What is the CSRD?
The Corporate Sustainability Reporting Directive (CSRD) is the successor of the Non-Financial Reporting Directive (NFRD). Only approximately 11,600 capital-market oriented corporations, financial service providers, and insurers needed to comply with it in the past and until 2022. From 2023 onwards, the CSRD will need to be applied by approximately 49,000 companies in the EU, regardless of their capital market orientation. Its objective is to encourage and urge companies to better manage and improve their environmental, social, and governance (ESG) impact.
As of today, the EU responsible working group for this topic, the EFRAG (European Financial Reporting Advisory Group), has released a working paper on the CSRD reporting framework for the first two of in total six environmental goals based on the EU Taxonomy. These being climate change mitigation and climate change adaption. The criteria for the further four goals are expected to be published in October 2022. With the release and implementation of the environmental reporting part of this framework, the EU intends to meet the set climate goals for 2050. By October 2023 the reduced standards for small and medium-sized companies with securities listed on the regulated market as well as sector-specific standards applicable for all companies will be published. The goals for the social and governance topics will be successively released in the next years.
What makes the CSRD additionally so distinct compared to previous and existing mandatory reporting standards is not only the transparency that the sustainability statements will allow for on all levels, but also that it impels management boards to put this topic very high on their agenda. This is because they need to outline how they in their function as management board implement ESG in their company.
As the infographic above shows, the CSRD reporting standard is designed along with the so-called rules of three and covers
- Three layers (sector-independent, sector-specific, and company-specific) for a high degree of comparability with other companies
- Three reporting areas (strategy, implementation, and performance measurement) for a high degree of relevance
- Three topics (environment, social, and governance)
The complete model is called ESG+ and shall provide for disclosures named “sustainability statement”. The most important advancement of the CSRD is in the three reporting layers that directly connect ESG strategy with its implementation and its subsequent performance measurement in numbers and KPIs. These three reporting layers not only need to be applied and put into context for the three ESG topics, but also need to consider these from a sector-agnostic, industry-specific, and company-specific perspective.
On the strategic reporting level, companies need to define quantitative targets for the six environmental goals, provide information on the effects of climate change on the company and a respective strategy, the company’s resilience towards climate change and the actual and potential impact of the company and its strategy on the climate, as well as the related risks and opportunities. As the EU would like to anchor the topic also on management board level, a detailed description of the company’s governance efforts on board level is also required, as well as a description of how the steering of the topic on management and operational level works. Information on remuneration incentives related to GHG emission reduction is also part of the reporting, as are details on internal carbon pricing tools.
The implementation reporting part covers the writing and development of respective environmental policies. The policies need to outline who is responsible, what the underlying resources and due diligence management processes are, and how the policies are implemented. This not only for the company itself, but also along the up- and downstream value chain. The implementation part furthermore covers how the GHG emission reduction targets shall be achieved and what adaptive actions and resources will be used to manage the physical climate risk.
The performance measurement part requires the provision of quantitative data for defined criteria for the past three years and targets for the future including milestones for 2025 and 2030, and if relevant up to 2050. Thereby the scope covers not only the company’s direct emissions (Scope 1 of the GHG protocol) and Scope 2 emissions, caused indirectly from the generation of energy used by third-party providers. It also covers Scope 3 emissions, that include the emissions caused in the up- and downstream value chain of the company (e.g. waste disposal, goods transport). Another aspect of the performance measurement part is to disclose what portion of the relevant revenue, capital expenditure, and operational expenditure is generated respectively spent on so-called EU Taxonomy eligible and aligned items. In short, how much does a company’s business contribute to the six environmental goals of the EU Taxonomy, also in monetary terms. Furthermore, the performance measurement level connects with the strategic level and reflects the “double materiality” concept, i.e., it covers the inside-out perspective (impact of the company on the environment) as well as the outside-in perspective (impact of environment on the company and related financial risks).
The above-outlined information is only a very high-level summary of the CSRD, as the actual CSRD is far more complex and detailed. To get a first impression of how the reporting standard for the first two environmental goals of the EU Taxonomy will look in detail, please see the “climate standard working prototype” working paper published by the EFRAG.
Besides the actual content of the reporting, there is more to the CSRD. For example, the sustainability statement shall become a mandatory part of the annual report and be a separate chapter in the obligatory management report. The EU aims to make this statement an equally important part of a company’s annual reporting as for example the financial statements. This is further emphasised by the fact that the sustainability statement will be needed to be audited by a third party. At the beginning with a so-called limited assurance audit, but it is expected that in the future this will be changed to reasonable assurance which would make the sustainability statement an as important part of the annual reporting as the other mandatory statements.
Thus, companies are well-advised to start working on the preparation for the CSRD rather today than tomorrow, because besides compiling the comprehensive and technically challenging information, a company needs to implement respective documentable processes that allow auditors to trace the information. Furthermore, the sustainability statement needs also to be published in the digital XHTML format (ESEF data format), which allows for a high degree of comparability between companies and industries.
Good news for companies that already report along with GRI, SASB, IIRC, TCFD, CDSB or CDP. They will probably have it easier as the responsible working group EFRAG cooperates with the providers of the mentioned reporting standards to develop a comprehensive and future-proof reporting standard.
EMPACT Consulting is a boutique consultancy firm for businesses and governments in the field of CSR, CR, ESG, RBC, and Sustainability. EMPACT Consulting is not a (chartered) accountant or tax advisory firm and this publication is only intended as a general overview and discussion of the subject dealt with. It does not create an advisor-client relationship and is not intended to be, and should not be used as, a substitute for taking advice in any specific situation. EMPACT Consulting will accept no responsibility or liability for any actions taken or not taken based on this publication.