European Corporate Sustainability Reporting Directive: Strategic Game-Changer or Compliance Exercise

By Alexander McQueen | 4Q 2024 | IN-7570

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The Corporate Sustainability Reporting Directive (CSRD) is an environmental disclosure regulation in the European Union (EU), approved by the European Parliament in November 2022. The legislation, which entered into force in January 2023, mandates organizations to publish reports on their environmental and social activities. The first companies within the scope of the CSRD were given 2 years to prepare for the first disclosure, the date of which is set for January 1, 2025.

By publishing environmental performance information and creating accountability for their actions, it is expected that companies will increase efforts to cut emissions and improve operational sustainability. However, compliance with the CSRD has proven to be difficult for many companies as they grapple with the challenges of data collection, standardized reporting, and third-party auditing. There is also debate as to whether the CSRD will be enough to spark change or whether it will merely be a compliance exercise for those that fall under the scope.

The CSRD builds upon the existing Non-Financial Reporting Directive (NFRD), requiring reporting of detailed and comparable sustainability information covering qualitative and quantitative measures across the value chain. Companies must disclose information on the risks and opportunities arising from Environmental, Social, and Governance (ESG)-related issues, as well as their impact on the environment, which is to be reported alongside financial information in annual reports. The CSRD requires disclosure of information across 10 ESG topics across the three ESG categories:

• Environmental: Climate change, pollution, water and marine resources, biodiversity and ecosystems, resource management, circular economy
• Social: Workforce, value chain workers, community impact, consumers and users
• Government: Business conduct

The CSRD is set to have global impacts, not just impacting European countries, but any country that has a presence in the EU. CSRD disclosure requirements are due to be gradually phased in over the next few years depending on the size of the business. The companies affected in each disclosure year are outlined below:

• 2025 = Companies with over 500 employees
• 2026 = Companies with over 250 employees, €50 million in turnover and/or €25 million in total assets
• 2027 = Companies with over 10 employees, €0.9 million in turnover and/or €0.45 million in assets
• 2028 = Non-EU companies with over €150 million in turnover and at least one subsidiary/branch in the EU

The purpose of the CSRD is to support consumers, policymakers, and investors in evaluating the non-financial performance of large global organizations, thus encouraging these organizations to adopt more responsible and eco-conscious business approaches. Reporting sustainability information helps investors direct investment to those more focused on developing sustainable technology, and helps consumers select more sustainable products. The introduction of the CSRD led to the development of ESG reporting software tools to support compliance, both from globally leading organizations like Siemens and Schneider Electric and dedicated software providers such as Greenly, Persefoni, and SustainIQ.

The CSRD will undoubtedly create significant improvements in corporate transparency and accountability regarding the environmental impact of business operations. The introduction of consistent reporting standards at a global level will gradually bring an end to greenwashing as more companies are impacted by the legislation.

Despite this, it is uncertain whether the CSRD will create any meaningful improvement in the sustainability of company operations, particularly over the next 5 years or so, as there is no guarantee transparency will lead to change. As the first wave of companies prepare for disclosure at the start of 2025, many are still struggling with the challenges of data availability and value chain complexity, creating concerns over completeness and validity of disclosures. Addressing and measuring supply chain emissions, for example, is time-consuming and resource-intensive, often taking years as companies need to collaborate with suppliers and establish targets. This can disincentivize efforts to measure and report accurate ESG data.

Some companies are said to be taking a "bare minimum approach" to CSRD compliance, hesitant about deviating from usual business processes out of consideration for environmental goals due to fear of loss of profits. Smaller companies not yet impacted by the legislation have also been offered initial leniency and delays in penalty enforcement, creating a lack of urgency to initiate compliance efforts.

While there are question marks over the success of the CSRD in achieving its purpose, it has significant potential in driving corporate sustainability by tying sustainability to a company's revenue, creating financial incentives for sustainable practices. Companies are required to report how sustainability issues may impact their financial position through financial materiality assessments, encouraging them to act on opportunities that enable greater sustainability and profitability. Companies that pay more attention to sustainability reporting will also have better access to funding and improve their reputation by demonstrating commitment to sustainable business practices.

To maximize the success of the CSRD, the EU must ensure it maintains rigorous enforcement efforts and continues to encourage organizations to take sustainable action. The CSRD may serve only as the beginning of a string of regulations that serve to mandate improvements in sustainable operations across industries. Companies not yet affected are advised to begin compliance preparations now and be open to the opportunities for sustainability and profitability that the CSRD may bring.