In the EU, there is no let-up on the horizon in the pace of change and complexity in the ESG regulatory sphere, with a number of key regulatory developments in the past few months. These regulatory developments do not only affect EU companies, but also non-EU companies with businesses operating in the EU. In this blog we consider how the EU Corporate Sustainability Reporting Directive (the CSRD) potentially impacts businesses in Asia.
What does the CSRD require?
The CSRD was adopted at the end of 2022 and entered into force on 5 January this year. The CSRD aims to strengthen the current EU rules on social and environmental reporting that were introduced in 2014 by the EU Non-Financial Reporting Directive (NFRD). Under the CSRD, in-scope entities will have to report information on a wide range of environmental, social and governance (ESG) factors across their value chain, therefore requiring in-scope entities to make extensive sustainability disclosures in their annual reports.
What are the main features of the CSRD?
The main features of the CSRD are:
- Mandatory European sustainability reporting standards (ESRS): In-scope entities will need to report against the ESRS developed by the European Financial Reporting Advisory Group (EFRAG). A first set of ESRS is expected to be adopted by the EU Commission by 30 June 2023 (although there have been rumours in the press that some of the requirements in the exposure drafts may be relaxed, so one to watch).
- New assurance requirement: The CSRD introduces, for the first time, a general EU-wide audit (assurance) requirement for sustainability information, to help ensure that reported information is accurate and reliable.
- Extension of scope of application: The CSRD extends the scope of the current regime from large public interest entities to all large companies and all EU-listed small or medium-sized companies (SMEs), except EU-listed micro-enterprises. (See defined terms at the bottom of this blog).
How will non-EU companies be impacted by the CSRD?
Many non-EU companies will be affected by the CSRD, in particular in the following cases:
- Reporting obligation of EU subsidiaries: EU subsidiaries of non-EU companies that qualify as a large company or listed small or medium-sized company are required to report on a non-consolidated basis under the new regulations.
- Reporting obligation of non-EU parents: As of 2029, non-EU companies with a net turnover of more than EUR 150 million in the EU and having (i) a large or listed subsidiary in the EU or (ii) a branch with a net turnover of more than EUR 40 million in the EU are required to prepare a non-financial report at a consolidated level. (Note that non-EU companies may be caught by the requirements as early as 2025 as discussed below).
- Reporting obligation of non-EU issuers: Non-EU issuers, being companies which have equity or debt securities listed on an EU regulated market, can also be caught by the scope of the CSRD.
Different exemptions are available if the in-scope company is already covered by a sustainability report using “equivalent” standards. Guidelines on this equivalence test will be developed by the EU Commission. We are not aware of any jurisdiction to be granted such status by the EU Commission to date. The International Sustainability Standards Board (ISSB) standards are perhaps the most promising prospect for this, albeit there are still some fundamental differences between the proposed ISSB standards and the ESRS (for example, the ISSB is currently suggesting that materiality should be based on “enterprise value” – i.e. how climate and other sustainability issues impact the value of the company – as opposed to “double materiality” proposed by the ESRS which includes the impact a company has on the climate and wider society).
What has to be reported by in-scope non-EU companies?
The scope of the reporting obligation is broad. In-scope companies will have to report information on the full range of ESG issues relevant to their business, in line with the ESRS. This includes information on “sustainability matters” (i.e. environmental, social and employee matters, respect for human rights, anti-corruption and anti-bribery matters, and governance matters). Listen here to an explanation of what the ESRS are, what they require, what their current status is and next steps.
The reporting must cover sustainability risks faced by the company, as well as the impact of the business on broader ESG objectives – referred to as “double materiality”. Listen here to an explanation of the issue of “double materiality”.
What are the implications for companies’ value chains?
The materiality assessment must identify material impacts, risks and opportunities connected to the group through its direct, and indirect, business relationships in the upstream and/or downstream value chain. Listen here to an explanation of the implication on a companies’ value chain.
When will the CSRD apply from?
Application of the CSRD will be phased in from 2025 (for financial years starting on or after 1 January 2024) to 2029 (for financial years starting on or after 1 January 2028). However, when exactly a company is caught within this timeframe will depend on a variety of factors. For the purposes of this blog, we have provided a simplified overview of what is typically quite a complex line of analysis – for example, as to whether the application is at both entity and consolidated levels or whether certain exemptions apply. What is worth noting is that with regard to non-EU issuers, the CSRD does not just amend the Accounting Directive, it also amends the Transparency Directive which applies to both EU and non-EU entities who have securities listed on an EU regulated market (subject to some exemptions discussed below).
For non-EU companies, at a high and simplified level:
- Sustainability reporting in 2025 (for financial year 2024) - will have to be published by non-EU issuers (i.e., entities which have equity or debt listed on an EU regulated market) which are large undertakings exceeding the average number of 500 employees or parent undertakings of a large group exceeding the average number of 500 employees on a consolidated basis, who are, at present, subject to the existing NFRD.
- Sustainability reporting in 2026 (for financial year 2025) – applies essentially to non-EU issuers which are large undertakings or parent undertakings of a large group but that are not currently subject to NFRD.
- Sustainability reporting in 2027 (for financial year 2026) - applies to certain types of non-EU issuers which are banks and insurers, but also SME undertakings with transferable securities admitted on an EU regulated market and which are not micro-undertakings. SMEs that are in-scope here can defer their reporting until 2028 but they have to explain why they have chosen to do so in their management report.
- Sustainability reporting in 2029 (for financial year 2028) – will apply to non-EU companies with a net turnover of more than EUR 150 million in the EU and having (i) a large or listed subsidiary in the EU or (ii) a branch with a net turnover of more than EUR 40 million in the EU. The non-financial report needs to cover, for subsidiary undertakings, the group level of the third-country ultimate parent undertaking and, for branches, the group level or, if not applicable, the individual level of the third-country undertaking.
What exemptions could apply?
The exemption analysis is, again complex. Two exemptions we would highlight are:
- the wholesale debt exemption under the Transparency Directive, for non-EU issuers which exclusively have high denomination debt securities (and by “high”, this refers to a denomination per unit of at least EUR 100,000, or EUR 50,000 where the debt securities were admitted to trading before 31 December 2010); and
- under the Accounting Directive, an exemption for undertakings which report or are included in a consolidated report of their parent entity prepared under the law of a third country in case of an EU determination of equivalence of the reporting standards.
Listen here for further explanation of who the CSRD applies to, when it will apply and some of the exemptions.
How does the CSRD interplay with other disclosure standards being developed in Asia?
Important questions remain about the interoperability of the ESRS with other sustainability reporting standards. The ISSB is expected to publish the final version of its climate disclosure standard and general disclosure requirements in June 2023. Although the ISSB standards will not themselves be legally binding, a few jurisdictions (including Hong Kong SAR (see our blog post), Singapore and Mainland China) are expected to adopt substantially equivalent standards and other countries may follow. As it is currently not foreseeable which sustainability standards will be classified as equivalent to the CSRD (as discussed above), companies may need to be prepared to issue sustainability reports based on different legal requirements.
What do companies in Asia have to consider?
The changes coming in through the CSRD will have an impact on sustainability disclosure and reporting and on value chains of many companies in Asia. Research shows that over 10,000 non-EU companies are estimated to be subject to the new reporting regime under the CSRD (source: Refinitiv). As a first step, companies that do business with the EU should identify those entities in their group that may be subject to the new regulations. The application tests are complex and should be worked through on an entity-by-entity basis.
Companies subject to the CSRD will have to adapt their existing systems and processes to source, validate and provide the necessary information. A significant amount of capacity-building and preparation will be required to comply with these new requirements. For many businesses in Asia this will require changes to the way they currently operate, transact and report, and how they interact with their business partners.
“Public interest entities” are essentially EU entities that meet at least one of the following criteria: (i) they have securities on a regulated market, (ii) credit institutions, (iii) insurance undertakings, or (iv) any other entity designated by an EU Member State as such.
“Large companies” are companies exceeding two of the three following criteria: (i) balance sheet total of EUR 20 million, (ii) net turnover of EUR 40 million and (iii) 250 employees on average during the financial year.
“Medium-sized companies” are companies not exceeding two of the three following criteria: (i) balance sheet total of EUR 20 million, (ii) net turnover of EUR 40 million and (iii) 250 employees on average during the financial year.
“Small companies” are companies not exceeding two of the three following criteria: (i) balance sheet total of EUR 4 million, (ii) net turnover of EUR 8 million and (iii) 50 employees on average during the financial year.
Linklaters CSRD podcasts
In our EU CSRD demystified podcast series, we explore in bitesize format various aspects of the CSRD that businesses need to be aware of.