The CSRD: Breaking Down the Walls Between ESG and Finance
Update June 2022
The Council and European Parliament have reached a provisional political agreement on a proposal for the new rules for corporate sustainability reporting. The latest proposal will require all large companies, listed companies and small and medium-sized companies in the EU to provide more detailed and accessible sustainability reporting on issues such as environmental rights, social rights, human rights and governance factors.
The proposed rules also apply to non-EU companies generating a net turnover of €150 million in the EU and which have at least one subsidiary or branch in the EU. Once approved, the application of the EU corporate sustainability reporting rules will take place in three stages:
- Companies that fall under the Non-financial Reporting Directive in financial year 2024;
- All large companies in financial year 2025;
- And listed small and medium-sized companies in the financial year 2026.
There’s a lot to talk about in the European Commission’s proposals for a Corporate Sustainability Reporting Directive (CSRD) that were first shared on 21 April, 2021. I will explore some of its biggest talking points in a moment, but for now I’m going to start with a change that might seem trivial to some. The name of the directive.
The CRSD enhances and strengthens the measures already in place as a result of the Non-Financial Reporting Directive (NFRD) and is, in part, the result of a series of consultations that started as far back as 2018. Clearly, a great deal of feedback was received and considered during that time. But this feedback was unified by many emerging themes—one being that, “many stakeholders consider the term ‘non-financial’ to be inaccurate, in particular because it implies that the information in question has no financial relevance."
Is all ESG data really “non-financial”?
Many organisations have long argued that a number of ESG topics have a clear financial impact. This is the case with BlackRock, which often refers to the financial effect of ESG-related issues in its famous annual CEO letters. At Bloomberg, Michael Bloomberg chairs the Task Force on Climate-Related Financial Disclosures. And the financial merit of ESG initiatives has been the topic of many speeches over the years at the IFRS Foundation. Significantly, the IFRS Foundation recently established a working group to start toward the proposed SSB, noting that the “working group will be chaired by the IFRS Foundation and include participation by the IASB, given the need for connectivity with financial reporting."
As a result, the European Commission’s impact assessment concluded that, “many organisations, initiatives and practitioners in this field refer to 'sustainability’ information. It is therefore preferable to use the term ‘sustainability information’ in place of ‘non-financial information.' Directive 2013/34/EU should therefore be amended to take account of this change in terminology.” The result of this? The CSRD.
It’s not just the name that’s changing—ESG requirements are evolving
The terminology and name update has been made to bring alignment and connectivity between sustainability and financial information into long-awaited legal form. But it’s far from the only proposed change. Highlights include:
Sustainability reporting is now proposed to be mandatory in management reports as part of the annual financial report. The option for member states to exempt companies from including sustainability in their management reports has been removed.
The ESEF introduced the concept of digital tagging (using the Inline XBRL® standard) for financial reporting. This proposal includes the requirement that publicly listed companies disclose the sustainability information, "in a digital, machine-readable format” and points to the ESEF as that format.
One major proposal introduced (when compared with the current NFRD) is to, “require all companies within the scope to seek limited assurance for reported sustainability information while including an option to move toward a reasonable assurance requirement at a later stage.” This initial move toward limited assurance will bring more of the reliability currently associated with financial information to the future for sustainability information. It’s also worth noting that the proposal leaves the option open to move to full assurance and audit.
The responsibility for ensuring that the management commentary (in the AFR) contains information reporting in accordance with the standards is proposed to sit with “the people responsible for financial reporting.” Thus bringing sign-off inline with financial statements.
What is the business impact of these proposals?
The European Commission is required to perform an impact assessment. It is keen to emphasise that while there is inevitably a cost to companies, “the aim is to achieve the best value outcome in terms of objectives and associated costs."
This “best value” approach is reflected in its expectation that some updates, in particular the creation of the standards (clarifying required disclosures and frameworks) and the potential to reduce the number of ad hoc information requests from investors, will relieve some of that cost burden. However, it’s worth remembering that, even with no change in the NFRD, the demand from investors is unquestionably increasing and will continue to do so as the Sustainable Finance Disclosure Regulation (SFDR) and the EU Taxonomy come into force. To meet this demand, businesses face significant pressure to improve the quality of the ESG information that they share with investors and the market.
The imperative to align ESG processes with finance processes gives companies the opportunity to make use of their wealth of experience in the financial domain. The tactics that they use to build closer connections between the teams and processes will help bring ESG data and controls up to speed. Sustainability matters do have financial relevance and, with a shared oversight and final report, it makes sense to break down the walls between finance and sustainability. Which is good—because that’s exactly what the CSRD proposes to do.
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