CSRD, the new EU climate regulation explained

September 16, 2022
Written by
Pierre-Louis Lemaire
CSRD, the new EU climate regulation explained
Table of contents

What is the CSRD

The Corporate Sustainability Reporting Directive is a new climate regulation proposed by the European Union to expand the scope of companies required to disclose sustainability-related information in their financial reports. Starting in 2025, the most prominent companies will have to comply with this regulation and report on environmental, social, and governance dimensions.

Fast forward to 2027, all listed and large companies with operations in the EU and listed SMEs will have to comply with the CSRD. It is estimated that more than 50,000 companies will eventually fall under the CSRD. Reporting standards for the CSRD are still under development, and a first draft will be officially released in October 2022.

According to the EU’s website, the CSRD will “enable investors to re-orient investments towards more sustainable technologies and businesses, [..] and be instrumental in making Europe climate neutral by 2050”.

Summarized, the CSRD:

  • extends the scope to all large companies and all companies listed on regulated markets;
  • requires the audit of reported information;
  • introduces more detailed reporting requirements;
  • requires companies to digitally ‘tag’ the reported information.

Why impose a new climate regulation

Current regulation is obsolete

The current climate regulation in the European Union is called the NFRD for Non-Financial Reporting Directive. Developed in the mid-2010s, this regulation promoted openness about corporate social responsibility and provided investors with the company-level information they needed to make sustainability-focused investment decisions.

While having established essential sustainability reporting principles, the EU considers the current regulation obsolete. In fact, many reports prepared under the NFRD often omit information that investors and stakeholders consider important. The lack of clear and strict reporting standards has also led to disparities in sustainability reporting between EU member states, making it more difficult and unreliable to compare information across companies.

The European Union is also acting to make the investment ecosystem greener and more sustainable through the Sustainable Finance Disclosure Regulation. This means that investors must be aware of the environmental impact of companies if the green investment market is to be taken seriously.

The Corporate Sustainability Reporting Directive aims to standardize sustainability reporting standards while increasing corporate actions’ transparency and accountability.

The CSRD will cover more companies

The current Non-Financial Reporting Directive only applies to companies considered "public interest enterprises", such as banks, insurance companies, and publicly traded companies. In other words, only about 11,000 companies are currently covered by the NFRD.

With the EU's goal of becoming climate neutral by 2050 and the first continent to reach net zero, it is essential to rapidly transform its business ecosystem into a long-term sustainable economy. This means that more companies must report on their sustainability impact, which is why the CSRD will expand the scope of companies that will be regulated.

This new climate regulation will nearly quadruple the number of companies required to disclose sustainability information, from 11,000 for the NFRD to more than 50,000 under the CSRD. The Corporate Sustainability Reporting Directive will cover all large companies, both listed and unlisted, without the previous threshold of 500 employees. Some SMEs will also fall under the CSRD.

CSRD’s timeline explained

2021 to 2024

The European Parliament proposed the CSRD publicly on April 21st, 2021. The proposal is believed to be transposed into legislation by the end of 2022. Member states should incorporate the directive into their national laws by December 1st, 2022.

The European Financial Reporting Advisory Group (EFRAG) is responsible for developing the reporting standards drafts. According to the CSRD’s timeline, a first draft containing some conceptual guidelines and ‘core’ standards will be officially published by October 2022. Following this report, one more draft will be published by the end of 2023. The final version of reporting standards will be released in mid-2024. Nevertheless, companies that will be subject to the CSRD should already start studying the already available resources to collect the needed information as soon as possible.

2025 to 2027

Starting in 2025, all large companies already subject to the Non-Financial Reporting Directive will be required to publish CSRD-compliant sustainability reports covering the previous financial year (2024 for the first report). This will include approximately 11,000 companies already required to report under the NFRD.

By 2026, the CSRD will come into force by making it mandatory for every large company with operations in the EU (i.e., also companies based outside the EU) to submit sustainability reports in line with the CSRD standards.

Finally, in 2027 SMEs subject to the CSRD will have to publish their first sustainability reports, covering the financial year of 2026. However, reporting standards are likely to be simpler for SMEs, considering they are smaller companies.

Reporting standards will be in open access with the goal for companies not falling under the CSRD to use them as guidelines for their sustainability reporting. The EU aims that investors start considering the CSRD as a standard for sustainability reporting, and increase their investments in companies that make an effort to produce such reports.

Beyond

According to the EU, a review of the CSRD will probably take place at least three years after the regulation comes into force when sufficient evidence can be collected about the initiative’s impact.

Which companies will need to be compliant

The CSRD expands the scope of the directive from "public interest enterprises" such as listed companies, banks, and insurance companies to any large company with operations in the EU, as well as publicly traded SMEs. The CSRD will cover more than four times the number of companies that the NFRD currently covers. This increases the number of companies required to publish sustainability reports from 11,000 to over 50,000 under the new directive.

Companies the CSRD applies to

In 2025, all companies already subject to the NFRD will have to be CSRD compliant.

Starting in 2026, all companies that meet at least two of the following criteria will be subject to the CSRD:

  • 250 and more employees on average during the financial year
  • €40m or more in net turnover
  • €20m or more in total assets

Starting in 2027, publicly traded SMEs will also be required to comply with the CSRD:

→ Medium-sized companies that meet at least 2 of the following criteria:

  • 50 - 249 employees on average during the financial year
  • €8m - €40m in net turnover
  • €4m - €20m in total assets

→ Small-sized companies which meet at least 2 of the following criteria:

  • 10 - 49 employees on average during the financial year
  • €700k - €8m net turnover
  • €350k - €4m in total assets

International and non-European companies with more than €150 million in annual turnover within the EU will also have to meet the CSRD requirements from 2026.

Companies the CSRD does not apply to

Still, many companies will not fall under the CSRD. However, these companies are free to use the CSRD reporting standards to increase their transparency on sustainability matters and meet demand from investors to disclose more information about their environmental impacts.

Listed SMEs with financial assets on growth markets or multilateral trading facilities will probably not have to report under the CSRD, as well as non-listed SMEs.

Listed micro-enterprises will not be subject to the CSRD if they meet at least two of these requirements:

  • 10 and less employees on average during the financial year
  • Less than € 700K in net turnover
  • Less than € 350K in total assets

CSRD’s reporting requirements

What topics will be covered by the CSRD

In developing this new climate regulation, the EU aims to align its reporting requirements with other policies such as the Sustainable Financial Reporting Regulation (SFDR) or other sustainability reporting initiatives (e.g., ESG criteria, CDP). To do so, the EU put the European Financial Reporting Advisory Group (EFRAG) in charge of creating these reporting standards. The EFRAG relies on a public-private partnership and will advise the Commission to put into law these standards. While a first official draft should be published in October 2022, we already have access to a working paper from the EFRAG.

Similar to the NFRD, companies will be required to report from a "double materiality" perspective, explaining how sustainability issues affect their operations and impact people and the environment. Reports must disclose information along these three dimensions: environmental, social, and governance.

CSRD’s possible reporting requirements as disclosed in the EFRAG working paper.

Technical and audits requirements

For the first time, the CSRD will require that data disclosed in reports be verified by third parties to ensure the accuracy and reliability of the information reported. This will go a long way toward addressing stakeholder and investor concerns about the accuracy of sustainability data that companies currently report.

The EU plans to take a "phased approach", requiring only "limited" assurance, for now, to reduce costs for companies. This approach is also better suited to the current market for sustainability auditors. However, the EU retains the option to adopt more stringent assurance requirements in the future. Companies and auditors should therefore work together to prepare for such a change. Companies will be allowed to become auditors by EU member states, which will broaden the scope of potential auditors.

Also, in an effort to lower costs for companies and improve the ways investors can compare companies, the CSRD will require reporting companies to prepare their reports in a digital format. To be clear, data will have to be reported in an XHTML format and ‘tagged’ according to the upcoming reporting standard. Unfortunately, we don’t have access to details yet.

Special standards for SMEs

The CSRD will affect some SMEs (to see which ones, come back to this section). Small businesses will have to report on their sustainability impacts or face fines. However, to lower the costs of money, time, and resources for these companies, the EU plans to make reporting standards simpler and lighter for SMEs. While being developed alongside the classic reporting standards, it is believed they will be more lenient. A first draft containing SME reporting standards will be officially published in mid-2023.

How to prepare for the upcoming CSRD

The European Union plans to become the first "Net-Zero" continent. States must become climate leaders and act accordingly. As a result, climate regulation will accelerate over time and affect more companies. Implementing the CSRD is the first step toward a sustainable business ecosystem in the EU. However, it is already having an impact on all large companies, as well as foreign companies and some SMEs.

By implementing the Corporate Sustainability Reporting Directive, the EU is raising the bar of investor and stakeholder expectations of companies, whether or not they fall under the CSRD. Indeed, the proposal will be broken down into more lenient versions so that smaller companies can use them on a voluntary basis. The proposal already indicates that companies that choose to use them will build investor confidence and interest. Considering that investors are also subject to regulations requiring sustainability reporting and that banks must report on the sustainability impact of their investments or loans, this should not be taken lightly.

Companies that choose to start investing in climate reporting will have significant advantages over their competitors in the future green business environment.

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