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What is the new Corporate Sustainability Reporting Directive bringing to the table?

Officially, EU Parliament has adopted the Corporate Sustainability Reporting Directive (further: CSRD) on November 10, 2022. Within the next week, on November 28, 2022, we are expecting to see the decision of European Council on the same matter.

It is recognized by the EU that transparency of large companies and reporting about environmental, social, human rights and similar issues (we will refer to them as ESG parameters or corporate sustainability parameters) are crucial for sustainable development. Informing shareholders, employees, general public and financial institutions about the impact that the company has on the environment, the way it is managed and the way it is treating its’ employees, along with the rest of ESG topics is making a big difference in the ways the companies are perceived by all of the Stakeholders.

For these reasons, the EU has already put significant effort in obliging large companies to undergo non-financial reporting, primarily through the Directive 2014/95/EU (Non-Financial Reporting Directive, or NFRD), amending the Directive 2013/34/EU, which proclaims the obligation of large undertakings to include non-financial report in their management report.

The Commission report of 2021 on the review clauses in Directives 2013/34/EU, 2014/95/EU, and 2013/50/EU and its accompanying fitness check on the EU framework for public reporting by companies (‘Commission report on the review clauses and its accompanying fitness check’) identified problems as to the effectiveness of Directive 2014/95/EU.

There is significant evidence that many undertakings do not disclose material information on all major sustainability-related topics, including climate-related information such as all GHG emissions, and factors that affect biodiversity. The report also identified the limited comparability and reliability of sustainability information as significant problems. Additionally, many undertakings from which users need sustainability information are not obliged to report such information. Accordingly, there is a clear need for a robust and affordable reporting framework that is accompanied by effective auditing practices to ensure the reliability of data and avoid greenwashing and double counting.

In the light of the European Green Deal, Sustainable Finance Agenda, and abovementioned report and fitness check of the application of relevant Directives, the CSRD is now looking to reform the NFRD, and reduce its shortcomings, as perceived by the EU.

The scope of application is broadened and now about 50.000 companies are going to be obliged to publish their ESG reports, along with some non-EU businesses. Amending the paragraphs of the consolidated version of the Directive 2013/34/EU that are related to non-financial reporting – it’s, inter alia, redefining scope of application, introducing standards of Sustainability reporting, polishing the definitions (net turnover). It is at the same time amending the Directive 2006/43/EC, broadening its scope, and creating an obligation for some non-EU undertakings, which is particularly interesting.

With earlier legislative efforts, EU has already made significant regulation when it comes to companies informing the public about their ESG parameters, such as Regulation No 575/2013, which requires large institutions which have issued securities that are admitted to trading on a regulated market to disclose information on ESG risks from 28 June 2022, Regulation 2019/2033 and Directive 2019/2034 that contains provisions concerning the introduction of an ESG risk dimension in the Supervisory Review and Evaluation Process (SREP) by competent authorities, and contains ESG risk disclosure requirements for investment firms. On 6 July 2021, the Commission also adopted a proposal for a Regulation of the European Parliament and of the Council on European green bonds, following up on the Action Plan on Financing Sustainable Growth.

Two issues discussed when it comes to ESG reporting are greenwashing and the subjective scope of obligation of non-financial, or ESG reporting – who are the ones that should be obliged to undergo ESG report?

A classification system of environmentally sustainable economic activities with the aim of scaling up sustainable investments and combatting greenwashing of financial products that claim to be sustainable is existing, along with environmental, social and governance disclosure requirements for benchmark administrators and minimum standards for the construction of EU Climate Transition Benchmarks and EU Paris-aligned Benchmarks.

Well-structured and detailed guidelines, standards, benchmarks and minimum requirements are necessary for effectiveness of corporate sustainability reporting, in order to avoid manipulation of information that has already been occurring with these reports. We, as public, consumers, shareholders, regulators, financial institutions need to hold some sort of “legal certainty” when it comes to ESG reporting.

Moreover, the CSRD will be applied to subsidiary undertaking established in its territory whose ultimate parent undertaking is governed by the law of a third country or branches of a third-country company that are operating in the territory of the EU Member state, with the condition that they generated more than a defined net turnover. The CSRD requires publishing sustainability reports at the group level of that ultimate third-country parent undertaking.

It is left to be seen how this Directive will be applied in practice, will the reporting standards and guidelines be clear and restrictive, yet flexible enough, and how will it affect the “newcomers” to sustainability reporting.

Foto by Đorđe Vukojičić