With the European Green Deal 1, the European Commission has announced a comprehensive program in 2019 that aims to make the EU climate neutral by 2050 and to promote sustainable business. The European Green Deal provides for an extensive range of measures that penetrate the most diverse areas of business and industry. A major focus is on the transparency of companies concerning sustainability aspects.
Under the European Green Deal, there are several innovations that introduce new reporting requirements on sustainability aspects in corporate reporting. The three most important new EU regulations on sustainability reporting are the EU Taxonomy for sustainable activities, the Sustainable Finance Disclosure Regulation (SFDR) and the Corporate Sustainability Reporting Directive (CSRD).
What is the CSRD?
The CSRD 1 2 concerns the sustainability reporting of companies. The main directive of the EU’s legal requirements for sustainability reporting for companies has so far been the so-called Non-Financial Reporting Directive (NFRD), or CSR Directive 3 in German. However, this directive only applies to capital market-oriented companies with more than 500 employees. The NFRD requires these companies to disclose non-financial information in a so-called “non-financial” report. The fact that many important companies are not covered by this directive, as well as the not very detailed content requirements for the “non-financial” report, was identified as a problem by the European Commission.
The CSRD is the planned renewal of the NFRD, which should improve these points. The CSRD is currently still in the proposal stage and is being discussed in the European Parliament and Council. It would extend the current scope of the CSR Directive to all large companies, regardless of their capital market orientation. This would then include all companies that meet 2 of the following 3 criteria: more than 250 employees, a balance sheet total of more than 20 million euros or sales of more than 40 million euros. In addition, small and medium-sized capital market-oriented companies will be required to report on sustainability aspects.
The content of reporting on sustainability aspects is also to be defined more concretely using own EU Sustainability Reporting Standards. These are to be developed and continuously refined by the European Financial Reporting Advisory Group (EFRAG) 4. The EU Sustainability Reporting Standards will be based on existing leading reporting standards such as the Global Reporting Initiative (GRI) 5, the Sustainability Accounting Standards Boards (SASB) 6, the German Sustainability Code (DNK) 7, and the recommendations of the Task Force Climate-related Financial Disclosures (TCFD) 8.
It is also envisaged that the information for the CSRD must be integrated into the management report on a mandatory basis. Another major change is the planned mandatory external audit of the disclosures. The main planned changes are summarized in Figure 1.
How does the CSRD relate to the EU taxonomy and the SFDR?
The EU Taxonomy, the CSRD, and the SFDR form the part of a larger “Sustainable Finance Framework” of the EU, which anchors sustainability factors at various levels of the economy (see Figure 2, own illustration based on 1 ).
The EU taxonomy is a common classification system for the EU economic area that determines which activities are considered environmentally sustainable. Based on this, metrics such as the percentage of sales or investments in “environmentally sustainable” activities can be collected and reported. Companies covered by the CSRD must include certain metrics based on the EU taxonomy in the CSRD report. Financial companies covered by the SFDR, in turn, also need the EU Taxonomy information from the companies’ CSRD report for their disclosure requirements, among other things.
The SFDR is a new regulation that requires financial companies, i.e. companies that offer financial and investment products, to disclose information about the sustainability impacts of their financial products. This may include, for example, information about the greenhouse gas (GHG) emissions of the investments underlying the financial products. To comply with these disclosures, financial companies require, in part, the relevant information from the CSRD reports of the companies in which they invest. The CSRD is therefore relevant to the SFDR as it makes the required information accessible. For financial products that partially or fully pursue the goal of “sustainable investment,” the taxonomy-compliant portion of the investment must also be disclosed via the SFDR.
Who is required to report what and when?
The CSRD is currently still at the draft stage. If it were to be accepted in its current form, this would affect all large companies, regardless of their capital market orientation, as well as all small and medium-sized capital market-oriented companies, as already described above. This would significantly expand the group of companies compared to the currently applicable NFRD or CSR Directive.
The exact content of the information to be reported is to be specified in separate EU Sustainability Reporting Standards. These have not yet been developed, but an insight is provided on the one hand by the CSRD proposal 1 and on the other hand by the working papers already published by EFRAG regarding the standards 2 (] (e.g. the working paper of the standard on climate protection 3). A key underlying principle is the principle of double materiality. Double materiality encompasses both “impact materiality”, i.e., the significant impact of the company on sustainability aspects, and “financial materiality”, i.e., the significant impact of sustainability aspects on the company. Other basic principles include certain quality requirements, such as relevance, verifiability, and comparability of the information. The inclusion of both qualitative and quantitative information, as well as the reporting of forward-looking and retrospective information, are also part of these basic principles. The connectivity of financial information and sustainability information, or integrated reporting, is also to be at the heart of the new reporting requirements.
According to EFRAG’s proposal, general information on the company’s sustainability strategy will be provided first. This is followed by information on measures and performance measurements for specific topics. The proposal includes a structuring of the topics based on the Environment, Social, Governance (ESG) concept. The Environment (E) or environmental topics could then be further substructured based on the EU taxonomy goals, for example. This potential breakdown is shown in Figure 3. For example, a concrete key figure to be reported for the environmental topic of climate protection would be the GHG emissions for Scopes 1 to 3 4.
According to the latest discussions 1, CSRD disclosures are to be a mandatory part of the management report for large capital market-oriented companies with more than 500 employees that are currently already covered by the CSR Directive from the financial year 2024 on. For the remaining large companies, the CSRD reporting obligation is to start for the financial year 2025. The small and medium-sized capital market-oriented companies would get another slightly longer deadline, with the first mandatory reporting for the financial year 2026.
The EU Sustainability Reporting Standards are to be developed in several steps. By October 2022, the first basic standards are planned, which will enable solid reporting with the most relevant information for the 2024 financial year, the year in which the first companies will be obliged to report. More advanced standards will then be developed by October 2023 and October 2024. In addition, it is planned that in the future the standards will be continuously revised, expanded and adapted, as is the case with financial accounting standards.
What new challenges does this pose for companies?
The CSRD builds on existing concepts of sustainability reporting. These are already relatively widespread with existing frameworks such as the GRI standards, the SASB standards and the DNK. Certain topic areas have also already been elaborated on in detail, e.g., the topic climate change mitigation with the TCFD recommendations. Larger capital market-oriented companies in particular have already had pressure to disclose sustainability information. With the introduction of the CSR Directive, these companies have also been legally obligated to disclose information for a few years now.
Nevertheless, there is still a significant proportion of companies that do not yet conduct sustainability reporting, or at least not yet to the structured extent that is expected to be required by the CSRD. Due to the expanded circle of reporting entities, it will be a major challenge to introduce sustainability reporting to a broad range of companies and to establish appropriate reporting processes there.
In addition, for the companies already reporting, the mandatory audit and the tighter content requirements will increase the demands on data quality and the scope of data, in some cases considerably. Companies will have to make their sustainability information auditable and potentially develop new topic areas. In particular, topic complexes such as the circular economy or biodiversity have not yet been as comprehensively elaborated in reporting as, for example, climate protection. The collection of quantifiable key figures, the setting of concrete targets, and the progress report on the achievement of these targets represent further key challenges of the new reporting obligation.
As compliance with the CSRD calls for increasing integration of sustainability aspects into corporate strategy, the CSRD fundamentally strengthens the trend toward anchoring sustainability aspects more and more in business. This relates specifically to the management of business activities, but also to the performance assessment of activities and projects based on sustainability targets and quantitative sustainability performance indicators.
How can we support you?
FfE has already gained experience with the new regulations and their significance for companies in the energy and financial sectors.
We are pleased to support you with the new requirements in the course of the CSRD with, among other things:
- Translation of the regulations into concrete requirements
- Collection and preparation of energy and emissions data for reporting purposes
- Implementation of life cycle analyses
- Training on the “Life Cycle Assessment (LCA)” methodology
- Preparation of guidelines for the quantification of sustainability indicators