The EU is set to adopt its new Corporate Sustainability Reporting Directive (CSRD) in October 2022, in accordance with the EU Green Deal pledge. In its attempts to expand sustainability information for consumers, the CSRD will revise the existing Non-Financial Reporting Directive (2014) and significantly raise reporting requirements on enterprises falling within its scope. The new directive will also increase the number of companies subject to EU sustainability reporting obligations, including non-European companies. Codo summarizes what you should know about it.
Where does this new rule come from?
The reporting rules under the current Non-Financial Reporting Directive (NFRD, adopted in 2014) were important in establishing principles for large companies’ ESG reporting. It also introduced a “double materiality perspective”, which requires corporations to report on how sustainability issues influence their company, but also their own impact on people and the environment. However, the information that companies reported under this framework was found insufficient and reports would often omit crucial information for investors and other stakeholders’ decisions.
With the CSRD, the European Commission aims to close the accountability gap created by the problems in the quality of reporting under the existing rules on disclosure of non-financial information. It is the first time the Commission defines a common reporting framework for non-financial data.
The CSRD is part of the EU Green Deal Package. The purpose of the Green Deal is to make Europe the first climate-neutral continent by 2050. It is the EU’s response to achieving the targets laid down in the 2015 Paris Agreement. The EU’s action package ‘Fit for 55’ works towards the first step: reducing net emissions by at least 55% by 2030.
What are the new rules?
The CSRD amends the NFRD directive of 2014 in the areas of scope, reporting, standards, and digitalization. It requires more extensive reporting by asking large corporations to report on sustainability issues such as environmental rights (climate change and biodiversity), social rights, human rights, and governance factors.
Regarding environmental factors, the reporting will include the Greenhouse Gas Protocol (disclosing companies’ Scope 1,2 and 3 emissions). In addition, the six environment impact criteria established by the EU Taxonomy Regulation, EU’s classification system for sustainable economic activities, will be covered. The companies will be required to disclose how they substantially contribute to the environmental goals while not damaging any of these six environment impact criteria; climate change mitigation, climate change adaptation, water and marine resources, resource use and circular economy, pollution, biodiversity and ecosystems, respectively.
Aligned with these standards, companies will be required to disclose their sustainability targets and science-based transition plans (if any) that they have established to ensure their business model and strategy are compatible with:
- the transition to a sustainable economy;
- the objectives of limiting global warming to 1.5°C in line with the Paris Agreement; and
- achieving climate neutrality by 2050 in line with the EU’s goals in the European Climate Law, with no or limited overshoot.
In this sense, the CSRD disclosures are broader than the upcoming rules of the US Securities & Exchange Commission. The new directive requires more forward-looking company information, including targets and progress. The CSRD also includes a certification requirement for sustainability reporting, as well as better information accessibility by asking companies to include it in a separate area of corporate management reports (instead of the annual report under the rules of NFRD). Lastly, the reporting is expected to be in line with Sustainable Finance Disclosure Regulation (SFDR), the European regulation introduced to improve transparency in the market for sustainable investment products and to prevent greenwashing.
Who ensures the quality of reporting?
Under the new rules, an accredited independent auditor or certifier must certify reporting and confirm that the sustainability information complies with the certification requirements that have been approved by the EU. The reporting of non-European corporations must also be validated by an accredited auditor.
Who will be covered by the directive?
- Large companies that meet at least two of the three following criteria: 250 employees and/or €40M turnover and/or €20M total assets.
- Non-European Companies generating a net turnover of €150 million in the EU and which have at least one subsidiary or branch in the EU.
- The rules also apply to SMEs listed in the EU. An opt-out will be possible for SMEs during the transitional period, meaning that they will be exempted from the application of the directive until 2028.
In total, CSRD is expected to cover 49,000 companies, a substantially larger number than the 11,600 companies covered by the NFRD.
From what date will the rules apply?
The application of the regulation will take place in three steps:
- 1st January 2024 for companies already subject to the non-financial reporting directive (reports published in 2025)
- 1st January 2025 for large companies (category 1) that are not presently subject to the non-financial reporting directive (reports published in 2026)
- 1st January 2026 for listed SMEs, small and non-complex credit institutions and captive insurance undertakings (reports published in 2027)
How will Japanese companies be impacted?
This directive will have consequences for Japanese companies operating in Europe either as part of the “Non-European Companies” or “Large Companies” segments that are being covered.
Under the CSRD, all EU subsidiaries of non-EU parent companies are considered the same as all other legitimately registered companies in the EU. As a result, provided the qualifications are met, the EU subsidiary of a Japanese parent firm may be classified as a large EU company under category 1. This could be the case of Toyota for instance, considering the size of its Toyota Europe subsidiary.
If a Japanese parent company does not match the description of large companies in category 1, it can still be included in category 2, if conditions are met – at least one subsidiary/branch in Europe and at least €150 million of turnover.
Furthermore, the CSRD retains the subsidiary exemption, which means that a subsidiary is exempted from reporting provided its parent firm reports on a consolidated basis for the group as a whole.
Japanese banks and investors will also be covered even if they issue a small bond that can only be sold to institutional investors in the EU, as long as they fit the criteria. This extended coverage has already stirred some debate among large US banks, upon concerns that if an Asian client of theirs lists a single debt instrument in the EU, it will have to provide pages of audited information about its whole operation.
More information
- Questions and Answers: Corporate Sustainability Reporting Directive proposal (European Commission)
- New rules on corporate sustainability reporting: provisional political agreement between the Council and the European Parliament (Council of the EU, June 2022)
- Proposals for a relevant and dynamic EU sustainability reporting standard setting (EFRAG, February 2021)
Photo credit: Funtap / Getty Images / Creative Commons
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About our insight articles
Codo’s Insights are a series of articles written by our team, on topics that we identify as strategic for our clients and partners. We focus on developments related to corporate environmental sustainability, with the aim of supporting exchanges between Japan and other regions.
This article was written by Ilayda Tenim. It was translated to Japanese by Morgane Benoist and Minami Shinohara.
Codo Advisory is an independent consultancy helping companies in Japan at all stages of their green transformation. Codo’s wide range of services are built upon internationally recognized science-based methodologies. They include climate education, ESG certification advisory, zero-carbon strategy definition and boutique consulting. Codo’s clients are organizations of all sizes and sectors looking to improve their global competitiveness and reduce their climate-related risks.
Codo Advisory is a Japan-based consulting agenc