Preparing for new sustainability reporting requirements in Europe: a roadmap for 2023
December 23, 2022
On December 14, 2022, the Corporate Sustainability Reporting Directive (CSRD) was published by the European Union. It is a broad environmental, social, and governance (ESG) reporting framework that will impose uniform, mandatory reporting requirements on many companies with European operations, including companies not based in Europe.
The CSRD brings another major pillar to Europe's legislation on sustainability and non-financial reporting. As early as 2014, Europe adopted its Non-Financial Reporting Directive, which is now replaced by the CSRD. In subsequent years, the EU worked on its strategy to implement the UN's Sustainable Development Goals (SDGs) through various commitments and action plans, including the 2018 Action Plan on Financing Sustainable Growth and the 2019 Green Deal, which aims to transform the EU into a modern, resource-efficient and competitive economy with no net GHG emissions by 2050 while protecting natural capital and the well-being of citizens. Sector-specific requirements, particularly for financial market participants, have also been implemented, most notably through the Sustainable Finance Disclosure Regulation (SFDR) and the EU Taxonomy Regulation.
The adoption of the CSRD represents a major step towards increasing corporate transparency and promoting responsible business practices across Europe and beyond. For one thing, it will considerably increase the number of companies that are subject to sustainability reporting requirements. In addition, it will require a heightened level of audit assurance, with the appointment of independent auditors to certify reports. For these and other reasons, the CSRD will likely be a key element for board agendas in 2023. Implementation, however, will require mobilization of teams at all levels of the organization, including considerable coordination with operations, finance and procurement teams, particularly on supply chain issues, as well as reviewing and making changes to existing reporting infrastructure. How can companies prepare for these requirements? Here are a few elements for consideration.
Sustainability governance. Companies should consider beginning by establishing a sustainability team or committee to ensure the CSRD is integrated into business objectives and operations, with authority to manage disclosure and reporting both internally and in coordination with business partners and advisors.
Understanding reporting requirements. Companies will need to devote time to understanding mandatory sustainability topics under the CSRD, including environmental, social, employee-related, human rights, anti-corruption/anti-bribery and diversity issues. This includes reviewing these elements from the "double materiality" perspective under the CSRD, which requires disclosing not only the impacts of ESG factors on the company, but also the company's impact on its environment and social systems.
Gap analysis and reporting plan. Companies should also perform a gap analysis to assess how their current reporting practices compare with CSRD requirements, then develop a plan to produce the required reports, identifying areas where additional processes are needed and prioritizing actions accordingly.
Benchmarking and KPI development. Companies will also need a sound process for setting meaningful sustainability KPIs according to business strategy and industry standards/benchmarks in order to measure progress towards goals. In order to do so, a benchmarking exercise can be completed in order to review and, where appropriate, incorporate best practices from business peers.
Comprehensive supply chain analysis and diligence. The CSRD cannot truly be an efficient tool in the ecological transition without companies undertaking a comprehensive supply chain analysis and diligence exercise. Indeed, companies must examine practices and sustainability performance at all levels of the value chain, including suppliers at the Tier 1, Tier 2 and Tier 3 level.
Data collection and management. The CSRD requires companies to collect, manage and provide data related to their sustainability performance in order to prepare the required disclosures. Companies should consider investing in systems capable of collecting information covering supply chain sustainability and business impact, which will enable them to ensure compliance with all CSRD requirements.
Reviewing existing systems architecture. Companies should review their enterprise resource planning systems to ensure they are able to capture relevant data related to the material aspects of ESG performance in accordance with the CSRD's requirements. Building out a systems architecture that allows for data aggregation, as well as assigning internal control processes to manage sustainability-related information, will help to ensure accuracy when it comes to filing reports.
Anticipating audits. Because the CSRD will impose a third-party audit obligation, companies should begin to review which auditing firms it will work with, attentive to existing or potential conflicts of interest that such firms may have. While a “limited” assurance standard will be required at first, the CSRD will eventually require a more rigorous, “reasonable” assurance standard in 2028, to the extent feasible.
Risk assessment and risk management. Companies will have to assess the impact of sustainability risks at all levels of business, including in the supply chain, to anticipate and manage any business risks. To this end, they should consider ways to mitigate sustainability-related risks through risk management tools such as sustainable procurement policies, business continuity plans and human rights due diligence processes, as well as risks relating to green-washing.
Stakeholder engagement and feedback. Companies must develop an effective stakeholder engagement program to identify potential stakeholders, assess risks, and determine how best to communicate these findings going forward. This should include actively seeking the views of employees, suppliers and other business partners, customers, investors and local communities in order to better understand their sustainability expectations and integrate this feedback into reporting.
Equivalency standards. Based on certain exemptions for subsidiaries of non-EU parent entities, companies should also look at whether their existing disclosures could be considered equivalent to those required under the CSRD. It is worth noting that the current climate change disclosure proposal in the United States is much more narrow in scope (adopting the single materiality perspective), and would appear to be incompatible with the European approach, which requires the double materiality perspective. That being said, because the process for determining equivalence is as yet unclear, there is uncertainty as to how this will apply in practice.
By taking these steps now, companies can begin to prepare for the CSRD requirements and ensure they are ready when the filing dates arrive. With a focused approach to compliance preparation, companies will be better positioned ahead of the deadline and able to leverage reporting as an opportunity for innovation towards building a more sustainable business model. This will ensure that the reporting requirements are not only a tool for stakeholder engagement but also a real tool in the ecological transition.
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