The roadmap for the EU Commission’s milestone Corporate Sustainability Reporting Directive is taking shape and now is the time to start preparing for a brave new era in non-financial reporting, writes Conor Holland

With the Corporate Sustainability Reporting Directive (CSRD) now approved by the European Council, entities in the EU must begin to invest significant time and resources in preparing for the advent of a new era in non-financial reporting, which places the public disclosure of environmental, social affairs and governance matters (ESG) matters on a par with financial information.

Under the CSRD, entities will have to disclose much more sustainability-related information about their business models, strategy and supply chains than they have to date. They will also need to report ESG information in a standardised format that can be assured by an independent third party.

For those charged with governance, the CSRD will bring further augmented requirements. Audit committees will need to oversee new reporting processes and monitor the effectiveness of systems and controls setup. They will also have enhanced responsibilities. Along with monitoring an entity’s ESG reporting process, and evaluating the integrity of the sustainability information reported by that entity, audit committees will need to:

• Monitor the effectiveness of the entity’s internal quality control and risk management systems and internal audit functions;
• Monitor the assurance of annual and consolidated sustainability reporting;
• Inform the entity’s administrative or supervisory body of the outcome of the assurance of sustainability reporting; and
• Review and monitor the independence of the assurance provider.

The CSRD stipulates the requirement for limited assurance over the reported information. However, it also includes the option for assurance requirements to evolve to reasonable assurance at a later stage.

The EU estimates that 49,000 companies across the EU will fall under the requirements of the new CSRD Directive, compared to the 11,600 companies that currently have reporting obligations. The EU has confirmed that the implementation of the CSRD will take place in three stages:

• 1 January 2024 for companies already subject to the non-financial reporting directive (reporting in 2025 for the financial year 2024);
• 1 January 2025 for large companies that are not presently subject to the non-financial reporting directive (reporting in 2026 for the financial year 2025);
• 1 January 2026 for listed SMEs, small and non-complex credit institutions, and captive insurance undertakings (reporting in 2027 for the financial year 2026).

A large undertaking is defined as an entity that exceeds at least two of the following criteria:

• A net turnover of €40 million
• A balance sheet total of €20 million
• 250 employees on average over the financial year

The final text of the CSRD has also set timelines for when the Commission should adopt further delegated acts on reporting standards, with 30 June 2023 set as the date by which the Commission should adopt delegated acts specifying the information that undertakings will be required to report.

European Financial Reporting Advisory Group

In tandem, the European Financial Reporting Advisory Group (EFRAG) is working on a first set of draft sustainability reporting standards (ESRS). These draft standards will be ready for consideration by the Commission once the Parliament and Council have agreed a legislative text. The current draft standards provide an outline as to the depth and breadth of what entities will be required to report.

Significantly, the ESRS should be considered as analogous to accountancy standards—with detailed disclosure requirements (qualitative and quantitative), a conceptual framework and associated application guidance.

Readers should take note—the ESRS are much more than a handful of metrics supplementary to the financial statements. They represent a step change in what corporate reporting entails, moving non-financial information toward an equilibrium with financial information.

Moreover, the reporting boundaries would be based on financial statements but expanded significantly for the upstream and downstream value chain, meaning an entity would need to capture material sustainability matters that are connected to the entity by its direct or indirect business relationships, regardless of its level of control over them.

While the standards and associated requirements are now largely finalised, in early November 2022, EFRAG published a revised iteration to the draft ESRS, introducing certain changes to the original draft standards. While the broad requirements and content remain largely the same, some notable changes include:

• Structure of the reporting areas has been aligned with TCFD (Task Force on Climate-Related Financial Disclosures) and ISSB (International Sustainability Standards Board) standards – specifically, the ESRS will be tailored around “governance”, “strategy”, “management of impacts, risks and opportunities”, and “metrics and targets”.
• Definition of financial materiality is now more closely aligned to ISSB standards.
• Impact materiality is more commensurate with the GRI (Global Reporting Initiative) definition of impact materiality.
• Time horizons are now just a recommendation; entities may deviate and would disclose their entity-specific time horizons used.
• Incorporation of one governance standard into the cross-cutting standard requirements on the reporting area of governance.
• Slight reduction in the number of data points required within the disclosure requirements.

ESRS and international standards

By adopting double materiality principles, the proposed ESRS consider a wider range of stakeholders than IFRS® Sustainability Disclosure Standards or the US Securities and Exchange Commission (SEC) published proposal. Instead, they aim to meet public policy objectives as well as meeting the needs of capital markets.

It is the ISSB’s aim to create a global baseline for sustainability reporting standards that allows local standard setters to add additional requirements (building blocks), rather than face a coexistence of multiple separate frameworks.

The CSRD requires EFRAG to take account of global standard-setting initiatives to the greatest extent possible. In this regard, EFRAG has published a comparison with the ISSB’s proposals and committed to joining an ISSB working group to drive global alignment. However, in the short term, entities and investors may potentially have to deal with three sets of sustainability reporting standards in setting up their reporting processes, controls, and governance.

Key differences

• The proposed ESRS list detailed disclosure requirements for all ESG topics. The proposed IFRS Sustainability Disclosure Standards would also require disclosure in relation to all relevant ESG topics, but the ISSB has to date only prepared a detailed exposure draft on climate, asking preparers to consider general requirements and other sources of information to report on other sustainability topics. The SEC focused on climate in its recent proposal.
• The proposed ESRS are more prescriptive, and the number of disclosure requirements significantly exceeds those in the proposed IFRS Sustainability Disclosure Standards.
• Whereas the proposed IFRS Sustainability Disclosure Standards are intended to focus on the information needs of capital markets, ESRS also aim to address the policy objectives of the EU by addressing wider stakeholder needs.

Given the significance of the directive—and the remaining time to get ready for it—entities should now start preparing for its implementation. It is important that entities develop plans to understand the full extent of the CSRD requirements, and the implications for their reporting infrastructure. As such, they should take some immediate steps to prepare, and consider:

• Performing a gap analysis—i.e. what the entity reports today, contrasted with what will be required under the CSRD. This is a useful exercise to inform entities on where resources should be directed, including how management identify sustainability-related information, and what KPIs they will be required to report on.
• Undertaking a ‘double materiality’ analysis to identify what topics would be considered material from an impact and financial perspective—as required under the CSRD.
• Get ‘assurance ready’—entities will need to be comfortable that processes and controls exist to support ESG information, and that the information can ultimately be assured.

The Corporate Sustainability Reporting Directive represents a fundamental change in the nature of corporate reporting—the time to act is now and the first deadline is closing in.