The CSRD proposal 

On 21 April 2021, the European Commission published a package of legislation and other documents on ESG and sustainable finance, including a Proposal for a Corporate Sustainability Reporting Directive (CSRD), which will revise and extend rules introduced by the Non-Financial Reporting Directive (NFRD). The aim of the CSRD is to require consistent reporting on sustainability risks and impacts by all large companies. The draft CSRD should be read in conjunction with this Commission Communication and Q&A.

For more information on other aspects of the April package, see our client briefing: Sustainable Finance Package: what next for Taxonomy, NFRD and MiFID II/UCITS/AIFMD/Insurance ESG amendments and our blog post: European Commission publishes final climate change taxonomy delegated act.

Name change: NFRD becomes CSRD

First things first – to reflect the fact that many of the ESG issues currently covered by the NFRD have a financial impact, the Commission agrees that it no longer makes sense to keep calling it “non-financial” reporting. The new term is “corporate sustainability reporting”. So the NFRD will become the CSRD.

Why are changes being made?

The EU (along with many other countries including the UK) is aiming to become net zero by 2050 and has also agreed a 55% reduction on 1990 levels of greenhouse gases by 2030. In order to reach these targets, vast amounts of capital (in particular private capital) need to be redirected towards greener, more sustainable activities. Which means investors need more and better information on which to base their investment decisions - not just on climate change but also on a much wider range of other sustainability issues including diversity & inclusion. Basically, if something is capable of having a financial impact on their investment in the short, medium or long term, then investors want to know about it. So they need climate and other sustainability information that is relevant, reliable and comparable.

At present, the NFRD requires large public interest entities (see below) to report on a wide range of environmental, social and governance issues relevant to their business. However, the NFRD does not mandate which reporting standards they need to use when they report this information.

In addition, asset managers and financial advisers are being required to report on a wide range of sustainability issues under new requirements in the Sustainable Finance Disclosure Regulation (SFDR), starting this March. The Taxonomy Regulation will also require companies and financial institutions covered by the NFRD to report on how (and to what extent) their activities are aligned with the EU taxonomy, from 1 January 2022. For more information on the SFDR and Taxonomy Regulation, see our publication: Sustainable Finance Sources: survival guide.

So the Commission consulted in 2020 on what changes need to be made to the NFRD regime.

Scope extended – who will be required to report?

At present, the NFRD applies to “large public interest entities” (large PIEs) – that is, those which have more than 500 employees; a balance sheet total of EUR 20 million and/or net turnover of EUR 40 million; and which are one of the following types of entities: (i) EU entities that have transferable securities admitted to trading on an EU regulated market; (ii) EU credit institutions; (iii) EU insurance undertakings; and (iv) EU entities that are designated by Member States as public-interest entities.

The CSRD proposal extends the scope of the regime from large PIEs to all large companies (listed or not) and all listed companies, except listed micro-enterprises. "Large companies" for these purposes means companies exceeding two out of three of the following criteria: a balance sheet total of EUR 20 million; net turnover of EUR 40 million; and an average number of employees during the financial year of more than 250. This means that nearly 50,000 companies in the EU will now need to follow detailed EU sustainability reporting standards, compared to 11,000 companies under the current regime.

What will they be required to report and will there be mandatory reporting standards?

Under the proposal, in-scope companies would have to report information on the full range of ESG issues relevant to their business, in accordance with mandatory EU sustainability reporting standards. This includes information on all “sustainability matters” as defined by the proposal. These are: environmental, social and employee matters, respect for human rights, anti-corruption and anti-bribery matters, and governance matters. More proportionate standards will be developed for listed SMEs.

Reporting must cover not just sustainability risks faced by the company but also the impact of its business on broader ESG objectives (e.g. the impact of the business on climate change) – known as “double materiality”. Consistent with the existing rules under the NFRD, in-scope companies will have to report about the risks to the company arising from sustainability issues, and about their own impacts on people and the environment. This will include information on companies’ global supply chains regarding issues such as forced and child labour and consistent with internationally recognised principles and frameworks such as the International Labour Organisation Declaration on Fundamental Principles and Rights at Work.

The European Financial Reporting Advisory Group (EFRAG) will be responsible for developing these draft standards. At the request of the Commission, EFRAG recently published technical recommendations and a roadmap for the development of EU sustainability reporting standards. Before adopting any standards, the Commission will be required to consult a whole array of people, including the Member States Expert Group on Sustainable Finance, the Platform on Sustainable Finance, the European Securities and Markets Authority (ESMA), the European Banking Authority (EBA) and the European Insurance and Occupational Pensions Authority (EIOPA).

These new EU sustainability reporting standards will need to be consistent with the ambition of the European Green Deal, as well as the disclosure requirements under the SFDR and Taxonomy Regulation. EU standards should also aim to incorporate the essential elements of globally accepted standards currently being developed but EU standards should go further where necessary to meet the EU's own ambitions and be consistent with the EU's legal framework. This means that companies will have to report the information that investors and other financial market participants subject to the SFDR need. So the new reporting standards will need to include indicators that correspond to the indicators contained in the SFDR.

Article 8 of the Taxonomy Regulation requires companies falling within the scope of the existing NFRD – and the additional companies brought under the scope of the proposed CSRD – to report on the extent to which their activities are sustainable (i.e. alignment with the EU taxonomy). The indicators for this will be specified in a separate delegated act – which the Commission has not yet published. Companies will have to report on these taxonomy indicators alongside the other sustainability information required under the CSRD. When developing the new reporting standards, EFRAG will need to take into account these taxonomy indicators and build on the “substantial contribution” and “do-no-significant-harm” criteria in the Taxonomy Regulation. The Commission is currently considering what requirements to impose on financial institutions reporting pursuant to the Taxonomy Regulation during the transition period when adequate information may not be readily available.

New assurance requirement for sustainability information 

The CSRD will introduce, for the first time, a general EU-wide audit (assurance) requirement for sustainability information, to help ensure that reported information is accurate and reliable.

Although the objective is to have a similar level of assurance for financial and sustainability reporting, the Commission believes that a progressive approach is needed. It is therefore proposing to start with a “limited” assurance requirement. It considers that a more demanding level of assurance (such as “reasonable assurance”) is difficult at this stage in the absence of sustainability assurance standards. However, the proposal gives the Commission the possibility of adopting such standards in due course.

The proposal also allows Member States to open up the market for sustainability assurance services to so-called “independent assurance services providers”. This means that Member States could choose to allow firms other than the usual auditors of financial information to assure sustainability information.

Information will need to be provided in digital format so that it can feed into the forthcoming European Single Access Point

The CSRD proposal requires companies to prepare their financial statements and their management report in XHTML format in accordance with the ESEF Regulation and to “tag” their reported sustainability information according to a digital categorisation system as and when specified in that Regulation. This digital categorisation system would be developed together with the sustainability reporting standards.

This will mean that sustainability information can easily be incorporated in the European Single Access Point (ESAP) envisaged in the Capital Markets Union Action Plan. The Commission has said it will put forward an ESAP proposal later this year.

Although this may sound like a nerdy point, this has significant practical implications as AI is increasingly being used by third party ESG data and ratings providers (as well as asset managers' and banks’ in-house teams) to scour vast amounts of publicly available sustainability information across the globe. So making this process easier and cheaper by increasing digitalisation of sustainability information will have benefits all around.

Timings and next steps

 The next step is for the European Parliament and the Council to negotiate a final legislative text on the basis of the Commission’s proposal.

The average length of the EU legislative procedure is around 18 months. The final timetable will depend on how the Parliament and Council progress in their negotiations. If they reach agreement in the first half of 2022, then the Commission should be able to adopt the first set of reporting standards under the new legislation by the end of 2022. That would mean that obligated companies would apply the new CSRD standards for the first time to reports published in 2024, covering financial year 2023.

In parallel, EFRAG will start work on a first set of draft sustainability reporting standards. These draft standards could then be ready for consideration by the Commission once the Parliament and Council have agreed a legislative text. EFRAG aims to work on this in two chunks and will have the first set of draft standards ready by mid-2022. This first set seems likely to include guidance on double materiality and quality of information; cross-cutting 'core’ standards covering reporting areas, reporting structure and entity-specific materiality assessment; and certain ‘core’ standards and ‘advanced’ standards for some priority sub-topics such as climate change. Indeed, TCFD related obligations are likely to be included in the first set of guidance.

The second set of draft standards is planned to cover alignment with the public good (this means core with public policy agreements, goals, frameworks, and regulatory packages), retrospective and forward looking information, reporting boundaries and levels (though this feels as though it should move to the first set of standards), and connectivity with financial reporting and any remaining advanced standards required.

The CSRD proposal says that the Commission should adopt a first set of reporting standards by 31 October 2022, specifying the information that undertakings should disclose with regard to all reporting areas and sustainability matters and that financial market participants need in order to comply with the disclosure obligations in the SFDR. The Commission should adopt a second set of reporting standards at the latest by 31 October 2023, specifying complementary information that undertakings should disclose about sustainability matters and reporting areas where necessary, and sector-specific information. 

The Commission would then review the standards every 3 years to take account of relevant developments, including the development of international standards (such as those being developed by the IFRS Foundation).