To foster responsible corporate behaviour, a number of legislations targeted at supply chain due diligence are being created. Some examples are the German Supply Chain Act, Battery Regulation, and Corporate Sustainability Reporting Directive (CSRD). In this article we will discuss the latter.
The Corporate Sustainability Reporting Directive makes it mandatory for large companies and all companies listed on regulated markets to disclose sustainability information. Starting from fiscal years beginning on or after January 1, 2024, large firms already subject to the Non-Financial Reporting Directive (NFRD) will have to report along the environmental, social, and governance dimensions.
The requirements for other large companies will apply to fiscal years starting on or after January 1, 2025. Listed SMEs will be subject to the CSRD for fiscal years starting on or after January 1, 2026. Non-listed SMEs can voluntarily comply with the standards. All reported information will have to be digitally tagged and audited. Breach of the regulation causes penalties, while compliance brings about significant benefits such as an increase in green investment, monetization of sustainability efforts, and harmonization of reporting processes. Read further for details.
What is the aim of the Corporate Sustainability Reporting Directive?
The Corporate Sustainability Reporting Directive creates a common reporting framework that improves the content and quality of sustainability information. Ultimately, the legislation aims to increase the firms’ trustworthiness in the eyes of stakeholders such as investors, banks, customers, and consumers.
In terms of the legislative background, the directive is part of the European Union’s (EU) Sustainable Finance Package, which aims to enhance the flow of money to sustainable activities. The package also includes the EU Taxonomy Delegated Act and six amending Delegated Acts. The directive widens the scope of the Non-Financial Reporting Directive (NFRD) adopted in 2014. Before being fully implemented, the directive has to undergo a complex policy-making process.
What is the timeline?
The Corporate Sustainability Reporting Directive was adopted on the 21st of April 2021. In December 2022, the European Commission is adopted the European Sustainability Reporting Standards (ESRS) developed with EFRAG which outline the specific reporting categories. Member states have 18 months to transpose the CSRD into their national legislation. The directive comes into force for large firms already subject to the NFRD for fiscal years starting on or after January 1, 2024, and for other large firms for fiscal years starting on or after January 1, 2025. Listed SMEs will be subject to the CSRD for fiscal years starting on or after January 1, 2026. The final stage of the policymaking process will be reached when the reporting requirements are fully developed and implemented.
Who is subject to the Corporate Sustainability Reporting Directive?
The Corporate Sustainability Reporting Directive expands the reporting requirements to more entities, including those organised as foundations, trusts, or franchises1.
In particular, the directive applies to:
1. All large companies that meet at least two of the following criteria (applies from fiscal years starting on or after January 1, 2024, for companies already subject to the NFRD, and from fiscal years starting on or after January 1, 2025, for other large companies)
- 250 and more employees on average during the financial year5
- € 40M or more in net turnover
- € 20M or more in total assets
2. Listed SMEs, i.e. those whose financial assets are traded on EU markets (applies from fiscal years starting on or after January 1, 2026)
The directive does not apply to non-listed SMEs and micro-enterprises, but they can opt to comply with the standards voluntarily.
What are the requirements of the Corporate Sustainability Reporting Directive?
Firms will have to disclose detailed information on human rights, the environment, and governance in their management reports. The subject matters will have to be prepared according to a strict set of standards known as the European Sustainability Reporting Standards (ESRS). These standards were developed by the European Financial Reporting Advisory Group (EFRAG) and were adopted by the European Commission in December 2023. The ESRS and the double materiality assessment provide detailed frameworks for what to disclose and how to structure the information to broaden traditional reporting and alignment with Europe's broader sustainabilty goals.
1. What information should enterprises disclose in the reports?
The EU is planning to make the standards consistent with the EU’s legal framework (the European Green Deal, Sustainable Finance Disclosure Regulation (SFDR) and Taxonomy Regulation)1 and global initiatives for sustainability reporting and existing sustainability frameworks (e.g., SDGs, ESG criteria). Therefore, the EU sustainability reports will use similar indicators (see Table 1 for the overview of the indicators). The standards will include the information that financial market participants have to share according to the SFDR. The firms will be evaluating whether their activities are sustainable in line with the technical screening criteria set out in the Taxonomy Regulation and its delegated acts.
Firms will have to include a report on how sustainability issues affect their performance, position, and development (the ‘outside-in’ perspective) and on the impact their activities have on people and the environment (the ‘inside-out’ perspective)1. This will be indicated along the following dimensions.8
Furthermore, firms will have to disclose information about the intangibles. In particular, how non-physical resources contribute to value creation. Intangibles include such forms of capital as social, human, and intellectual, as well as value captured from research and development.
Both large firms and SMEs will have to report along the aforementioned indicators. However, the reporting standards for SMEs will be more lenient4. These standards are being developed together with the standards for large firms.
2. How to to communicate the sustainability information according to the Corporate Sustainability Reporting Directive?
Firms have to include sustainability information in the annual management reports. It should be available in an electronic XHTML format and have a digital ‘tag’. The goal of this measure is to make the reports machine-readable and easily feed them into the European Single Access Point. The exact digitalisation standards are yet to be specified in the European Single Electronic Format (ESEF) Regulation and the European Single Access Point Regulation.
The reports will have to be prepared in accordance with the ESRS and submitted annually within the 12 months after the start of the financial year on January 1st (e.g., submit reports before January 1st, 2025, for the financial year starting on January 1st, 2024). Large companies that are already subject to the NFRD will use the ESRS for the first time for the reports submitted on January 1st, 2025. All other large firms will use the ESRS in 2026 for the first time. Standards for SMEs will apply in 2027.
Communicated information, including its compliance with the standards, will require assurance. Usual auditors and independent assurance services providers can verify the reports. Both of them should be accredited to evaluate whether the reports comply with requirements1. The option to use the independent firms has been added due to the lack of sustainability audit services and standards. For the same reason, firms will start with a limited assurance requirement. As soon as the Commission adopts sufficient sustainability audit standards, the scope would widen to a more demanding reasonable assurance.
The requirements of the Corporate Sustainability Reporting Directive are rigid and detailed. Adjusting operations to them is a complex process, but the medium- and long-term benefits it will bring are significant.
Why is it important to comply with the Corporate Sustainability Reporting Directive?
Compliance with the regulation is not only important to avoid financial repercussions but also presents a growth opportunity. Not complying can cause administrative penalties and exclusion from investments portfolios. At the same time, compliance can bring more clarity to the reporting process, attract green investments, increase a firm’s public accountability, and bring about innovations.
Avoid sanctions and exclusion from investment portfolios
If a company is found to be non-compliant with the Corporate Sustainability Reporting Directive, the firms will face administrative sanctions. There are three possible penalties:
- First, a public statement about the breach.
- Second, an order on the name of the entity requiring to change the conduct.
- Third, financial sanctions.
It is up to member states to choose the penalty. They also have to define the extent of the sanctions when they transpose the directive to local law. For example, according to the German version of the current NFRD, firms are fined up to either € 10M, 5% of the annual turnover, or twice the amount of the profits gained / losses avoided because of the breach.9
Another consequence of insufficient reporting is the loss of investments for the reasons of investor protection and upcoming legislation1. There is a growing awareness that sustainability-related issues can affect the firms’ performance which pushes away potential investors7. This risk will grow as sustainability information becomes ever more important throughout the financial system due to upcoming legislation targeted at enhancing green investments. For example, the SFDR forces investors to share how they account for the effects of their investments on people and the environment.10 The Taxonomy Regulation is another legislation that increases the demand for sustainability information by requiring firms under the scope of the sustainability reporting directive to disclose the extent to which their activities are environmentally sustainable according to the taxonomy.
Utilise harmonised reporting standards
Harmonisation of the reporting standards will simplify reporting2, as enterprises would no longer have to deal with overlapping standards and inconsistent requests from stakeholders. The common framework will act as a single reporting solution, eliminating complexity and harnessing cooperation. Having a single comprehensive reporting framework will make it easier for firms to get the information they need for ensuring responsible business conduct from their partners (suppliers, clients, and investee companies), without constantly requesting additional information. According to the European parliament, the decrease in such requests will save € 24 200 - 41 700 per company annually4.
Monetise sustainability efforts
Being early adopters of non-financial reporting, firms can capture the growing demand for sustainability. Reporting can improve the image of a firm in the eyes of important stakeholders1. Financial market participants such as investors and banks increasingly need information from businesses on their impacts on the environment and people to comply with disclosure requirements under the SFDR. Reliable reporting enhances investors’ engagement by enabling them to account for sustainability-related risks. Additionally, the importance of making quantifiable and transparent sustainability claims is gaining popularity among consumers as they become more aware of greenwashing. A recent study indicated that two-thirds of consumers are willing to pay extra for sustainable products.11 Taking responsibility for their impacts helps firms harness public trust and acquire new consumers1.
Besides being important for various stakeholders, understanding the performance on the non-financial indicators can bring about new insights and innovation to the production processes. For example, decreasing costs by reducing energy consumption or monetising waste.
To circumvent the sanctions and utilise the benefits of the regulation, it is necessary to comply. However, it is often not clear where to start.
How to set up a reporting process in accordance with the Corporate Sustainability Reporting Directive?
The Corporate Sustainability Reporting Directive makes it mandatory to report on sustainability indicators as defined by the ESRS, but adjusting to the new requirements is not easy, and firms have to start preparing now.
- Begin with harnessing cooperation along your supply chains to get the information you need for reporting purposes from your business partners (suppliers, clients, and investee companies). This might be done through contractual agreements that ensure data sharing across your supply chain for the purpose of the reporting in line with the ESRS.
- Find auditing agencies to substantiate the collected sustainability information.
- Choose a reliable and scalable medium where the collected information can be stored in an XHTML format and from which it can be fed into the European Single Access Point with a digital ‘tag’. Currently, the majority of companies are accustomed to emailing pdf, and excel documents upon customer requests. However, this data sharing process is not scalable nor secure.
- Keep an eye on the legislative procedure. Pay extra attention to the standard-setting by the European Financial Reporting Advisory Group, EU Taxonomy Delegated Acts, European Single Electronic Format Regulation, European Single Access Point Regulation, and the transposition of the directive in EU member states.
- Until the final reporting framework is made available in mid 2024 for large firms and in 2026 for SMEs, ensuring traceability of supply chains is useful. The full visibility, though not being directly required by the regulation, has two key benefits. First, being aware of what is happening will help you evaluate the business practices along a wide range of indicators, including the social, environmental, and governance criteria. Hence, you would be ready for any standards. Second, the visibility can be used to substantiate the sustainability claims, consequently making your reports credible in the eyes of the information’s user (be it governments, investors, or consumers). Further, you can find information about how to achieve supply chain traceability.
How Circularise can help with complying with the Corporate Sustainability Reporting Directive?
To ensure you know what is happening across the supply chain, continually tracking the impact and chain of custody of all material that passes through a manufacturing company is required. However, this is a significant undertaking and presents a web of challenges from resourcing, to data integrity, and protecting company intellectual property. This is why Circuarise has developed a tried and tested, blockchain-powered software platform, which provides supply chain traceability that can not only be trusted but also integrated with existing operational processes.
See how we achieved visibility into the Porsche supply chain.
Conclusion
The CSRD aims to make reliable and structured sustainability information available for various stakeholders. It does so by forcing firms to disclose information on non-financial indicators. Enterprises will have to include a report on how sustainability issues affect their performance, position and development, and on the impact their activities have on people and the environment.
The directive applies to large companies, SMEs listed on official EU markets, SMEs carrying out high-risk activities, and non-EU companies operating in the EU internal market. The standards are going to be less rigid for SMEs. The sustainability information will have to be communicated through annual management reports, available in an electronic format and have a digital tag. The reports will also require audit and assurance. To effectively respond to new legislative measures, firms have to start preparing now.
Building on the Corporate Sustainability Reporting Directive (CSRD), the Corporate Sustainability Due Diligence Directive (CS3D or CSDDD) introduces a comprehensive policy that requires in-scope companies to address sustainability risks and negative impacts across their business activities. The CS3D places a legal obligation on large enterprises to implement due diligence procedures that assess and mitigate risks related to internationally recognised human rights and environmental concerns. Read more about the key difference between the CSRD and CS3D.
Circularise is the leading software platform that provides end-to-end traceability for complex industrial supply chains. We offer two traceability solutions: MassBalancer to automate mass balance bookkeeping and Digital Product Passports for end-to-end batch traceability.
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