What is the CSRD?
The Corporate Sustainability Reporting Directive (CSRD) represents a pivotal milestone in the journey towards sustainability within the European Union. Officially adopted by the European Parliament in November 2022, the CSRD (Directive 2022/2464) is an addition to the Non Financial Reporting Directive (NFRD). After the European Commission published its proposal for a directive in April 2021, the negotiators from the Commission, the Council and the European Parliament reached a compromise on 21 June 2022. The new regulations must be implemented by the member states 18 months later. According to the CSRD, companies will have to report on a broader range of sustainability issues in a separate section of the management report, including ESG issues and climate-related risks and opportunities. In doing so, companies must follow a set of sustainability reporting standards, the ESRS, developed by the European Financial Reporting Advisory Group (EFRAG) in consultation with stakeholders. This requires companies to report their sustainability information in a digital format using the eXtensible Business Reporting Language (XBRL), which facilitates the analysis and comparison of data.
What is the objective?
The primary objective of the CSRD is to establish a standardised framework for reporting non-financial data among companies operating within the EU. This framework is designed to facilitate the reporting of essential non-financial information, enabling investors, civil society groups, consumers, policymakers, and various stakeholders to make informed decisions based on a company's non-financial performance. After disclosure of the information, the non-financial corporate report is assessed by independently accredited auditors. The audit can be carried out by the auditor, another auditor or an independent assurance provider (Member State option). The EU plans to gradually increase the audit standard from limited assurance to reasonable assurance and to develop EU auditing standards for reasonable assurance audits by October 2028.The handling of reporting at group level according to CSRD allows subsidiaries to be exempted from the reporting obligation in principle. However, this exemption does not apply to capital market-oriented subsidiaries. It should also be noted that if the risks and impacts of the subsidiary and parent differ significantly, the risks and impacts of the subsidiary must be disclosed in the group management report.
Who is affected by the EU Taxonomy?
Compared to the NFRD, the CSRD now makes significantly more companies subject to reporting requirements. For reporting, a chronological sequence of the implementation roadmap is planned depending on the type of company: All companies reporting under the NFRD must report under the CSRD from 2025 for the reporting year 2024. From 2026, large companies (limited liability companies, credit institutions and insurance companies) that meet at least two of the three characteristics on the balance sheet date will then have to disclose their information in accordance with the CSRD for the 2025 reporting year if they meet two of the following three criteria:
- At least 250 employees on an annual average,
- 40 million € turnover, and
- Net sales of €20 million
One year later, from 2027 for the reporting year 2026, all small and medium-sized enterprises (SMEs), other listed companies (with 10 to 250 employees) and captive (re)insurance companies will be subject to CSRD reporting, with extensions possible until 2028. Micro-enterprises are excluded. From 2029 for the reporting year 2028, all European subsidiaries or branches of non-European parent companies that generate more than €150 million in cumulative turnover in the EU and have at least one EU branch or EU subsidiary that generates at least €40 million in net turnover in the EU are then subject to reporting. The EU subsidiary or EU branch is responsible for publishing the non-EU company's sustainability report. The non-EU company's sustainability reports should be prepared in accordance with separate EU reporting standards (i.e. standards other than those applicable to EU companies). The company may also report according to the standards applicable to EU companies or according to standards deemed equivalent by a Commission decision. More detailed requirements for non-EU companies subject to CSRD are currently being developed and are expected to be adopted in mid-2024.
European Sustainability Reporting Standards
The European Sustainability Reporting Standards (ESRS) are the standardised reporting standards that companies obliged to report according to the CSRD must adhere to. The ESRS was adopted on July 31 2023 and consists of a sector-agnostic part, which applies to all companies regardless of sector, and a sector-specific part, which is currently being developed by the European Financial Reporting Advisory Group (EFRAG) on behalf of the EU Commission. The sector agnostic standards in turn entails twelve standards:
- Two cross cutting standards (ESRS 1 & ESRS 2) about general information and disclosures
- Five environmental standards (ESRS E1 Climate Change; ESRS E2 Pollution; ESRS E3 Marine & water resources; ESRS E4 Biodiversity and ecosystems and ESRS E5 Resource use and circular economy)
- Four social standards (ESRS S1 Own workforce; ESRS S2 Workers in the value chain; ESRS S3 Affected communities and ESRS S4 Consumers and end-users)
- One governance standard (ESRS G1 Business conduct)
The standards about the ESG-topics, the so called ‘topical standards’, follow the same structure: They are all comprised for the most part of indicators for their specific topic, that companies must disclose. Additionally, enterprises are according to all topical standards required to report policies and derived actions to mitigate any negative impacts or risks and to use positive impacts as opportunities arising in the specific topical field. In general, these standards comprise a total of 84 disclosure requirements, 37 sub-topics and 1,144 data points that companies must report on depending on the outcome of their materiality analysis (For more information, see the section ‘double materiality assessement’).If companies assess that any information relevant for the report is not covered neither by the sector agnostic, nor ion the future by the sector specific standards, then they are obliged to disclose this information in a separate ‘company specific disclosure’ section of their sustainability report.
Concepts of the CSRD
EU Taxonomy within CSRD
The CSRD operates in harmony with other pivotal sustainability regulations within the EU, including the Sustainable Finance Disclosure Regulation (SFDR) and the EU Taxonomy Regulation. Notably, the EU Taxonomy will be integrated into the mandatory reporting obligations established by the CSRD, further aligning businesses with sustainable finance principles and environmental objectives. Companies obliged to report according to the CSRD must disclose their sustainable financial KPIs in harmony with Article 8 of the EU Taxonomy. Furthermore, the ESRS E1 Climate change stipulates that companies must draft an environmental transition plan, which one key aspect is the alignment of the economic activities of the enterprise with the EU Taxonomy.
Due Diligence Process
The corporate due diligence process for sustainability matters also plays a central role in the CSRD. According to ESRS, the sustainability due diligence process is an ongoing practice that responds to changes in the company's strategy, business model, activities, business relationships, operations, procurement and sales context. Furthermore, the process is derived from the international instruments of the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises and includes the following as a core concept: the identification and assessment of negative impacts caused or contributed to by the company, as well as negative impacts directly related to the company's own operations, products or services through its business relationships. If the entity cannot address all impacts at once, the due diligence process allows priorities to be set depending on the severity and likelihood of the impacts (Draft ESRS 1 General requirements, 2022.).
The constant recording and assessment of the company's impacts through the due diligence process is an essential input for the materiality assessment of internal processes of ESG issues. As ESG issues are broad and their relevance varies from company to company, an assessment is needed of which issues are particularly relevant in the context of sustainability management and which ESG aspects the public should be informed about in the sustainability report. Compared to the NFRD, the CSRD prescribes the definition of material sustainability topics according to the principle of double materiality (DM) and thus a significant expansion of relevant topics. For the materiality analysis according to double materiality, two dimensions must be considered: Environmental materiality and financial materiality. To prevent misunderstandings or misinterpretations of the dual materiality analysis, EFRAG was tasked with firmly anchoring the principle in the ESRS as part of the development of the CSRD.
According to ESRS, the starting point of any materiality assessment is the identification of environmental materiality (inside-out) (Draft ESRS 1 General requirements, 2022). This materiality dimension assesses the impact of a company's business activities on the environment and society. In identifying and assessing impacts, risks and opportunities within the value chain, entities should focus on areas where material impacts are most likely to occur due to the nature of the activities, business relationships, geography or other risk factors. The two dimensions of double materiality (Source: Communication from the Commission - Guidelines for reporting non-financial information: Addendum on climate-related reporting, n.d.).
For actual adverse impacts, materiality is based on the severity of the impact, while potential adverse impacts is based on the severity and likelihood of the impact. The severity is determined on the basis of
- the scale;
- the scope; and
- the immutability of the impact
and is calculated additively. In the case of a potential negative impact on human rights, the severity of the impact takes precedence over the probability of occurrence.In contrast, the calculation of positive significant impacts differs depending on the type of impact: In the case of
- actual positive impacts, the magnitude and extent of the impact must be considered; in the case of
- potential negative impacts, the magnitude, extent and likelihood of the impact (Draft ESRS 1 General requirements, 2022).
Financial materiality (outside-in) completes the materiality assessment according to double materiality. Here, the impact of the environment and society on the company's business activities is assessed. In this step, companies should derive risks and opportunities from past or future events that have an impact on the following:
- assets and liabilities that have already been recognised in financial reporting or that will be recognised as a result of future events; or
- value-creating factors that do not meet the accounting definition of asset and liability recognition and/or the related recognition criteria cash flow generation and, more generally, the development of the business.
Furthermore, financial materiality is not limited to matters that are under the direct control of the company concerned but can also relate to the material risks and opportunities arising from business relationships with other companies/stakeholders. In the context of the financial effects arising from a company's dependence on natural and social resources, a distinction is made between two types of effects. On the one hand, those effects that influence the company's ability to obtain and use resources it needs for its business processes, and to influence the quality and pricing of these resources. And, on the other hand, those effects that affect the company's ability to access business relationships (with other companies, with stakeholders) that it needs for its business processes under economically acceptable conditions.
To calculate financial materiality, it is necessary to consider,
To calculate financial materiality, it is necessary to consider,
- the probability of occurrence and
- the magnitude of the potential financial impact must be determined.
For the concrete implementation of the materiality assessment, companies need to consider several aspects in their materiality analysis according to double materiality. An important support for conducting a materiality analysis is a status quo analysis of the company, which should determine the business model, the business strategy, features of the value chain, the target market and the stakeholders. In addition, a list of sustainability topics based on the ESRS, the actual and potential, positive and negative impacts formulated for them, and the involvement of stakeholders is crucial for the success of a materiality analysis. Since all disclosure requirements of the ESRS, apart from ESRS 2, are to be assessed by the double materiality approach the circle of topics to be disclosed varies from company to company.
For sustainability reporting according to the ESRS, the life cycle perspective is also gaining importance in the regulations. Life cycle assessment (LCA) and the concept of accounting for greenhouse gas (GHG) emissions according to the Greenhouse Gas Protocol (GHG Protocol), subdivided into Scopes 1, 2 and 3, play an important role. Scope 1 emissions are defined as direct emissions from own or controlled sources, whereas Scope 2 emissions are indirect emissions from the generation of purchased energy. In this context, scope 3 emissions are defined as all indirect emissions that do not fall under scope 2 and arise in the reporting company's value chain, including upstream and downstream emissions. While LCA assesses various environmental impacts of products or services, GHG accounting according to the GHG Protocol refers to the organisational or company level. Despite the different objects of investigation (product vs. company), a life cycle assessment and Scope 3 emissions according to the GHG Protocol, however, record such environmental or climate impacts that go far beyond the pure effects within the company. This is because both LCA and Scope 3 emissions accounting consider the entire life cycle of the product or company. In particular, the accounting of GHG emissions occupies a central place in the CSRD, in ESRS E1 Climate Change, with the obligation of all companies to disclose their GHG balance in accordance with the GHG Protocol (see ESRS E1).
CSRD and VIRIDAD
Viridad recognizes the significance of the CSRD in promoting corporate transparency and sustainability. We are committed to assisting our clients in adhering to these important standards, thereby contributing to a more sustainable and responsible business landscape in the EU and beyond.At Viridad, we're committed to simplifying the CSRD reporting process and helping you harness the power of sustainability reporting to drive your business towards a more sustainable and responsible future. Explore our services to see how we can assist you on this transformative journey.