The Corporate Sustainability Reporting Directive (CSRD) is an important step in corporate accountability, as it pushes companies to take responsibility for their actions on the physical, social, and environmental aspects. This directive aims to create a more sustainable economic model and a deeper coexistence with the Environmental, Social, and Governance (ESG) issues.
In this article, we will explore the CSRD’s impact on compliance, highlighting the new requirements, key provisions, and the challenges companies may face in meeting these obligations. We’ll also discuss how this directive fits into the broader regulatory framework of sustainability reporting.
What is the Corporate Sustainability Reporting Directive (CSRD)?
The CSRD is an extension and revision of the Non-Financial Reporting Directive (NFRD), which has been in force since 2014. While the NFRD applied to large public-interest companies with over 500 employees, the CSRD broadened this scope. Under the CSRD, approximately 50,000 companies in the European Union (EU) are now required to report on sustainability-related topics, including those from non-EU countries with substantial operations within the EU.
The CSRD was enacted to create more uniformity and transparency in corporate sustainability disclosures. Companies must not only report on their impact on the environment and society, but also how sustainability issues affect their business, a concept referred to as “double materiality.”
Key Provisions of the CSRD
There are many important provisions that set the CSRD apart from previous regulations and make compliance more complex. Here are the salient provisions of this directive:
Extended Scope
The CSRD applies to all large companies, regardless of whether they are listed on the stock market. It also applies to non-EU companies operating in the EU if they meet certain criteria. Also, SMEs listed on regulated markets must comply, although there are provisions for more simplified reporting standards for smaller entities.
Mandatory Assurance
A new requirement under the CSRD is the introduction of mandatory third-party assurance for sustainability information. This means that companies must have their sustainability reports verified by an external auditor or certifying body, much like financial statements.
Alignment with International Standards
The CSRD mandates that companies report according to the European Sustainability Reporting Standards (ESRS), which align closely with existing international standards such as those set by the Global Reporting Initiative (GRI) and the Task Force on Climate-related Financial Disclosures (TCFD).
Digital Reporting Requirements
Companies must provide digital tagging of sustainability information, in order to make the data machine-readable. This move supports greater accessibility and comparability of information across companies and industries.
Sector-Specific Standards
The CSRD includes sector-specific reporting standards to reflect the particular sustainability challenges and risks associated with different industries.
Now that you know the key provisions, let’s analyze how they impact an organization’s compliance processes.
How the CSRD Impacts Corporate Compliance
Compliance with the CSRD presents new challenges for companies, particularly in terms of data collection, reporting, and verification. Let’s break down the main areas of impact.
Increased Reporting Burden
The shift from the NFRD to the CSRD dramatically increases the number of companies that must report on sustainability issues, and it broadens the scope of reporting required. Companies must now provide detailed disclosures on a wide range of ESG topics, including climate change, biodiversity, human rights, and social factors such as diversity and inclusion.
This increase in the scope of reporting requires companies to invest in systems, people, and processes for collecting and managing non-financial data. Many companies may not have the infrastructure in place to handle this level of detail, and building these capabilities can be expensive.
Need for Third-Party Assurance
The requirement for third-party assurance adds a layer of complexity and expense to compliance. This means companies must create sustainability reports that meet high standards of accuracy and reliability to pass external audits. This will likely require them to improve internal controls around sustainability data, similar to the controls they already have in place for financial reporting. While many larger companies are accustomed to undergoing financial audits, having sustainability data verified by an external auditor is a new requirement for most. This will involve additional costs, both in terms of hiring auditors and upgrading systems to ensure that sustainability data is accurate and auditable.
Double Materiality Reporting
The CSRD’s emphasis on “double materiality” poses a further challenge for compliance. Under this concept, companies must not only disclose how sustainability issues affect their business (financial materiality) but also how their operations impact the environment and society (impact materiality). This dual approach to materiality requires companies to conduct more in-depth analyses of their business operations and supply chains. Organizations may have to engage with a wider range of stakeholders, including employees, customers, and local communities, to understand and report on the broader social and environmental impacts of corporate activities.
Alignment with Other Regulations
Another notable aspect is that the CSRD is not an isolated piece of legislation; it fits into a broader framework of sustainability-related regulations, both at the EU level and internationally. Companies must navigate this web of regulations, to comply with the CSRD while also meeting the requirements of other laws such as the EU Taxonomy Regulation and the Sustainable Finance Disclosure Regulation (SFDR).
For context, the EU Taxonomy Regulation establishes a classification system for environmentally sustainable activities. Under the CSRD, companies are required to disclose how their activities align with the taxonomy, including what percentage of their revenue and capital expenditures are associated with sustainable activities.
Similarly, the Sustainable Finance Disclosure Regulation (SFDR) imposes sustainability disclosure requirements on financial market participants, particularly asset managers and investment funds. Companies subject to the CSRD must provide the necessary sustainability data to help financial institutions meet their SFDR obligations.
Furthermore, companies must check if their sustainability reports under the CSRD are consistent with the information provided to investors under the SFDR. This alignment is important for maintaining credibility and avoiding potential legal risks associated with misrepresentation or “greenwashing.”
Digital Reporting and Data Management
The requirement for digital tagging of sustainability information introduces a technical challenge for companies. The requirement to make data machine-readable means that companies have to adopt new technologies and reporting tools, like the European Single Electronic Format (ESEF).
This digital transformation of sustainability reporting could improve transparency and comparability, but it also requires considerable investment in data management systems. Companies also have the responsibility to keep their data accurate, up-to-date, and presented in a format that meets the technical standards set by the CSRD.
Potential Legal and Financial Risks
Failure to comply with the CSRD could lead to legal and financial repercussions for companies. Regulators may impose fines or other penalties for non-compliance, and there is also the risk of reputational damage if a company is found to be providing inaccurate or incomplete information about its sustainability practices.
Moreover, as investors and consumers increasingly prioritize sustainability, companies that fail to comply with the CSRD may find it harder to attract investment or maintain customer loyalty. Non-compliance could lead to a loss of competitive advantage at a time when sustainability is becoming a key driver of business success.
Due to these consequences, it makes sense for companies to invest in sustainability and reporting mechanisms, as it sets the stage for long-term growth and benefit.
Bottom Line
In conclusion, the Corporate Sustainability Reporting Directive (CSRD) is a transformative shift in how companies must engage with and report on sustainability issues. The directive imposes more stringent compliance requirements. It also extends reporting obligations to a wider range of companies, mandating third-party assurance, and requiring digital reporting standards.
For businesses, this means a big investment in new systems and processes to collect, verify, and report sustainability data. The challenge lies not just in meeting these requirements, but in doing so in a way that aligns with broader sustainability regulations such as the EU Taxonomy and SFDR.
Despite these limitations, companies that take proactive steps to comply with the CSRD will likely reap the rewards of greater transparency, improved stakeholder trust, and enhanced long-term competitiveness. However, the road to full compliance will not be without its challenges, and businesses must be prepared for the effort required to meet these new sustainability standards.