Following a year of talks, the European Parliament and the Council secured a political agreement on the Corporate Sustainability Reporting Directive (CSRD) on June 21. The CSRD attempts to improve the way corporations provide sustainability data, which differs from one organization to the next and is difficult to compare. The CSRD modifies and tightens the regulations established by the Non-financial Reporting Directive (NFRD) in 2014.
The CSRD is a crucial component of the European Green Deal and a game changer for sustainability reporting in the EU and beyond. For the first time, sustainability and financial reporting will be treated equally. Climate change and other sustainability challenges will provide investors with the knowledge they need to analyze investment risks. Furthermore, investors and the general public will be able to judge a company's performance not just in financial terms but also in terms of its contribution to a sustainable and equitable economic system.
The idea of 'double materiality' is included in the CSRD. This implies that businesses must report not just on how sustainability concerns may pose financial risks to the corporation (financial materiality), but also on their own impacts on people and the environment (impact materiality).
Increasingly, investors are interested in both sides of this dilemma. They, of course, want to understand the risks associated with their investments, and the sustainability reporting standards strengthen investor protection in this regard. However, many investors are interested in learning how their investments affect people and the environment. This is due in part to the rising market for sustainable investment products and in part to the fact that investors are obligated to report on these consequences, particularly under the EU's Sustainable Finance Disclosure Regulation.
Other stakeholders, such as civil society organizations and labor unions, require companies to provide a clear and impartial assessment of their influence on topics such as biodiversity, climate change, and human rights. External certification by auditors or other assurance providers, as well as clear and consistent impact-materiality disclosure criteria, will limit the danger of 'greenwashing.'
European sustainability reporting standards
The mandate for the Commission to develop mandatory European Sustainability Reporting Standards (ESRS) is the centerpiece of the CSRD. The European Financial Reporting Advisory Group (EFRAG) will create draft standards in stages. EFRAG is now consulting on the first set of thirteen draft ESRS addressing all environmental, social, and governance aspects mandated by the CSRD for adoption by the Commission by June 2023. EFRAG will establish sector-specific reporting requirements and proportional criteria for listed SMEs next year, with the goal of having them approved by the Commission by June 2024.
To prepare for this new standard-setting effort, EFRAG modified its governance structure by establishing a sustainability reporting board (SRB) backed by a specialized technical expert group, as mandated by Executive Vice-President Valdis Dombrovskis and Commissioner Mairead McGuinness. In accordance with the CSRD's public policy stance on sustainability reporting, EFRAG expanded its membership base to include civil society organizations and labor unions.
ESRS disclosure obligations should be relevant, reasonable, and consistent with the CSRD mandate. The CSRD accomplishes proportionality by phasing in reporting requirements for various categories of enterprises, including NFRD companies (first reporting after 2024), other major corporations (2025), and listed SMEs (2026). ESRS must achieve a balance between helpful information for investors and other stakeholders on the one hand, and possible expenses and burden on reporting enterprises on the other. Responses to EFRAG's public consultation on the first set of ESRS will be crucial in this regard.
Finally, ESRS will offer enterprises more clarity on what they must publish, allowing them to manage more effectively with the ever-increasing demand for sustainability information. ESRS will build a reporting structure that will allow enterprises to report on their sustainability performance in a systematic, credible, and comparative way.