The CSRD links measures aimed at achieving the goals of the European Green Deal and the Action Plan on Sustainable Finance. Starting in 2024, the number of companies required to comply with this directive will increase each year. Who will be affected by the CSRD, and when?
On January 5, 2023, Directive (EU) 2022/2462 of the European Parliament and of the Council of December 14, 2022, amending Regulation (EU) No 537/2014, Directive 2004/109/EC, Directive 2006/43/EC, and Directive 2013/34/EU as regards corporate sustainability reporting (Corporate Sustainability Reporting Directive, hereinafter referred to as the “CSRD”).
Why was the CSRD adopted?
The CSRD links measures to achieve the objectives of the European Green Deal and the Action Plan on Sustainable Finance. It introduces a system for assessing the impact of a company’s economic activities on the environment, the social sphere, and corporate governance, with the aim of ensuring transparency that will help investors, analysts, consumers, and other stakeholders better evaluate the sustainability performance of EU companies, as well as the related business impacts and risks.
In 2014, Directive (EU) 2014/95/EU of the European Parliament and of the Council on the disclosure of non-financial and diversity information (Non-Financial Reporting Directive, hereinafter the “NFRD”) was adopted. The NFRD, together with Regulation (EU) 2020/852 of the European Parliament and of the Council (EU) 2020/852 of June 18, 2020, establishing a framework to facilitate sustainable investment (hereinafter the “Taxonomy Regulation”), are the main components of sustainability reporting requirements underpinning the EU’s sustainable finance strategy. The CSRD builds upon the existing requirements of the NFRD, expanding and strengthening the rules for reporting non-financial sustainability information.
The current freedom to choose standards through which companies fulfill their ESG reporting (Environmental, Social, Governance) obligations will be replaced by mandatory European Sustainability Reporting Standards (hereinafter “ESRS”). The ESRS represent sustainability reporting standards within the EU and are an integral part of the CSRD.
According to the European Commission, the new rules are intended, among other things, to ensure that investors and other stakeholders have access to the information they need to assess investment risks arising from climate change and other sustainability issues, as well as transparency regarding companies’ impact on people and the environment.
Who will be affected by the CSRD and when?
The deadlines for the first non-financial sustainability reporting are set for the coming years as follows, depending on the category of companies:
2024: Large public-interest entities with more than 500 employees will be required to disclose sustainability information in 2025 for the 2024 financial year (the definition of public-interest entities is set forth in Section 2(14) of Act No. 431/ 2002 Coll. on Accounting, as amended, according to which an entity of public interest is understood to mean, for example, a bank, a branch of a foreign bank, an insurance company, a health insurance company, a management company, a pension management company, a securities dealer, etc.),
Year 2025: large companies that meet 2 of the following 3 criteria will be required to disclose sustainability information in 2026 for the 2025 financial year,
- turnover exceeding EUR 40 million,
- assets exceeding EUR 20 million,
- more than 250 employees,
2026: Small and medium-sized companies that have issued securities traded on a stock exchange in the EU will be required to disclose sustainability information in 2027 for the 2026 financial year,
2028: Companies from third countries with an EU turnover exceeding €150 million will be required to disclose sustainability information in 2029 for the 2028 financial year.
ESG reporting: What needs to be disclosed under sustainability
Until now, companies required to report corporate sustainability information could choose both the standards and the scope of their reporting. The CSRD aims to provide clarity and certainty regarding what sustainability information must be reported through mandatory standards, namely the ESRS standards. At the same time, the CSRD should facilitate the collection of information from suppliers, clients, and investee companies.
The draft ESRS standards were developed in 2022 by the European Financial Reporting Advisory Group (EFRAG). EFRAG consolidated existing non-financial reporting requirements with those of the European Green Deal and the EU Taxonomy. This set of standards was adopted by the European Commission on July 31, 2023. The ESRS provide a framework for what indicators companies must report and how they must report them to meet the requirements of the CSRD.
Currently, there are a total of 12 ESRS standards, which contain detailed information and metrics related to sustainability issues across 4 categories. These 4 categories include two cross-cutting standards and 10 thematic standards. Each focuses on environmental, social, or governance topics.
Cross-cutting standards: general principles and general disclosures.
Environmental standards: climate change, pollution, water and marine resources, biodiversity and ecosystems, resource use, and the circular economy.
Social standards: own workforce, workers in the value chain, affected communities, consumers, and end users.
Governance: business conduct.
Cross-cutting reporting is required of all organizations subject to the CSRD, while environmental, social, and governance reporting is mandatory for those companies that consider these aspects material.
General requirements
ESRS 1 establishes the framework for sustainability reporting. It provides mandatory concepts and principles for the preparation of sustainability reports under the CSRD. Companies subject to the CSRD must disclose material information about their sustainability-related impacts, risks, and opportunities in accordance with applicable ESRS.
Under ESRS 1, certain sustainability disclosures must be made regardless of the company’s materiality assessment. These include disclosures regarding governance, strategy, management of impacts, risks, and opportunities, as well as climate-related metrics and targets.
It is important to note that while ESRS 1 mandates these disclosures, companies may omit specific requirements and data if they can achieve the reporting objective through alternative means.
Sustainability information is valuable when it can predict future results or confirm existing ones. Stakeholders—that is, those who may be affected by or influence a company’s activities—play an important role in determining this value.
Companies must identify two main groups of stakeholders: affected stakeholders and users of sustainability reports. Affected stakeholders are those whose interests could be positively or negatively affected by the company’s activities. Users of sustainability reporting include a wide range of parties, such as investors, creditors, business partners, labor unions, civil society organizations, and others.
General Disclosures
ESRS 2 builds on the foundations laid in ESRS 1. It sets out sustainability disclosure requirements that apply universally. It includes a general description of the company, an overview of its business activities, and specific disclosures regarding compliance issues. The standard covers various aspects, including: the value chain, estimation uncertainty, changes in the preparation and presentation of sustainability information, prior-period errors, disclosures regarding strategy and governance, and the assessment of the materiality of sustainability impacts, risks, and opportunities.
Double materiality
Double materiality means that companies must view their sustainability aspects from two perspectives. On the one hand, they must assess the company’s impacts from an “inside-out” perspective. This dimension is called impact materiality. Impact materiality refers to the impact that companies have or may have on sustainability issues (e.g., carbon emissions, workforce diversity, respect for human rights). On the other hand, companies must include financial materiality in their materiality assessment from an “outside-in” perspective. Financial materiality refers to the impact that sustainability issues have or are likely to have on a company’s finances (e.g., cash flows, risk, access to financing).
Based on the double materiality assessment, companies will need to address their positive, negative, potential, actual, short-term, medium-term, and long-term impacts on the environment and society. At the same time, the effects of external factors on the company’s own profitability are taken into account.
All sustainability reports must therefore meet the double materiality standard, meaning that companies must report on:
- the materiality of the impact and
- financial materiality.
Taxonomy Regulation
The EU taxonomy is enshrined in the Taxonomy Regulation. Reporting under the CSRD must be in accordance with the EU taxonomy. Under the Green Deal, the European Union has committed to achieving climate neutrality by 2050, and the transition to a zero-emission economy will require a large volume of financial resources, both public and private. The taxonomy of sustainable activities is intended to help mobilize private capital for sustainable and low-carbon projects.
The EU taxonomy is primarily a tool enabling the classification of sustainable economic activities. It is intended to contribute to the transparency of investment characteristics and thus to more informed investment decisions. The EU taxonomy prioritizes ecological and sustainable business practices, but does not in itself prohibit investments in activities that do not meet the taxonomy’s criteria. Nor does it specify particular technologies required to meet the classification criteria; that is, it enshrines the principle of technological neutrality.
The EU Taxonomy defines six main environmental objectives used in the assessment. According to the EU Taxonomy, a green activity is one that significantly contributes to one of the six environmental objectives, namely: climate change mitigation, adaptation to climate change, sustainable use and protection of water and marine resources, transition to a circular economy, pollution prevention and control, and the protection and restoration of biodiversity and ecosystems.
The conditions for meeting the taxonomy requirements are contributing to at least one of the above objectives, while not significantly undermining the other objectives, and meeting minimum investment safeguards—i.e., investments should meet minimum safeguards in other areas of business—such as being free from corruption, not using child labor, and not discriminating, among others.
The taxonomy primarily applies to financial market participants, for whom it should facilitate reporting on the environmental goals to which their investments contribute and on the proportion of investments that are taxonomy-compliant. Furthermore, the taxonomy applies to companies already subject to non-financial reporting obligations (in the environmental or social sphere) and to the EU and member states, for whom it may be useful and authoritative in setting standards for environmentally sustainable financial products.
Preparing for the CSRD and ESG Reporting
The scope of the new requirements and rules regarding corporate sustainability reporting is comprehensive. ESG reflects a company’s creditworthiness, serving as an indicator of the company’s direction and one of the fundamental criteria for assessing a company as a suitable candidate for investment. Companies should therefore begin preparing well in advance to successfully and timely manage the initial reporting. Building internal expertise, analyzing ESRS gaps, and developing a plan with measures to be implemented gradually all require preparation. Reporting under the CSRD also requires numerous external engagements with stakeholders, which will most likely extend beyond the company’s boundaries; companies must also anticipate that it will be necessary to allocate sufficient financial and human resources to successfully manage ESG reporting. Companies should not underestimate the importance of reviewing the new EU standards in a timely manner and preparing for reporting; the remaining time should be used to prepare for compliance with the CSRD requirements.
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