Corporate Sustainability Reporting Directive (CSRD); an Overview highlighting Grey Areas

The Corporate Sustainability Reporting Directive (CSRD) is a significant piece of legislation in the European Union (EU) aimed at enhancing and standardizing the sustainability reporting of companies. It marks a significant shift from voluntary to mandatory sustainability reporting, intending to improve transparency and accountability in corporate sustainability practices. Here’s an overview of CSRD and its application in the USA, Europe, and the United Kingdom, as well as the current challenges in this field.

Overview of the CSRD

The CSRD was adopted by the European Parliament in 2021 and is a revision of the Non-Financial Reporting Directive (NFRD). It significantly expands the scope and requirements for sustainability reporting:

Scope: The CSRD applies to a broader range of companies than the NFRD, including large companies (listed or unlisted), as well as small and medium-sized enterprises (SMEs) listed on EU-regulated markets. Approximately 50,000 companies in the EU will be subject to the CSRD, compared to around 11,000 under the NFRD.
Reporting Standards: Companies are required to report according to the European Sustainability Reporting Standards (ESRS), developed by the European Financial Reporting Advisory Group (EFRAG). These standards cover environmental, social, and governance (ESG) issues in detail.
Auditing: The CSRD introduces a requirement for companies to have their sustainability information independently audited, ensuring the reliability and accuracy of the data.
Digital Reporting: Companies will need to publish their sustainability reports in a digital, machine-readable format, facilitating accessibility and analysis.

Application in the USA

The United States has not adopted the CSRD, as it is an EU-specific directive. However, its principles and influence are increasingly being felt:

Voluntary Reporting: Many U.S. companies, especially those with significant operations in Europe, voluntarily align with CSRD standards or similar frameworks like the Global Reporting Initiative (GRI) or the Task Force on Climate-related Financial Disclosures (TCFD).
Regulatory Environment: The U.S. Securities and Exchange Commission (SEC) has proposed rules to enhance and standardize climate-related disclosures, which mirrors some aspects of the CSRD but is less comprehensive. These proposals have been met with both support and opposition, reflecting the ongoing debate over the role of regulation in sustainability reporting.
Investor Pressure: U.S. companies are facing growing pressure from investors, consumers, and other stakeholders to adopt more transparent and robust sustainability practices. This has led to a gradual shift towards more detailed and standardized reporting, influenced by the global trend that the CSRD is part of.

Application in Europe

In Europe, the CSRD is a binding directive with wide-ranging implications:

Mandatory Compliance: European companies within the scope of the CSRD are required to comply, starting with large companies in 2024, followed by other companies in subsequent years.
Integration with EU Policies: The CSRD aligns with broader EU initiatives such as the European Green Deal and the Sustainable Finance Disclosure Regulation (SFDR). It aims to create a cohesive framework that drives the EU’s sustainability goals.
Challenges: Implementation of the CSRD poses challenges for companies, particularly in terms of data collection, reporting, and compliance costs. Smaller companies may struggle with the complexity and resource demands of the new reporting requirements.

Application in the United Kingdom

Post-Brexit, the United Kingdom is not bound by the CSRD, but it has pursued its sustainability reporting agenda:

TCFD Alignment: The UK government has mandated climate-related financial disclosures in line with the TCFD for large companies, pension schemes, and financial institutions, effective from 2021. This aligns closely with the CSRD’s objectives but is narrower in scope.
Corporate Governance Code: The UK Corporate Governance Code encourages companies to report on their environmental and social impacts, although this is not as prescriptive as the CSRD.
Future Developments: The UK may further develop its reporting requirements to keep pace with international standards, including those set by the CSRD. However, there is a balance to be struck between maintaining competitiveness and aligning with global best practices.

Current Challenges in Sustainability Reporting

The implementation of comprehensive sustainability reporting frameworks like the CSRD presents several challenges:

Data Availability and Quality: Companies often struggle with collecting reliable, consistent, and comparable data, particularly across global operations. The quality of sustainability data is also variable, which can undermine the credibility of reports.
Costs of Compliance: Compliance with detailed reporting requirements can be costly, particularly for smaller companies. This includes costs associated with data collection, reporting infrastructure, and third-party auditing.
Harmonization of Standards: The proliferation of different reporting standards and frameworks (e.g., GRI, TCFD, SASB) creates confusion and complexity for companies operating across multiple jurisdictions. The CSRD attempts to address this by providing a unified standard in the EU, but global harmonization remains a challenge.
Materiality: Determining what is material (i.e., what information should be reported) is a significant challenge. Companies must assess not only financial materiality but also the impact on stakeholders, which can be subjective and context-dependent.
Regulatory Divergence: Different regions have varying requirements and standards, creating complexity for multinational companies. While the CSRD seeks to standardize reporting within the EU, companies operating in the U.S., UK, and other regions face a patchwork of regulations.
Greenwashing: There is a risk that companies may engage in greenwashing, presenting an overly positive view of their sustainability practices. The CSRD’s auditing requirements aim to mitigate this, but enforcement and ensuring the integrity of reporting remain ongoing concerns.

First Conclusion

The CSRD represents a significant step forward in sustainability reporting, particularly in Europe. While it is not directly applicable in the USA and the UK, its influence is being felt globally, as companies and regulators adapt to the increasing demand for transparency and accountability in corporate sustainability practices. However, challenges such as data quality, compliance costs, and regulatory divergence need to be addressed to ensure the effectiveness and credibility of sustainability reporting.

Grey Areas in the Implementation of CSRD

The Corporate Sustainability Reporting Directive (CSRD) represents a significant step toward enhancing corporate transparency on environmental, social, and governance (ESG) matters in Europe. However, its implementation does involve several “grey areas” where ambiguity, challenges, or uncertainties may arise. Here are some of the key grey areas:

1. Scope of Applicability

Thresholds and Inclusion: The CSRD applies to a wide range of companies, including large EU companies, listed SMEs, and non-EU companies with significant activities in the EU. However, determining the exact threshold for non-EU companies can be complex, particularly for those with indirect activities or complex organizational structures. Defining what constitutes “significant activities” in the EU can also be challenging.
Sector-Specific Requirements: Different industries have varying degrees of ESG risks and impacts. The directive’s general framework may not fully address the nuances of each sector, leading to uncertainty on how to tailor reporting practices.

2. Data Collection and Quality

Availability of Data: Many companies, particularly SMEs, may struggle with the availability of accurate and reliable data for the required sustainability metrics. This is particularly true for non-financial data, which may not have been systematically collected or reported before.
Data Accuracy and Verification: Ensuring the accuracy and consistency of sustainability data across different regions and companies is challenging. The CSRD requires that reported information be audited, but the standards and methodologies for this verification process are still evolving, leading to potential discrepancies.

3. Alignment with Other Reporting Standards

Multiple Frameworks: Companies already reporting under other frameworks like the Global Reporting Initiative (GRI), Task Force on Climate-related Financial Disclosures (TCFD), or the EU Taxonomy may face challenges in aligning these with the CSRD. Differences in definitions, metrics, and reporting methodologies can lead to confusion and duplication of efforts.
Harmonization with International Standards: The CSRD is part of the EU’s broader push for global ESG reporting standards, but it’s unclear how well it will align with other international initiatives. Companies operating globally might face difficulties in reconciling EU-specific requirements with those of other jurisdictions.

4. Materiality and Double Materiality

Interpreting Double Materiality: The CSRD introduces the concept of double materiality, where companies must consider both financial materiality (how sustainability issues affect the company) and environmental/social materiality (how the company affects the environment and society). Determining what is material under this dual lens can be complex and subjective.
Dynamic Nature of Materiality: As ESG issues evolve, what is considered material today might change in the future. Companies need to establish processes to regularly reassess materiality, which can be resource-intensive and uncertain.

5. Reporting Deadlines and Timelines

Readiness of Companies: The timelines for CSRD implementation are ambitious, particularly for smaller companies and those new to sustainability reporting. Preparing the necessary systems, processes, and governance structures to comply with the CSRD in a timely manner is a significant challenge.
Phased Implementation: The directive is being rolled out in phases, but the transitions between phases are not always clear. Companies in different phases might face uncertainties in how to prepare for future reporting obligations.

6. Costs of Compliance

Implementation Costs: Complying with the CSRD will likely involve significant costs, including investments in data collection systems, reporting processes, and external assurance. For smaller companies, these costs could be disproportionately high relative to their resources.
Competitive Disparities: Companies with more resources may find it easier to comply with the CSRD, potentially creating competitive disparities between large and small companies, or between EU-based and non-EU companies.

7. Role of Stakeholders

Stakeholder Engagement: The CSRD emphasizes the importance of stakeholder engagement in determining material issues and reporting practices. However, companies might struggle to effectively identify and engage with all relevant stakeholders, especially in complex supply chains.
Impact on Supply Chains: The requirement to report on the entire value chain, including upstream and downstream impacts, presents challenges in gathering data from suppliers and customers, particularly in global supply chains where there may be varying levels of transparency and data availability.

8. Enforcement and Penalties

Regulatory Oversight: The mechanisms for enforcing compliance with the CSRD across different EU member states may vary, leading to inconsistencies in enforcement and potentially creating an uneven playing field.
Penalties for Non-Compliance: While penalties for non-compliance are anticipated, the specifics of how they will be applied across different jurisdictions remain uncertain. This can create uncertainty for companies trying to assess the risks associated with non-compliance.

9. Impact on Financial Markets

Market Reactions: There is uncertainty about how investors and financial markets will react to the increased transparency and the potential for identifying ESG risks that may not have been previously disclosed. Companies may face pressure from investors or other stakeholders as new information comes to light.
Integration with Financial Reporting: Integrating sustainability information with traditional financial reporting can be complex, especially given the different timelines, metrics, and standards involved.

10. Cultural and Regional Differences

Cultural Variations in Reporting: The CSRD will be applied across the diverse cultural and regulatory landscapes of the EU. Different countries may have varying expectations and norms around transparency and ESG issues, leading to challenges in standardizing reporting practices.
Regional Disparities: There may be regional disparities in how the CSRD is implemented and interpreted, particularly between more developed economies and emerging markets within the EU. This could lead to different levels of compliance and reporting quality across regions.

These grey areas highlight the complexities involved in implementing the CSRD. Companies will need to navigate these challenges carefully, seeking guidance and possibly engaging with regulators, auditors, and other stakeholders to ensure they meet their obligations effectively.

Comparison of main Differences between CSRD and US SEC regulations

The Corporate Sustainability Reporting Directive (CSRD) and the U.S. Securities and Exchange Commission (SEC) regulations both address corporate transparency and reporting, but they differ significantly in scope, focus, and requirements. Here’s a comparison of the main differences between the CSRD and SEC regulations:

1. Scope and Coverage

CSRD (EU Regulation): The CSRD applies to a broad range of companies within the EU, including large companies, listed companies, and certain small and medium-sized enterprises (SMEs). It covers both EU companies and non-EU companies with substantial operations in the EU (i.e., those generating significant revenue in the EU).
SEC Regulations (US Regulation): SEC regulations primarily apply to publicly listed companies in the United States. The scope is narrower, primarily focusing on financial reporting and disclosures related to publicly traded companies.

2. Focus of Reporting

CSRD: The CSRD mandates comprehensive sustainability reporting, including environmental, social, and governance (ESG) factors. It requires companies to report on their impact on the environment, society, and human rights, as well as on governance practices. CSRD emphasizes the concept of “double materiality,” which means companies must report both on how sustainability issues affect their financial performance and how their activities impact people and the environment.
SEC: The SEC’s focus has traditionally been on financial disclosures and protecting investors by ensuring transparency in financial reporting. While the SEC has introduced some ESG-related requirements (e.g., climate-related disclosures), these are generally less comprehensive than those under the CSRD. The SEC’s approach is more focused on materiality from a financial perspective—how ESG factors could impact a company’s financial performance.

3. Reporting Standards and Frameworks

CSRD: The CSRD requires companies to use the European Sustainability Reporting Standards (ESRS), which are developed to align with international frameworks like the Global Reporting Initiative (GRI) and the Task Force on Climate-related Financial Disclosures (TCFD). The ESRS are designed to ensure consistent, comparable, and reliable sustainability information across the EU.
SEC: The SEC does not mandate a specific sustainability reporting standard. However, companies are often expected to refer to existing frameworks like TCFD or the Sustainability Accounting Standards Board (SASB) if they disclose ESG information. The SEC’s climate disclosure rule proposals have suggested more standardized ESG reporting, but this is still more limited compared to the EU’s approach.

4. Verification and Assurance

CSRD: The CSRD requires companies to obtain third-party assurance for their sustainability reports, ensuring the accuracy and reliability of the reported information. The level of assurance required is generally “limited assurance,” with the possibility of moving towards “reasonable assurance” over time.
SEC: Currently, the SEC does not require third-party assurance for ESG disclosures, although companies may voluntarily seek assurance. The focus is primarily on the accuracy of financial disclosures, with less stringent requirements for ESG-related information.

5. Enforcement and Penalties

CSRD: The CSRD includes stricter enforcement mechanisms and penalties for non-compliance, reflecting the EU’s strong regulatory approach to sustainability. Companies that fail to comply may face fines and other legal consequences, particularly in the EU member states.
SEC: The SEC enforces compliance primarily through legal actions, fines, and penalties, but this has traditionally focused on financial misreporting or fraud. Enforcement related to ESG disclosures is still evolving, with penalties generally tied to misleading or inaccurate financial statements rather than sustainability-specific issues.

6. Timeline and Implementation

CSRD: The CSRD has a phased implementation timeline starting from 2024 for large companies, with broader applicability over the following years, including for SMEs. The directive is part of the EU’s broader push for sustainable finance and the European Green Deal.
SEC: The timeline for new ESG regulations under the SEC, particularly for climate-related disclosures, is still developing, with proposals subject to public comment and potential revisions. Implementation of any new SEC rules is typically slower and involves significant industry feedback.

7. Global Influence

CSRD: The CSRD is seen as a leading global standard for sustainability reporting and could influence international reporting practices beyond the EU. Non-EU companies with significant business in Europe may also be indirectly affected.
SEC: The SEC’s influence is primarily within the U.S., although its regulations can have global implications, especially for multinational companies listed on U.S. exchanges.

In summary, the CSRD is broader in scope, more comprehensive in its ESG focus, and has stricter assurance and enforcement requirements compared to the SEC’s current regulations. The SEC’s regulations are more focused on financial materiality, with emerging requirements for climate and ESG disclosures that are still evolving.

Leon Terblanche (LL.M)

Member of the International Law Association