In last year’s edition of the Finance Dublin Yearbook, I described how the EU was building a comprehensive and legally binding sustainable finance regulatory framework to help it achieve its ambition to become a modern, resource efficient and competitive economy with no net emissions of greenhouse gases by 2050, as articulated by its European Green Deal communication issued in December 2019.

There have been significant developments in the past 12 months as that framework continues to evolve and take shape, none more so than with respect to new sustainability disclosure obligations which are being introduced for companies and financial institutions.

There are a number of reasons why access to better, more reliable and comparable sustainability information is needed, including to make companies more accountable for their impact, to avoid greenwashing, to direct capital to more sustainable companies and investments, to allow investors and lenders to take account of sustainability-related risks and opportunities, and to identify risk which could ultimately become systemic and pose a threat to financial and economic stability.
Although some companies have been making voluntary disclosures for a long time, EU rules on mandatory sustainability reporting are relatively new. The Non-Financial Reporting Directive (NFRD), which amended the Accounting Directive, was adopted less than a decade ago and was only implemented in Ireland in 2017. At the time, NFRD was described as the world’s foremost legislation on corporate transparency.

However, the common consensus now is that it is not fit for purpose due to its narrow scope, the lack of any third party assurance requirement, and the reported information not being sufficiently comparable or reliable in the absence of a common reporting framework.

To address these shortcomings, in early 2020 an initiative was launched to overhaul NFRD and that initiative has now led to the adoption of the Corporate Sustainability Reporting Directive (CSRD), which entered into force in early February 2023 with Member States required to transpose it into domestic legislation by 6 July 2024.

The reporting obligations under CSRD will be introduced on a phased basis. Companies that are already subject to reporting obligations under NFRD will be required to report in 2025 on its financial year commencing on or after 1 January 2024. Other large companies that are not currently subject to NFRD will be required to report in 2026 on its financial year commencing on or after 1 January 2025. SMEs are due to start reporting in 2027 with respect to the financial year commencing on or after 1 January 2026 but can elect to opt-out for a further two years. Finally, in-scope third country undertakings will be required to report in 2029 for financial years commencing on or after 1 January 2028.

Under the new reporting regime being introduced by CSRD, the scope of the reporting obligations will be expanded to a much broader range of companies, including all large companies, and all companies with securities listed on a regulated market (excluding certain smaller companies categorised as micro-undertakings). The sustainability report will have to be contained in the relevant company’s directors’ report which will end the common practice of companies producing separate sustainability reports to house this information. The information will be publicly available, ultimately through a single access point, be digitally tagged and be machine readable.

As part of the enhanced reporting regime, the relevant information will be subject to an assurance requirement, with auditors being required to express an opinion on a limited assurance basis on compliance with the reporting requirements of CSRD with this potentially being upgraded to reasonable assurance in due course if assurance standards are adopted by the European Commission. Most significantly, CSRD introduces a new mandatory sustainability reporting standard which will be adopted by the European Commission by way of delegated regulations under CSRD.

Ultimately, the aim is to ensure that the information disclosed is understandable, relevant, verifiable, and comparable and presented in a faithful manner. The standards are required to take into account the information required to be reported under other European legislation such as the Sustainable Finance Disclosure Regulation, as well as the work of global standard-setting initiatives for sustainability reporting.

CSRD envisages simplified standards being produced for listed SMEs that are subject to the reporting obligations or for other SMEs that want to report on a voluntary basis.

In November 2022, the European Financial Reporting Advisory Group (EFRAG) announced the submission of the first set of draft European Sustainability Reporting Standards (ESRS) to the European Commission. EFRAG is a technical adviser to the European Commission under CSRD and assists the European Commission in producing and periodically reviewing the standards.

The draft ESRS contain 82 disclosure requirements and are comprised in cross-cutting standards (meaning they apply to all sustainability matters) and topical standards (covering specific sustainability topics such as climate change, biodiversity, employees and so on). The draft ESRS include sector-agnostic and sector-specific disclosure requirements and also provide for entity-specific disclosures to be made by companies where they conclude that an impact, risk or opportunity not covered or covered with insufficient granularity by an ESRS is material due to its specific facts and circumstances. In the course of developing these draft ESRS, EFRAG has engaged with other global standard setters, including the International Sustainability Standards Board (ISSB), to maximise interoperability of their standards and to avoid double-reporting by companies across different reporting frameworks.

In particular, as drafted, ESRS will require companies to publish detailed information on, amongst other things, their direct and indirect greenhouse gas emissions (Scopes 1, 2 and 3), their energy consumption, their levels of pollution of air, water and soil, its water consumption, and their impact on biodiversity and ecosystems. They will also have to report on social matters such as its gender distribution at top management, work-related injuries and fatalities, the entitlement to and use of family leave. Reporting obligations will also extend to workers in its value chain, its affected communities and its consumers and end-users, including its processes for engaging with such workers, communities, consumers and end-users, and remediating negative impacts. Disclosures will also be required on matters relating to business conduct, including on corporate culture, the management of relationships with suppliers, its payment practices (with an emphasis on how these impact SMEs), any political lobbying activities, and its systems to prevent and detect corruption and bribery.

The impact of this new approach to reporting is going to be profound. CSRD, when taken together with other EU disclosure obligations such as under the Taxonomy Regulation which require companies to provide information on how ‘taxonomy-aligned’ their economic activities are by reference to detailed technical screening criteria adopted by the European Commission, and SFDR which imposes incredibly detailed and granular reporting requirements on financial market participants and financial advisers in respect of their financial products and processes, will enable the production of league tables, benchmarks and sectoral comparisons all based on reliable, publicly available information. Banks are also subject to additional disclosure obligations under the applicable EU prudential framework, including an obligation to produce an extended banking book taxonomy alignment ratio (extending their reporting requirements under the Taxonomy Regulation to produce a more limited green asset ratio) and also covering disclosures on ESG risks, climate change transition risk, and climate change physical risk.

These disclosures will drive behaviour. Consider a company releasing its results showing increased profits but also disclosing that its emissions are increasing, that it is polluting local rivers, destroying natural habitats, exploiting its workforce or benefiting from the exploitation of workers in its value chain. Companies in that position will be less attractive to investment managers trying to pick so-called Article 8 and Article 9 investments based on the criteria set out in SFDR. The same picture emerges when you consider it from the perspective of a bank which will be incentivised by its own disclosures under CSRD, the Taxonomy Regulation and its prudential disclosures to lend to more sustainable businesses as its own investors and regulators look to assess its own sustainability credentials and the bank’s own exposure to ESG risks.

And then, of course, we must consider the reaction of consumers, suppliers, employees, broader civil society, regulators, and policy makers, where the publication of negative sustainability information, at a time of increased concern about the climate catastrophe, habitat loss, cost of living crisis and so on, can have a hugely detrimental impact on business and ultimately call into question a company’s social licence to operate.

This is why sustainability reporting is about much more than simply collecting the information and compiling the reports themselves, although that will require extensive internal coordination and robust processes to be put in place. Companies should take the opportunity presented by reporting to review their operations and to implement any necessary reforms or take measures to improve their performance from a sustainability perspective to enable them to present themselves in the best possible light once the mandatory reporting obligations come into effect.

Of course, it goes without saying that disclosure on sustainability matters is only one part of a much larger project that is underway to retrofit our economies and societies to make them fit for the monumental challenges we face – at EU level through the implementation of the Fit for 55 package of measures and domestically through the implementation of Government policies such as those referred to in the most recent Climate Action Plan 2023. Measures to be adopted relating to carbon pricing (making it more expensive to carry on carbon-intensive activities), tighter standards and regulations (which will drive higher standards in sectors such as real estate and transport), more stringent procedural rules (such as those proposed by the EU’s proposal for a Corporate Sustainability Due Diligence Directive) and the development of green and sustainable financial products are also designed to direct businesses onto a more sustainable pathway.

Time is running out to avoid the worst effects of climate breakdown and biodiversity loss and so expect the pace of change demanded of companies on these and other sustainability matters to continue to increase.