“Reports often omit information that investors and other stakeholders think is important. Reported information can be hard to compare from company to company, and users of the information are often unsure whether they can trust it.” – The European Commission.
In the wake of increased climate threats due to global climate change, regulators, governments, policymakers, and other stakeholder groups around the world work together to address the climate emergency by taking urgent action to combat climate change and its impacts. As regulators respond to public policy pressures, the number of environmental, social and governance (ESG) disclosure standards and frameworks continue to grow, leading to a battle to sort the alphabet soup of developments in the regulation of ESG-related reporting requirements. Given the dynamic sustainability regulatory landscape, organizations face growing demands from investors, regulators and other stakeholders for transparency and accountability to provide ESG targets, policies, and actions to demonstrate how the climate change issues have been considered.
An increase in mandatory sustainability reporting is evident, and global regulatory bodies are focusing on harmonizing the plethora of sustainability standards to improve transparency of non-financial information whilst complying with existing legislation. To meet this need, the European Commission (EC), has recently released the Corporate Sustainability Reporting Directive (CSRD), which main aim is to harmonize sustainability reporting in Europe while avoiding greenwashing.
CSRD is a directive, part of the EU Green Deal Package, the purpose of which is to make Europe the first carbon climate-neutral continent by 2050. To support the EU Sustainable Finance Package, CSRD modernizes and strengthens the rules concerning the social and environmental information that companies must report. CSRD will require companies to report on how sustainability issues impact their business and how their operations in turn affect people and the planet, following the double materiality principle.
CSRD amends and replaces Non-Financial Reporting Directive (NFRD). The European Parliament adopted the Directive 2014/95/EU on the disclosure of non-financial and diversity information by large companies and groups in 2014. The law applies to public companies with more than 500 employees.
Understanding CSRD and ESRS
CSRD is the legislation that mandates subjected companies to report on sustainability issue in accordance with the final delegated act of the European Sustainability Reporting Standards (ESRS). While ESRS is the reporting framework, companies must use to disclose their sustainability performance under the CSRD.
CSRD aims for transparent, comparable, and trusted sustainability reporting from over 49,000 EU-based companies, subsidiaries, and global companies. CSRD came into force in the European Union on January 5, 2023, to improve corporate ESG disclosure quality, enabling investors and stakeholders to assess sustainability risks.
The European Financial Reporting Advisory Group (EFRAG) developed the ESRS, a set of standards for companies to comply with the CSRD as mandated by the EC to ensure a comprehensive and coherent set of standards. With the support of volunteer working groups, EFRAG produced draft standards, which were reviewed and handed over to the EC. These standards are closely aligned with the Global Reporting Initiative (GRI) standards, which are based on public consultation and technical inputs from the GRI group members. The EC published its proposed standards, which were considered over a four-week consultation period. On July 31, 2023, the EC adopted the standards with a final delegated act, requiring all EU member states to implement them. The CSRD will be rolled out in a phased approach from 2024, Public Interest Entities (PIEs) and large, over-500-employee companies having listed shares on EU-regulated markets will be the first to be introduced (e.g., those currently subject to NFRD reporting requirements). Figure 1 below shows the ESRS timeline of when and which companies should disclose.
Figure 1: ESRS timeline of when and which companies should disclose
CSRD Companies in Scope
Companies must comply with the CSRD if they fulfill two out of the following three requirements, as shown in figure 2. Additionally, separate standards will be developed for small and medium-sized enterprises (SMEs) and non-EU parent companies. Non-EU parent companies with a combined group turnover of more than €150 million in the EU also require compliance with the CSRD.
Listed SMEs can report simplified standards to make the disclosure of sustainability information easier for them. To assist SMEs in playing their part in the shift to a sustainable economy, these standards would be scaled to correspond with SMEs' capacities and make it simpler for them to provide information to banks, clients, investors, and other stakeholders. Exemptions apply for micro-undertakings including EU and non-EU subsidiaries of 10 employees, net revenue of €700 thousand or total assets of €350 thousand and for certain debt listings. Small and non-complex institutions and captive insurers are treated like listed SMEs have the option to opt out until 2028.
Furthermore, SMEs are not subjected to any additional reporting obligations under the CSRD, except for those that have securities listed on regulated exchanges. The EC has also suggested creating separate requirements that non-listed SMEs may voluntarily follow, even if the CSRD does not apply to them.
Figure 2: company subject to CSRD, two of the three criteria
“High quality and reliable public reporting by companies will help create a culture of greater public accountability.” – The European Commission.
In figure 3, the delegated act encompasses twelve finalized ESRS, consists of two cross-cutting standards, which apply to all sustainability matters, and ten topical standards covering a wide range of environmental, social and governance matters. EFRAG will develop sector-specific standards that are expected to be included in the future.
Figure 3: topical standards overview
The flowchart below (Figure 4) shows which disclosure requirements (DRs) determining disclosures under ESRS for the undertaking to include in reporting according to ESRS 1 general requirements. ESRS establish a materiality assessment as the foundation for sustainability reporting.
Figure 4: Necessary disclosure guidance flowchart (adapted from ESRS 1 Appendix E: Flowchart for determining disclosures under ESRS)
Overall, it is estimated that the new CSRD obligation will affect approximately 50,000 companies within the EU. It's important for SAP to help our customers navigate through the complexity of the requirements established in the ESRS drafts, with the main components of CSRD and ESRS including double materiality, prospective information, upstream and downstream value chain information, and sustainability due diligence. In the next quarter, additional ESRS KPIs and double materiality will be available in SAP Profitability and Performance Management (PaPM) solely focusing on reporting in line with ESRS. Stay tuned for more updates!
Reference
EFRAG
European Green Deal
Sustainable Finance
Overview Sustainable Finance
International Platform on Sustainable Finance
Corporate sustainability reporting
Corporate Sustainability Reporting Directive (CSRD) - 2022/2464/EU
Non-Financial Reporting Directive (NFRD) - 2014/95/EU
Questions and answers on the adoption of the ESRS
European sustainability reporting standards European sustainability reporting standards – first set ...
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