European Council approves directive on corporate sustainability reporting

On November 28, 2022, the European Council passed its Corporate Sustainability Reporting Directive (CSRD), which aims to improve the consistency of sustainability information that companies disclose. The directive will be published in the Official Journal of the European Union once signed by the presidents of the European Parliament and European Council, taking effect twenty days after publication.

The CSRD amends four pieces of EU legislation. In particular, it revises and strengthens the rules in the Non-Financial Reporting Directive (NFRD) and significantly expands the number of companies that are required to report sustainability information from 11,700 to about 50,000 companies. The new provisions establish requirements for more detailed reporting on the risks and impacts associated with corporate activity, including ESG (environmental, social and governance) matters.

Expanded scope and impacts for non-EU companies

EU law already requires large publicly-held companies with over 500 employees and an annual turnover of more than EUR 150 million to disclose information on how they operate and manage their social and environmental challenges.

With the CSRD, the new reporting requirements have been extended to insurance companies, financial institutions, companies with over 250 employees or with a turnover of EUR 40 million and EUR 20 million in assets (whether listed on stock exchanges or for large companies currently not subject to the NFRD), as well as small and mid-sized publicly listed enterprises (SMEs).

The inclusion of listed SMEs within the scope of the CSRD comes in the wake of calls for more ESG information from financial institutions, large companies involved in the SMEs’ value chains and other stakeholders at the time of granting credit.

In addition to expanding the scope of coverage within the EU itself, companies from countries outside the EU that generate an annual revenue of more than EUR 150 million inside the EU will also have to comply with the CSRD’s rules. This also applies to such companies that generate between EUR 40 million and EUR 150 million if 50% or more of the revenue stems from any of the textile, food and beverage, and mineral resources sectors.

Each type of company will have a specific deadline for adapting to the new requirements:

• Large companies (with over 500 employees) will be subject to the NFRD from January 1, 2024;
• Large companies that are not currently subject to the NFRD, from January 1, 2025;
• Listed SMEs (optional until 2028) and other companies from January 1, 2026, which must deliver updated reports in 2027.

Disclosures in unified management reports

The EU’s new directive emphasizes the need for more transparent reporting on sustainability, emphasizing that financial institutions, investors, and the general public must be able to access it easily. The CSRD determines that all ESG-related information must be provided in digital format in these companies’ management reports rather than in a separate sustainability report.

By unifying all data in a single report, it will be easier for readers to analyze the information and establish a clear relationship between companies’ ESG issues and financial information. This should also help to demystify the idea that ESG information belongs to a less important category.

Double materiality and detailed ESG information

While the quality of the information in companies’ sustainability reports is still generally perceived to be insufficient, the CRSD’s clarification of the concept of ‘double materiality’ represents a major step forward. This concept should guide companies in regard to all reporting on ESG matters under the mandatory EU regulations and standards.

The concept of double materiality sets a greater focus on how companies address sustainability issues in accounting standards, which as per the CRSD, include environmental, climate, labor, human rights, anti-corruption, and anti-bribery factors, as well as governance on these issues. Whereas ‘materiality’ considers the impact of sustainability issues on companies’ bottom line from the outside in, double materiality also considers how a company’s activities impact sustainability-related risks and opportunities on people and the environment from the inside out.

In addition to the qualitative and quantitative environmental and social data, companies must also disclose their strategies for handling ESG risks. Such strategies must outline companies’ ESG-related objective and business opportunities, their plans for transitioning to a sustainable economy, the role of governance and policy bodies in ESG matters, and due diligence on ESG matters, including in their value chains.

Auditing disclosures

The lack of standardization in sustainability reporting represents one of the major obstacles to the comparability and credibility of the data provided. Thus, the CRSD also aims to fight against ESGwashing, as well as develop global standards for sustainability reporting.

Companies must submit their sustainability reports to audits in order to ensure they provide reliable information. Initially, companies must contract an independent auditor to conduct a limited audit and give an opinion on whether the disclosed sustainability information complies with the EU’s requirements.

The opinion must be published together with the management report containing information on sustainability. This represents a progressive approach to ensuring necessary improvements in reporting sustainability information, especially considering that each EU member state remains responsible for proposing its own rules to guarantee the reliability of such audits, as to date, the European Commission has yet to develop general rules that would ensure credibility.

For further information on sustainability regulations, please contact Mattos Filho’s ESG practice area.