EU-corporations and non-EU corporations should prepare for new sustainability reporting obligations heading their way under the European Corporate Sustainability Reporting Directive (CSRD). The CSRD obliges certain companies to disclose sustainability information pursuant to certain European sustainability reporting standards. It came into force in January 2023 with EU member states having until July 2024 to transpose the first part of the new provisions into national law.

The CSRD vastly expands the types and number of companies that will be subject to sustainability reporting obligations going forward. Whilst currently approximately 11,600 undertakings are subject to non-financial reporting obligations, following the implementation of the CSRD, it is estimated that approximately 49,000 undertakings will become subject to sustainability reporting obligations across the EU.

The target group of sustainability reporting obligations has formerly been largely on public interest entities, i.e. EU and non-EU entities with securities listed on a EU regulated market as well as EU insurance entities and financial institutions. With the CSRD, the sustainability reporting obligations will be expanded to companies only meeting certain size-thresholds and thus trigger the vast expansion of reporting obligations. The reporting provisions will be phased-in over several years, giving companies time to prepare.

Who will the CSRD reporting obligations apply to?

The CSRD will apply to the following undertakings:

Phase 1: January 1, 2024

Individual reporting obligations apply for financial years starting on or after January 1, 2024 (with a first publication in 2025 on 2024 data) to large public interest entities (PIEs). PIEs are essentially companies with more than 500 employees on average and:

1. with securities listed on an EU regulated market; or
2. EU credit institutions; or
3. EU insurance undertakings; or
4. EU companies designated as PIEs by individual EU member states.

In addition, a consolidated reporting obligation will apply to large PIE EU parent undertakings for financial years starting on or after January 1, 2024 (with a first publication in 2025 on 2024 data), if the parent undertaking is a PIE.

Phase 2: January 1, 2025

Individual reporting obligations apply for financial years starting on or after January 1, 2025 (with a first publication in 2026 on 2025 data) to large EU undertakings, i.e. corporations that (on as single-entity level) exceed at least two of the “Largeness Criteria” over two consecutive years:

1. 250 employees;
2. EUR 40m ($44m) (currently proposed to be increased to EUR 50m ($55m) net turnover (revenue);
3. EUR 20m ($22m)(currently proposed to be increased to EUR 25m ($27.5m)) balance sheet total.

A consolidated reporting obligation will apply to parent undertakings for financial years starting on or after January 1, 2025 (with a first publication in 2026 on 2025 data), if the parent undertaking exceeds at least two of the above Largeness Criteria on a consolidated basis.

Phase 3: January 1, 2026

An individual reporting obligation will apply for financial years starting on or after January 1, 2026 (with a first publication in 2027 on 2026 data) for listed small- and medium-sized undertakings (Listed SMEs), i.e. EU undertakings which do not meet the Largeness Criteria, but which exceed at least two of the following criteria over two consecutive years:

1. ten employees;
2. more than EUR 700,000 ($770,000) (currently proposed to be amended to EUR 875,000 ($963,000)) net turnover (revenue); and/or
3. more than EUR 350,000 ($385,000) (currently proposed to be amended to EUR 437,500 ($481,400)) balance sheet total.

Phase 4: January 1, 2028

The CSRD also contains an extraterritorial element. The sustainability reporting obligations will, in the future, also extend to multinational corporations whose ultimate parent undertaking is a non-EU company, if the following criteria are fulfilled:

• the non-EU parent undertaking has at least one EU subsidiary which qualifies as a large undertaking or a listed SME (based on the criteria set out above); or
• the non-EU parent undertaking has at least one EU branch that generates a net turnover of more than EUR 40m ($44m) annually;

and

• the parent undertaking – on a group or individual level, if there is no group – generates at least EUR 150m ($165m) net turnover in the EU for two consecutive years.

If these criteria are met, the EU subsidiaries or EU branch(es) must draw up a sustainability report which will have to include sustainability information at the group level of the ultimate non-EU parent company. In other words, the EU subsidiaries or EU branch will, in principle, have to report on sustainability matters on a worldwide level for the entire group.

European Sustainability Reporting Standards

A new aspect of the CSRD is that undertakings subject to it will be obliged to report sustainability information in line with specific European Sustainability Reporting Standards (ESRS) which are/will be developed by the European Financial Reporting Advisory Group (EFRAG). The ESRS are intended to ensure that the sustainability information is understandable, relevant, truthful, verifiable and comparable. The ESRS contain specific disclosure requirements and regulate how and whether companies must report, including whether a disclosure is compulsory or whether disclosure is only required, if the information is “material”.

A first set of ESRS (which contains 12 standards relating to environment, social and governance) was adopted by the European Commission on July 31, 2023. These ESRS are sector-agnostic and apply to companies that have to report as of January 1, 2024 and January 1, 2025. Sector-specific standards, proportionate standards for listed SMEs and standards for entities subject to a worldwide sustainability reporting obligation were originally expected to be adopted by June 30, 2024, but is now expected to be pushed out by two years.

In the first set of ESRS, ESRS 1 and ESRS 2 are cross-cutting and set-out general requirements and disclosures to be made.

The objective of ESRS 1 is to provide an understanding of the architecture of ESRS, the drafting conventions and fundamental concepts used, and the general requirements for preparing and presenting sustainability information in accordance with the CSRD. ESRS 1 also contains guidance on how to report on the undertaking and its organization and how the ‘double materiality’ standard is to be applied. Accordingly, companies are obliged to report both on their own impact on people and the environment (inside-out perspective or “impact materiality”) and on the impact of sustainability aspects on their business (outside-in perspective or “financial materiality”). Guidance is also provided on which information must not be reported on in the first years, transitional provisions and incorporation by reference.

ESRS 2 establishes disclosure requirements on the information that the undertaking shall provide at a general level across all material sustainability matters. It includes disclosure requirements relating to the basis of preparation of the sustainability information, governance at the reporting entity, strategy, impact, risk and opportunity management by the respective reporting entity, as well as sustainability metrics and targets.

The ESRS include various topical standards.

ESRS E1 to ESRS E5 contain environmental reporting standards covering (i) climate, (ii) pollution, (iii) water and marine resources, (iv) biodiversity and ecosystems as well as (v) resource use and circular economy.

ESRS S1 to ESRS S4 contain social reporting standards covering the topics (i) own workforce, (ii) workers in the value chain, (iii) affected communities and (iv) consumers and end users. Lastly, ESRS G1 contains governance specific reporting standards with respect to business conduct.

In addition, the CSRD requires a statutory auditor, an audit firm or independent accredited assurance provider to review whether the sustainability information is reported in compliance with ESRS. With regard to the scope and depth of the audit, an audit with limited assurance is initially planned, followed by an audit with reasonable assurance as of October 1, 2028. The limited assurance opinion should cover the compliance of the sustainability reporting with the CSRD and ESRS, the process carried out by the undertaking to identify the sustainability information, compliance with the reporting format and taxonomy information.

The EU Commission may decide until October 1, 2028 whether to introduce a reasonable assurance audit. This would likely entail extensive procedures having to be adopted, including consideration of internal controls of the reporting undertaking and substantive testing.

Penalties and enforcement

The CSRD as a whole, including the penalties for an infringement of the CSRD, still require transposition into the national law of each individual EU member state. Under the directive, member states shall provide for penalties and take all the measures necessary to ensure that those penalties are enforced. The penalties provided for shall be effective, proportionate and dissuasive. In line with the penalties set by member states for infringements of financial and non-financial reporting obligations already in place, it is to be expected that penalties will take the form of fines against corporate entities as well as criminal penalties against board members.

The extensive corporate sustainability information that multinational corporates will have to disclose due to the CSRD/ESRS will likely nurture climate activism by public interest groups. Corporate sustainability reporting is primarily aimed at equipping stakeholders, including shareholders, investors, employees, activists and public interest groups with sustainability information about a corporation. It is to be expected that they will make use of it and challenge corporates on it.

In addition, it is to be expected that proxy advisors will scrutinize the CSRD/ESRS disclosures of listed corporates, including non-EU corporates, especially once the worldwide reporting obligation kicks in. Enforcement risk for US listed companies also stems from the SEC if it starts to show interest in the sustainability disclosures US corporates need to publish in Europe. The added attention of legislators, law enforcement authorities and public interest groups in ESG in general and CSRD/ESRS particularly increases the pressure on multinational corporations to pay increased attention to these topics, even if they may seem (geographically) far away.