The thoroughness of the CSRD process lends credibility to corporate descriptions of sustainability progress to-date and influences on a broad sphere of decision-making. Without the CSRD portrait requirements on sustainability risks and opportunities, it is hard direct firms towards more sustainable practices.
The CSRD is much more than a compliance exercise with lofty ESG narrations.
