European Union: EU Corporate Sustainability Reporting Directive – New ESG Disclosure Rules

BACKGROUND

In April 2021 the European Commission presented a proposal for a Corporate Sustainability Reporting Directive (CSRD) that would amend the current Non-Financial Reporting Directive (NFRD) and form part of the wider EU policy to require companies to publicly disclose information and data around environmental, social affairs and governance matters.

On 28 November 2022, the European Council adopted the CSRD following adoption by the European Parliament on 10 November 2022. The CSRD will come into force 20 days after publication in the EU Official Journal and EU member states will then have 18 months to incorporate it into their national laws.

SCOPE

The CSRD creates new sustainability reporting requirements and expands the scope of companies that will be subject to the EU sustainability reporting framework. Under the current NFRD, large EU listed companies, credit institutions, insurance companies and other entities are required to report and disclose certain sustainability information on an annual basis. The CSRD expands the scope of disclosure requirements to non-EU companies with substantial operations in the EU.

The CSRD will apply to:

1. All companies listed on any EU regulated market, except for listed micro companies. Although listed SMEs will also be covered they will have until 1 January 2026 to comply with the reporting requirements.

2. A "large undertaking" that is either an EU company or an EU subsidiary of a non-EU company. A "large undertaking" is a defined term in the Accounting Directive and means an entity that meets at least two of the following criteria:

a. A net turnover of €40 million;
b. A balance sheet total of €20 million;
c. 250 employees on average over the financial year.

3. Insurance companies and credit institutions.

Exemptions:

Listed micro companies and non-listed SMEs fall outside of the scope but can apply the rules voluntarily.

A subsidiary of a non-EU company with significant operations in the EU (net turnover of more than €150 million in the EU) will be exempt if the parent company includes the subsidiary in its sustainability report which needs to comply with either the CSRD or standards that are deemed to be equivalent to the CSRD. It is currently unclear how equivalence between standards will be determined and which non-EU countries will be deemed to have equivalent standards, for example the climate-related financial disclosure regulations in the UK.

The EU subsidiary will be responsible for publishing the sustainability report of the parent company.

WHAT STANDARDS WILL APPLY

Under the CSRD companies will be required to report using sustainability reporting standards that are currently being developed by the European Financial Reporting Advisory Group. The reporting standards will outline the information that companies are required to disclose with respect to sustainability and additional disclosure obligations. The European Commission is expected to adopt this set of standards by June 2023.

The European Commission is also seeking to develop a second set of reporting standards for specific sectors, listed SMEs and non-EU companies by June 2024.

WHAT WILL COMPANIES NEED TO DO IN PRACTICE

Companies that fall within the scope of the CSRD will need to familiarise themselves with the new requirements and may need to make substantial changes to how they prepare and disclose sustainability information.

As part of their management report, companies will need to report sustainability information in accordance with the new sustainability reporting standards. Management will need to provide additional sustainability information regarding their business models, strategy and supply chain.

In order for sustainability information to be easier to search and compare, companies will be required to prepare financial statements and management reports in a single XHTML format, tagged in accordance with a digital classification. Companies will also need to guarantee digital access to sustainability information.

Those responsible for the annual report in a company will be required to confirm that the management report is prepared in accordance with the sustainability reporting standards to the best of their knowledge.

TIMING

Once the CSRD is in force, the rules will apply between 2024 and 2028:

1. From 1 January 2024 for large companies (with over 500 employees) already subject to the NFRD, with reports on 2024 data due in 2025.

2. From 1 January 2025 for large companies that are not currently subject to the NFRD (with more than 250 employees and/or €40 million in turnover and/or €20 million in total assets), with reports on 2025 data due in 2026.

3. From 1 January 2026 for listed SMEs, with reports on 2026 data due in 2027. SMEs can opt-out until 2028.

4. For non-EU companies with an in-scope EU subsidiary, the new requirements apply from 1 January 2028 with reports on 2028 data due in 2029.

FINAL THOUGHTS

The CSRD will have implications for EU and non-EU companies that have significant operations in the EU and expands the disclosure requirements applicable to those companies. This is likely to increase compliance costs and regulatory risks. Companies should be preparing now for the implementation of the CSRD and be familiarising themselves with what its requirements mean for their business on a practical level.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.