We have recently written on various topics relating to sustainable finance, including social loan principles, greenwashing and the EU Taxonomy Regulation and the related screening criteria. Another important development took place when on 21 April 2021 the EC published a communication entitled "Directing Finance Towards the European Green Deal".
The communication discusses various endeavours, including a proposal for a Corporate Sustainability Reporting Directive (“CSRD”). The CSRD extends the scope of reporting to all large private companies and all companies listed on EU regulated market; the major initiatives proposed are considered below. This will significantly broaden the rules laid down by the Non-Financial Reporting Directive (“NFRD”), which itself set out standards for large public companies in terms of disclosures relating to environmental protection, social responsibility, employee welfare, anti-corruption and boardroom diversity.
At the time of writing, the NFRD applies to “large” public interest entities (“PIEs”). PIEs are defined as those entities which have had more than 500 employees in the preceding financial year. The NFRD also exempts subsidiaries from reporting obligations if that entity’s parent company agrees to undertake the reporting obligations on behalf of the entire group. Once effective, the CSRD will extend non-financial reporting requirements to large private companies as well as companies listed on EU regulated markets. A company is a large company where it meets two of the following three criteria: (i) it has at least 250 employees; (ii) annual turnover is in excess of €40m; and / or (iii) a company has assets in excess of €20m.
The CSRD is significant as, for the first time, small and medium enterprises will be subject to non-financial reporting obligations. It should be noted that SMEs are to be given an extra three years to comply with the obligations imposed by the CSRD.
The CSRD introduces detailed reporting requirements which are to be based upon an agreed set of standards. These standards are due to be adopted later this year. These standards will be introduced so as to ensure consistency between reporting requirements under the EU Taxonomy Regulation and company sustainability reporting. Companies will have to report on sustainability matters in accordance with the EU sustainability reporting standards. At present under the NFRD, entities may use a number of different frameworks in preparing their disclosure statements, including the UN Global Compact, OECD guidelines and ISO 26000 on social responsibility. The Commission also published reporting guidelines, but these were non-binding.
With regard to the substance of the material that is to be reported, this is based on the double materiality concept. Materiality is a key feature of financial disclosure. Material information is that which a reasonable person would consider important. Where information is considered important, such information merits disclosure. Double materiality goes further insofar as not only can impacts on a company itself be considered material, so too can a company’s impact on external factors be considered material (for example, a company’s impact on the climate or any other aspect of sustainability under the CSRD).
The introduction of the CSRD will allow investors and funds to allocate capital based on a more rounded and holistic picture of a company as a whole, against the wider backdrop of corporate sustainability. It is hoped that the CSRD will prevent investment decisions being made solely upon a company’s financial statements.
Companies will be required to make the reported information available to the European single access point (which Matheson have written about here) envisaged in the Capital Markets Union Action Plan (which we wrote about here). This would be achieved by digitally tagging reported information so that it is machine-readable.
The CSRD introduces an assurance obligation with respect to disclosures. Although limited at first, this obligation would introduce, for the first time, a general EU-wide audit (assurance) requirement for reported sustainability information. At the initial stages, the assurance obligation would be “limited”. Over time, the assurance obligation is intended to be expanded (similar to the level required of a company in respect of financial reporting). It may be possible for sustainability assurance to be undertaken by auditors other than the usual financial assurance auditors.
The European Parliament and the Council will negotiate a final text in parallel with work on the first set of draft sustainability reporting standards. The European Commission estimates that the earliest that companies would apply the standards would be in respect of financial year 2023, at which point the ‘greening’ of the European economy is expected to be well underway.
While the CSRD will likely lead to certain increased costs for companies to which it applies, it is arguable that codifying the reporting requirements should, in the long term, reduce the expected future costs for those companies of dealing with diverse information demands by investors and stakeholders. Amongst investors, there has been a significant increase in demand for corporate sustainability information in recent years. This increase in demand has been driven by the changing nature of risk and the growing levels of awareness regarding the financial implications of same.