SUSTAINABILITY REPORTING – WHAT SHOULD WE PREPARE FOR WITH THE ENTERING INTO FORCE OF THE CORPORATE SUSTAINABILITY REPORTING DIRECTIVE? (CSDR)

On 5 January 2023, the CSRD Sustainability Reporting Directive came into force, which significantly changes corporate reporting obligations related to the climate and environmental impact of business conduct.

In the upcoming years, large European undertakings and small and medium-sized listed undertakings will have to publish standardised sustainability reports. The CSRD (Corporate Sustainability Reporting Directive) will be crucial for sustainable finance by creating transparent and standardised sustainability reporting rules, which will undoubtedly have an impact on countering greenwashing as well.

Introduction of the CSRD.

For a long time, it has been pointed out that companies and other entities should not operate solely for profit, but should pursue socially important values. This belief gave rise to the concept of ESG (Enviroment, Social, Governance), which draws attention to the environmental, social and corporate governance implications of corporate conduct.

The previously applicable NFRD (Non-financial Reporting Directive) obliged companies to include an additional statement on non-financial information in their management reports. Within this information, the majority of information is presented on environmental, social, employee or human rights issues. However, due to the lack of standardised rules and requirements for non-financial reporting and the lack of a single standard, the NFRD gave too much discretion and did not guarantee the possibility for market participants and other interested parties to compare the information contained in the reports of different entities, while at the same time encouraging the practice of ‘greenwashing’, which consists of creating an environmentally friendly image by publishing selective or even untrue information about entity’s activities and practices.

Following numerous criticisms directed at the NFRD, in November 2022, after more than a year and a half of work, the European Parliament, and subsequently also the Council of the European Union, approved the draft of CSRD, which will significantly standardise the scope and way in which sustainability information is reported, including, among other things, by introducing an obligation to carry out a materiality test in accordance with the double materiality principle, the preparation of the report in accordance with uniform EU standards, the obligation to include a taxonomy in the report, the introduction of a uniform format for the presentation of the report (and appropriate tags), and the need for the report to be audited by an independent body.

Who and when will the requirements of the CSRD be extended to?

Currently, according to the Accounting Act, which implemented the NFRD, entities obliged to report non-financial information are large undertakings with more than 500 employees and meeting the financial criterion: PLN 85,000,000 for total balance sheet assets or PLN 170,000,000 for net revenues. The new ESG reporting obligations under the CSRD will be implemented in the following three stages:

First, they will cover entities that are already required to report non-financial information that will be required to report under the CSRD for the first time in the financial year starting 1^st of January 2024, i.e. in 2025.

Subsequently, the obligations under the CSRD will extend to so-called ‘large undertakings’, i.e. entities meeting at least two of the following criteria: employing more than 250 employees, reporting a balance sheet total of more than EUR 20,000,000 or reporting net turnover of more than EUR 40,000,000. These undertakings will be required to report under the CSRD for the first time in the financial year beginning 1^st of January 2025, i.e. in 2026.

The final group of entities that will be required to report under the CSRD are small and medium-sized listed undertakings, whose sustainability reporting obligation will arise for the first time in the financial year beginning 1^st of January 2026, i.e. in 2027.

Will the CSRD also apply to entities outside the European Union?

In addition to the three groups of entities indicated earlier, entities outside the European Union will also be included in the scope of application of the CSRD.  Undertakings that have an annual net turnover in the European Union of more than €150 million for each of the last two consecutive financial years and, have at least one large subsidiary, one subsidiary listed on a regulated market in the European Union or one branch in the European Union that generated more than €40 million in annual net turnover in the previous financial year will be required to report on sustainability from 1^st of January 2028.

What sustainability reporting standards will apply?

The CSRD will require companies to disclose information using a detailed set of sustainability reporting standards. On 23^rd of November 2022. EFRAG (European Financial Reporting Advisory Group) presented the final version of the prepared ESRS standards to the European Commission, which the European Commission will adopt in final form by 30^th of June 2024.

The ESRS describes in detail the scope of information that undertakings obliged under the CSRD will have to publish. These include, among others, information on:

1. Environmental issues – including: climate change, pollution, water and marine resources, biodiversity and ecosystems, and resource use and a circular economy;
2. Social issues – including: employment, workers in the value chain, vulnerable communities, consumers and end-users; and
3. Corporate governancee. relating to business conduct.

Particular emphasis is placed on the disclosure of greenhouse gas emissions.

In order to minimise disruption for those already reporting sustainability information, the ESRS will take into account existing standards and frameworks for sustainability reporting and accounting. For this very purpose, discussions are currently underway between the European Commission, EFRAG and the ISSB (International Sustainability Standards Board) to achieve the greatest possible degree of harmonisation between the European framework and the planned global ISSB standards.

What is double materiality principle?

The CSRD clarifies the obligation to provide information to the extent necessary to understand the undertaking’s development, performance and position, as well as the impact of the undertaking’s activities on environmental, social and labour issues, respect for human rights, anti-corruption and anti-bribery. The provisions of the CSRD impose both a requirement to provide information on how sustainability issues affect the undertaking and a requirement to provide information on the impact of the undertaking’s activities on people and the environment.

In other words, the information provided must be framed from both an ‘outside-in’ perspective, i.e. how external sustainability factors affect the situation of the entity, particularly from the point of view of risks and impacts relating to financial health and operational performance. In addition, the information provided must also be included from an ‘inside-out’ perspective (also referred to as an environmental or social perspective), which comes down to presenting the impact of the entity’s activities on the surroundings.

Importantly, obligated undertakings should consider each perspective of materiality separately and disclose both information relevant to both perspectives and information relevant to only one of them.

Where will sustainability information be located?

In contrast to the provisions of the NFRD, entities covered by the CSRD will have to report sustainability information in a clearly visible part of their reports. According to the European Commission, this solution will make the link between financial and sustainability information clearer and improve data accessibility for those interested in the interaction between financial and sustainability information.

Who will verify sustainability information?

Unlike the NFRD, the CSRD provides for ESG information to be audited by a certified auditor or an audit firm. It also allows for the possibility of delegating such an audit to an independent assurance provider. At present, it is not yet known whether this possibility will be used by the Polish legislator.

Importantly, until the European Commission issues an appropriate standard (which is expected by 2028), the audit of sustainability reporting will be conducted at a limited assurance level. Ultimately, however, the audit is to be carried out at a level of reasonable certainty, which is the current standard for financial statements.

Conclusion.

Undoubtedly, the CSRD will introduce significant changes, primarily expanding the scope of sustainability reporting and creating a much more comprehensive and unified set of standards for such reporting, which if introduced will help to address the problems associated with the lack of comparability of sustainability data and thus make it much more difficult for “greenwashing” to develop.