Sustainability reporting is a hot topic as more and more companies are required to report on their sustainability efforts. This is due not only to stricter legal requirements, but also to market expectations.
Under the EU Non-Financial-Reporting Directive (NFRD) and its national implementation, large public interest entities have been legally obliged to prepare and publish an annual report on their sustainability efforts since 2014. Since 2022, companies within the scope of the relevant implementing legislation of the NFRD must also fulfil the supplementary reporting obligations of the EU Taxonomy Regulation in their non-financial statement. For this purpose, these companies must review their business activities and determine the extent to which they contribute substantially to six specified EU environmental goals. In Germany, since 2023, there have been additional sustainability-related reporting obligations under the German Supply Chain Due Diligence Act, for companies with more than 3,000 employees, and from 2024 onwards, these will be extended to companies with more than 1,000 employees. Other EU Member States may also have additional obligations.
Sustainability reporting obligations will soon be significantly expanded under the new EU Corporate Sustainability Reporting Directive (CSRD), which replaces the current NFRD. While the NFRD affects about 11,000 companies across Europe, the CSRD will cover about 50,000 companies. It will be introduced in four phases in order to give companies sufficient time to prepare:
While legal obligations for sustainability reporting only currently apply to larger EU companies, the actual importance of reporting is growing steadily, particularly for small and medium-sized companies (SMEs). Larger companies, which are already subject to legal reporting obligations, usually also have to report on the sustainability efforts of their (smaller) suppliers and business partners as part of these reporting obligations. As a result, these smaller companies are increasingly being asked by their larger contractual partners to submit a report on their own sustainability efforts. If they refuse to do so, the larger business partner might threaten to terminate the business relationship.
This commercial pressure to report arises not only within traditional supply chains, but also in the context of other contractual relationships for SMEs. Commercial borrowers, for example, are regularly requested by their banks to submit sustainability information when applying for a loan. The same applies, for example, to start-up companies whose business shares are in the hands of a financial investor. Financial investors, in particular, demand sustainable action from their investment companies. For these reasons, more and more companies are introducing ESG (Environmental, Social and Governance) sustainability structures in their company, even when not legally obliged to do so.
The CSRD suggests sustainability reports could include information answering the following questions:
Based on the CSRD, the EU Commission has mandated the European Financial Reporting Advisory Group (EFRAG) to develop binding EU standards for sustainability reporting, known as the European Sustainability Reporting Standards (ESRS).
The first set of the ESRS was submitted to the EU Commission in November 2022 for review purposes and is expected to be adopted by the EU Commission in June 2023. The standards do not have to be transposed into national law first, but are directly applicable to all companies affected by the CSRD.
The ESRS set contain twelve sector-independent standards with a total of more than 80 individual disclosure requirements. These standards are divided into two cross-thematic standards and ten thematic standards, including five on environmental, four on social and one on governance issues.
ESRS 1 sets out general disclosure requirements, and, in particular, also the requirements for sustainability due diligence and materiality analysis. The purpose of these two processes is to determine which sustainability aspects are material for the reporting company. In this respect, the principle of dual materiality is assumed, which means that the company has to review
The other 11 standards in this first set of ESRS describe specific disclosure requirements in considerable detail. The standards contain 20 to 40 pages each. In some cases, one standard cross refers to another.
These will not, however, be the final standards in relation to CSRD. More are planned over the next years: a wide array of sector-specific standards that will be mandatory for all large companies within their respective business sector; slimmed down standards for SMEs; standards for non-EU companies; and further voluntary guidelines for SMEs.
More and more companies are subject to sustainability reporting requirements. Although statutory reporting requirements already exist, the CSRD greatly broadens the scope of obligations and the detail of reporting required. Complying with the CSRD, the ESRS and further guidelines, will be an enormous challenge for many businesses. Whether or not the ESRS actually make the reporting obligations manageable remains to be seen, but companies likely to be in scope should begin preparing now, including by carefully considering the required reporting standards. This is likely to take time. So even where legal requirements are still some way off, it will be worth preparing now, particularly given the additional commercial impetus to report.
Lorraine Smith gives an overview of the UK's framework of ESG reporting requirements and looks at how it might impact smaller companies in future.
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