Written by: Selin Akdemir
Date: 13/11/23
Data is one of the most important tools in the world. Companies, conglomerates, governments, international organisations, and individuals alike, all rely on data when making decisions. For this reason, it is indisputable that to deal with the climate crisis and ensure businesses are being steered towards creating a net-zero economy, significant amounts of data are needed. This is why countries around the world are introducing mandatory reporting standards. Compiling standardised and transparent data would help guide companies themselves with their transition, while also informing investors and consumers how to deal with such issues. The focus of this article is on the Corporate Sustainability Reporting Directive (CSRD) in the European Union. As this is applicable to multiple countries, there have been attempts to block the adoption of such law, warranting special attention and making recent headlines. The European Commission has successfully defeated these attempts, showing that we need to start prioritising climate change if we are to create a net-zero economy.
History of the CSRD
In 2019 the European Commission presented the Green Deal, which is a roadmap to making Europe the first climate-neutral continent by 2050 (1). In line with this commitment, the CSRD was adopted in 2021. Unlike its predecessor, the Non-Financial Reporting Directive (NFRD), the CSRD applies to more companies and has higher reporting requirements. The exact criteria by which companies should report on, in terms of water use, pollution, or the impact on local communities, was set out in July 2023 by the European Commission in the European Sustainability Reporting Standards (ESRS) (2).
The CSRD will impose obligations in a phased manner. Initially, it will require listed companies to comply with the requirements by 2024, but this will expand to large non-listed companies, as well as listed small and medium enterprises in 2025 and 2026. In the end it will apply to around 50,000 companies, compared to the NFRD which applies to only 11,700 companies (3). There are two important features of the CSRD that distinguish it from reporting requirements in other countries, in that it imposes a double materiality standard, while also being aligned with the EU taxonomy.
Double materiality
A distinctive feature of the CSRD is that it adopts a double materiality assessment. This approach was first introduced by France in 2015, yet has still not been adopted by the UK. Normally, companies need to disclose risks which climate change poses to their business. This is called single materiality. Risks usually fall within one of three categories (4). The first are physical risks, which are risks of direct damage, for instance by extreme weather events. These lead to lower asset values, defaults on loans, and increased insurance claims. The second category is transition risks, entailing risks of disruption caused by the adjustment to a low-carbon economy, such as the results of policy changes. This can lead to impacts on pricing and demand, as well as supply chain disruption. The final category, which until recently was not taken as seriously, is liability risks. This is a risk that companies will be liable for if not considering or responding to the impacts of climate change, leading to penalties and business disruption. Liability risks are as important as the other two types of risks, as was confirmed by the 2021 decision in Milieudefensie v Shell Plc, considered to be the first significant climate change litigation ruling against a corporation.
The CSRD goes beyond this single materiality assessment. It not only requires companies to disclose risks to their business, but also the risks that the business itself may pose to the environment. This is very significant and sets the EU apart from countries like the UK or the US.
EU taxonomy alignment
An important feature of the CSRD is that it is aligned with the EU taxonomy. A taxonomy gives an agreed definition of economic activities, meaning there is a common language across the investment chain. The fact that the CSRD is aligned with the EU taxonomy means the data it achieves will be easily comparable throughout all countries. Accordingly, investors will be able to compare different companies and decide on those which pose a smaller risk to climate change and have a lesser impact on the environment.
Oppositions to the CSRD
Before the reporting obligations are put in effect in January 2024, countries have been trying to oppose the CSRD or at least limit its scope. Opposition has been held on the basis that the red tape imposed by the CSRD will prevent companies in the EU from competing with companies elsewhere.
The first major attempt took place by Germany in September of this year, but it was defeated (5). Under the CSRD small and medium-sized countries are defined as companies with 250 employees, and they need to start reporting in 2026. Germany tried to change this definition to companies with 500 employees. If successful, this change would have exempted 8,000 companies from the reporting rules, however, it was not adopted. The second attempt took place just last month in October, when 44 right-wing and liberal MEPs tried to block the adoption of the ESRS (6). The lawmakers tried to reject the standards, which had already been loosened in the drafting stage on the grounds that they were “complex and of a high quantity.” The attempt was rejected. However, had it not been, there would be a very difficult situation as companies would be left in an uncertain position, not knowing how to apply the new financial reporting rules.
These attempts show the worries that are arising as these rules are becoming a reality. The costs and time associated with complying may, as feared, place a burden on companies that hurts their ability to stay competitive. Nevertheless, it is a necessary step if the EU is to meet its goals under the Green Deal.
Overall, the CSRD is just one example of sustainability disclosure rules being introduced across the world, as a means of encouraging companies to transition into compiling data about the risks climate change poses to business and the damages of economic activities to the environment. It is aimed that such information will lead companies to take climate risks seriously and adjust their economic activities accordingly. This will allow the world to transition to net-zero without a need for complete interventionist regulation.
Citations
(1) The European Green Deal, https://commission.europa.eu/strategy-and-policy/priorities-2019-2024/european-green-deal_en, accessed 11 November 2023.
(2) CSRD: European Commission adopts first set of the European Sustainability Reporting Standards (ESRS), Linklaters,
https://sustainablefutures.linklaters.com/post/102ilcl/csrd-european-commission-adopts-first-set-of-the-european-sustainability-reporti, accessed 11 November 2023.
(3) Corporate Sustainability Reporting Directive, KPMG, https://kpmg.com/nl/en/home/topics/environmental-social-governance/corporate-sustainability-reporting-directive.html#:~:text=The%20Corporate%20Sustainability%20Reporting%20Directive%20(CSRD)%20requires%20companies%20to%20report,(assurance)%20of%20reported%20information., accessed 11 November 2023.
(4) APRA releases guidance on managing the financial risks of climate change , Australian Prudential Regulation Authority, https://www.apra.gov.au/news-and-publications/apra-releases-guidance-on-managing-financial-risks-of-climate-change, accessed 11 November 2023.
(5) Alice Hancock, Germany pushes to exempt SMEs from green reporting rules, Financial Times, https://www.ft.com/content/4c533c07-a5ae-402d-8c1d-80c2ea416970, accessed 11 November 2023.
(6) Alice Hancock, More than 50,000 companies to report climate impact in EU after pushback fails, Financial Times, https://www.ft.com/content/a3216188-8e50-4a62-a8d9-e89172b3ddc7, accessed 11 November 2023.
(7) EU CSRD: Attempt by European Parliament to block first set of ESRS fails, Linklaters,
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