Sunlight is the best disinfectant as the saying goes, and the EU subscribes heavily to the view that if you want to effect change you must increase transparency.
To do this, two pieces of legislation have been introduced, building on the social impact and environmental reporting requirements of the Non-Financial Reporting Directive. The EU is now requiring the largest companies operating within its borders to shed light on their journey towards sustainability with mandatory reporting standards.
The Corporate Sustainability Reporting Directive
The Corporate Sustainability Reporting Directive (CSRD) came into force on the 14th of December 2022 and obligations will come into effect for the largest impacted companies from 2024.
The first companies which need to be ready for the new requirements are EU companies which are already subject to the Non-Financial Reporting Directive (NFRD). However, the scope of the CSRD is much wider.
- Large EU companies with over €20 million in assets, €40 million in net turnover or an average of 250 employees will need to prepare for reporting obligations alongside companies listed on an EU regulated market.
- Non-EU companies with over €150 million in EU turnover for two consecutive years and a large EU company subsidiary or branch with €40 million turnover will also come into scope.
This means that over the coming years, UK based companies who have significant operations in the EU may be impacted by the new rules and will need to be aware of them. For EU companies already required to report under the NFRD, CSRD reporting requirements kick in on 1st January 2024 with the first reports to be issued in 2025. For affected non-EU companies, the reporting requirements come in on 1st January 2028 with the first CSRD reports to be issued in 2029.
What will be required from companies?
Reporting requirements centre around governance and the strategies companies are implementing to measure and monitor sustainability risks and opportunities.
This includes an inside-out/outside-in approach which requires companies to report on the impact of their activities on sustainability, but also how the risks and opportunities arising from social and environmental issues may affect their own business. This is called a double-materiality assessment.
It is assumed that sustainability issues are becoming a material matter for companies. Companies must show that the governance structures they have in place are well-adapted to the challenge and demonstrate how sustainability KPIs will impact remuneration. They also need to consider and report on the impacts, risks and opportunities regarding Scope 3 emissions and their value chain.
Reports need to be made at the same time as the annual financial statements for the company and must be evidence-based and subject to clear, qualitative metrics as reports will be subject to audit.
These matters are complex and further guidance is expected regarding how to report on double-materiality.
Failure to report will be subject to material fines, which will be implemented at member state level. However, indirect impacts on reputation from failure to report appropriately may be an accompanying driver of compliance and change.
Corporate Sustainability Due Diligence Directive
Waiting in the wings behind CSRD is the Corporate Sustainability Due Diligence Directive (CSDDD). It is likely this will be adopted in 2024 and obligations are not yet fully crystallised. The focus of the Directive will be on ensuring that companies in scope have appropriate due diligence policies in place addressing potential human rights and environmental sustainability risks within their supply chain. Specific duties will be imposed on directors to ensure that policies are regularly reviewed and are fully implemented.
Next Steps for UK Companies
Companies based in the UK will need to consider whether they are likely to fall within scope of CSRD and the CSDDD and take steps to prepare if so.
The scale of the reporting obligations under the CSRD, assessing internal governance as well as the wider supply chain, poses a business transformation challenge. Companies will need to look to their processes and technology to ensure that data can be gathered appropriately and will need to be familiar with the complex metrics and calculations which will be required to report accurately. Companies with an under-resourced Procurement function may look to invest in this area to ensure that any impacts of the CSDDD will be manageable and that policies can be implemented.
Although the impetus comes from external legislation, businesses with a good story to tell will be able to make use of new reporting requirements to position themselves as leaders in this space, providing consumers with increased transparency and modelling how future-facing businesses can meet and overcome sustainability challenges while growing and thriving.