In a major shift toward corporate accountability, the European Union has recently overhauled its sustainability reporting rules under the Non-Financial Reporting Directive (NFRD) which applies to large, listed companies, banks and insurers with over 500 employees. The new Corporate Sustainability Reporting Directive (CSRD), adopted in December 2022, not only strengthens these requirements but also creates additional, complex challenges.
Notably, the CSRD extends reporting obligations to encompass all large companies and companies listed on EU regulated markets, excluding very small enterprises. It is estimated that around 50,000 companies will be covered compared to the roughly 11,700 covered under the NFRD. This means that CEOs and corporate leaders need to start preparing for the new reporting landscape as reporting under the CSRD kicks off for some entities already in 2025 (for the 2024 reporting year).
New EU directive
The EU CSRD adopted in December 2022 strengthens the existing rules on non-financial reporting that were introduced in the Accounting Directive by the 2014 Non-Financial Reporting Directive (NFRD). Apart from bringing many more businesses within the scope of application of the law, the new rules seek to ensure that the information reported is sufficient, reliable and comparable by specifying in greater detail what needs to be reported and obliging companies to use common sustainability reporting standards. The EU’s objective is to make covered businesses more publicly accountable by providing investors, citizens and other stakeholders with a comprehensive and credible overview of a business’ environmental and societal impact.
It also serves to equip companies subject to the Sustainable Finance Disclosures Regulation (SFDR) such as investment firms and insurers with the information they need for their own sustainability disclosures to their clients.
Expanded scope
The reforms break new ground by requiring all large companies and all companies listed on EU regulated markets (excluding listed micro-enterprises) to report on sustainability matters relating to environmental factors, social and human rights factors, and corporate governance. In particular, companies must disclose sustainability information on (a) how sustainability issues − such as climate change − affect their business (the internal perspective), and (b) how their activities affect people and the environment (the external perspective).
Compared to the rules under the Non-Financial Reporting Directive, the scope of the new requirements is considerably broader since the NFRD only covered large, listed undertakings, banks, and insurers with more than 500 employees.
| Large companies | An undertaking that fulfils at least two of the following three criteria:
i. Balance Sheet total in excess of €20 million* ii. Net Turnover in excess of €40 million* iii. Average number of employees in excess of 250 * Due to inflation readjustment, B/S size will increase to €25m and Turnover to €50m (see draft act C(2023) 7020) |
Moreover, since Article 8 of the Taxonomy Regulation applies to entities subject to non-financial reporting, companies falling under the scope of the NFRD/CSRD will also have to disclose how and to what extent their activities or investments are associated with economic activities that qualify as environmentally sustainable under the Taxonomy Regulation. This means that they must assess and report on the extent to which their activities or investments are taxonomy-eligible and taxonomy-aligned with economic activities that make a substantial contribution to at least one of six environmental objectives (ie, climate change mitigation or climate change adaptation), in accordance with the Disclosures Delegated Act (also known as Article 8 Delegated Act). Non-financial companies need to specifically disclose the proportion of their net turnover, operating and capital expenditure (OpEx, CapEx) derived from taxonomy-aligned activities. Financial companies (ie, banks, investment firms, asset managers, insurers) are required to disclose the proportion of their investments or financing in taxonomy-aligned activities, using the so-called “Green Investment Ratio”.
Sustainability information in management reports
The CSRD also extends the information that covered undertakings must disclose. Article 19a requires companies to include within their management report sustainability-related information on several issues. This includes the resilience of their business model and strategy to sustainability-related risks, time-bound targets, sustainability policies, the board’s role in respect of sustainability matters, and the company’s principal adverse impacts. The specific information that undertakings will be required to report, and the structure of such reporting, will be set out in the Sustainability Reporting Standards issued by the Commission.
In the case of a large group (defined similarly to a large undertaking), Article 29a requires the parent to include in its consolidated management report consolidated sustainability-related information on issues like the ones provided under Article 19a. Under certain conditions, an undertaking that is a subsidiary undertaking can be exempted from the reporting requirement where it is included in the consolidated management report of the parent.
European Sustainability Reporting Standards (ESRS)
The Directive requires companies to report information according to mandatory EU sustainability reporting standards. Article 29b provides for the development of reporting standards with respect to (a) environmental factors, (b) social and human rights factors, and (c) governance factors.
The European Commission has already developed the first set of ESRS in the form of a Delegated Regulation (not yet in force as pending co-legislator scrutiny, set to apply from January 1, 2024), providing for 12 sector-blind standards grouped under four topics. Apart from the first and second ESRS that are general, the remaining 10 standards are subject to a materiality assessment, meaning that a company is required to report only relevant information and may omit information that is not relevant (material) to its business and activities. This requires caution as the company’s materiality assessment process is subject to external assurance (see audit requirement below). An example of the structure of the sustainability report to be included in the management report, plus a flowchart for determining ESRS disclosures, is provided in the Annex to the Regulation.
| 12 STANDARDS | Cross-Cutting Standards: | 1. General Requirements | 2. General Disclosures |
|
Standards on Environmental Matters: |
E1: Climate change | E2: Pollution | |
| E3: Water and marine resources | E4: Biodiversity and ecosystems | ||
| E5: Resource use and circular economy | |||
| Standards on Social Matters: | S1: Own workforce | S2: Workers in the value chain | |
| S3: Affected communities | S4: Consumers and end-users | ||
| Standards on Governance: | G1: Business conduct |
It is notable that the ESRS Regulation provides for the phasing-in of certain data disclosure requirements. For instance, during the first year that they apply the standards, companies with less than 750 employees may omit certain emissions data and own workforce disclosures, while all companies may omit information on anticipated financial effects related to non-climate environmental issues and certain datapoints related to their own workforce.
Following the adoption of this first set of ESRS, the Commission will subsequently have to adopt a set of SME-specific ESRS (see below), a set of sector-specific ESRS, and a set of ESRS for non-EU companies.
Proportional reporting requirements for SMEs
Covered SMEs will benefit from a proportionate reporting regime, as the rules provide for the development of a separate set of simpler sustainability reporting standards. Draft versions of these proportionate standards are currently in development and are expected to be adopted in Q2 2024 in the form of a delegated act.
Covered SMEs will also benefit from a long transitional period as the first reporting year is 2027 (in relation to financial year 2026). Additionally, they have the possibility to opt out for two years, thus postponing the application of the rules until 2029 (for the 2028 reporting year).
Audit requirement and management responsibility
To ensure the accuracy and reliability of the disclosures, the Directive introduces for the first time an audit requirement for the reported sustainability information. Covered companies will be required to obtain “limited” assurance over their reported information. Member states have the option to permit a statutory auditor other than the one carrying out the statutory audit to provide this opinion and can also allow “independent assurance services providers” to do so.
The new rules moreover provide that members of the covered company’s management body bear collective responsibility for reporting sustainability information in accordance with the requirements of the Directive.
Non-EU companies
For third-country undertakings, the sustainability reporting requirement applies to all companies generating a net turnover of more than €150 million in the EU and which have at least one subsidiary or a branch in the EU exceeding certain thresholds.
Next steps and timeline
The CSRS Directive provides for a transposition period of 18 months, meaning that member states must have their national implementing legislation in place by July 6, 2024. Competent authorities in Cyprus have commenced preparatory work and a consultation on the transposition of the Directive is expected to take place in early 2024. Of particular focus will be the topics on which the Directive allows discretion to member states and the way in which authorities may exercise that discretion.
Reporting Timeline:
| Reporting Undertaking | Reporting Obligation | |
| Companies already subject to the Non-Financial Reporting Directive (NFRD) | Reporting in 2025 on the financial year 2024 | |
| Large companies not previously subject to NFRD | Reporting in 2026 on the financial year 2025 | |
| SMEs listed in regulated markets | Reporting in 2027 on the financial year 2026 (unless they exercise the 2 year opt-out) | |
| Third-country companies with net EU turnover of more than €150 million with subsidiary or branch in the EU | Reporting in 2029 on the financial year 2028 |
It is evident that the transition to CSRD and compliance with reporting requirements under Article 8 of the Taxonomy Regulation presents complex challenges and a significant learning curve for affected companies. It is crucial for these entities to determine their status under CSRD early on, and, if they are in-scope, start preparatory work on the information and data that will be required, the processes and controls that will need to be put in place, and the resources that will have to be committed. Conducting a comprehensive gap analysis is the first step towards gaining a clear understanding of the extent of the changes required and ensuring a smooth transition.
Stefanos Sofroniou is a senior associate at Elias Neocleous & Co LLC
