Holding business accountable for people & planet: the CSRD directive
By Jorge Alarcón Martín
Stone Soup Associate Consultant
November 16th 2022
After years of work the European Parliament approved last Thursday the Corporate Sustainability Reporting Directive (CSRD). What is at stake with this new piece of legislation?
First, CSRD replaces the former Non-Financial Reporting Directive (NFRD), enlarging its scope both in terms of organisations obliged by the norm and the breadth and depth of the sustainability issues to report on. Specifically, CSRD will bind approximately 50,000 companies across the EU, compared to the 11,000 companies covered by current legislation. Companies forced to engage in the reporting exercise as per CSRD encompass: large companies of a certain size (whether publicly-listed or not), SMEs with certain products or services listed in public markets, the banking and insurance sector, as well as any company deemed of “public interest” by the relevant authority. Examples of themes on which organisations will now have to disclose include: environmental impact, Human Rights, corruption and anti-bribery policies or employee wellbeing.
What makes CSRD stand out is how it places on equal footing financial and non-financial reporting. Conveniently, CSRD also enacts the obligation of ensuring digital access to all the sustainability information that is disclosed. The relevance of CSRD also comes from the comprehensive process of public consultations and the wide scope of the organisations involved in the making of the rule, including notably ESMA (European Securities and Markets Authority) and EBA (European Banking Authority), among others.
Two complementary and reinforcing mechanisms for CSRD
A crucial milestone for CSRD is how, besides the reporting obligation in itself, it includes two complementary and reinforcing mechanisms that strengthen the reporting exercise for the sake of transparency, uniformity and accountability. These two concern a set of reporting standards on the one hand, and the necessity for independent auditing and certification on the other.
- The inclusion of a specific set of corporate sustainability reporting standards will instrumentalise the disclosure of information. Thus, the standards are intended to provide a common language that will make corporations more accountable for their impacts on people and planet. These standards are being developed by EFRAG, the European Financial Reporting Advisory Group, a private association which acts as an expert body advising the European Commission. In fact, on 15th November EFRAG adopted a first set of draft standards submitted to the European Commission, which contribute to internal alignment with CSRD and the Taxonomy, but also international alignment and interoperability with the International Sustainability Standards Board (ISSB) and the Global Reporting Initiative (GRI).
- The auditing and certification obligation is a crucial lever to prevent greenwashing and impact washing, ensuring that the impacts, whether positive or negative, that companies report having on people and planet are truthful and accurate via third party verification.
CSRD: the last link in EU legislation?
In a way, CSRD has become the “missing link” of EU sustainability legislation. Its predecessor NFRD was adopted in 2014, and already established corporate sustainability reporting obligations for business organisations of certain characteristics. In 2018, the EU adopted a Plan of Action for Sustainable Finance that already expressed a commitment to promote sustainable finance and bring capital into sustainable activities and outcomes.
Then came SFDR (Sustainable Finance Disclosure Regulation) which, since 2020, has established a distinction of 3 types of sustainability-focused financial products and services. In complementarity to this classification of financial products according to their sustainability goals, SFDR includes an obligation of sustainability reporting for financial market participants and the integration of ESG factors into their risk management practice. In 2021, the European Green Deal came into force, as the overarching legislation that clearly charts the path towards a “modern, resource-efficient and competitive economy.” Also in 2021, the Taxonomy started to work as two of its six environmental objectives were approved.
The Taxonomy essentially emerges from the realisation that, in order to bring finance into sustainable activities and bridge the widely-acknowledged funding gap, a common language that clearly defined what is “sustainable” was urgently needed.
Now, CSRD complements all the previous legislation with its corporate sustainability reporting obligation, reinforced by the accompanying standards and the necessity for independent auditing. The symbiosis between SFRD, the Taxonomy and CSRD is expected to unlock finance for the accomplishment of the EU’s sustainability goals.
To be precise, SFDR is designed to facilitate investors the endeavour of distinguishing between different sustainable investment products and services. Now, CSRD and its corporate sustainability reporting requirements will enable financial actors to utilize transparent, comparable, verified and standardised information about the sustainability of the activities of the companies they finance. In addition, the Taxonomy unmistakably determines what a “sustainable activity is”, in such a way that any organisation claiming to be sustainable and aligned with the Taxonomy will necessarily report the information to prove such claim via CSRD requirements and its accompanying standards.
CSRD & double materiality
Interestingly, a unique feature that sets apart the European framework is how it enshrines the key concept of “double materiality”. Materiality refers to the quality of being relevant and significant for a specific purpose. In the impact and sustainability jargon, it implies the inclusion of non-financial information as “materially relevant” in financial analysis and decision-making. Now, materiality becomes double when it considers not only what would be materially relevant for an investor or from a financial standpoint, but also all what would be materially relevant by and for anyone affected by an activity. In other words, materiality becomes double inasmuch as it combines the so-called “outside-in” approach (considering the effects of external ESG factors onto the organisation), with an “inside-out” approach (considering the effects of the organisation itself and its activities on its external stakeholders, on people & planet). The Taxonomy with its distinction of what counts as sustainable, and SFDR and CSRD with their classification and reporting requirements, all draw essential inspiration from this double-materiality conceptualization.
Leading by example
Thus, with CSRD, SFDR and the Taxonomy working in deep integration and complementarity, the EU expects to galvanize investment into its sustainability objectives. Yet, the effects would resound much further, as it is expected that the new rules and standards will consolidate the EU’s leadership in sustainability and lead by example at the international level. Complementary initiatives on sustainability disclosures elsewhere, notably, the international efforts of ISSB and those of the Securities and Exchange Commission (SEC) in the USA, will likely lean on the EU’s vanguard work.
At Stone Soup, we closely follow and take interest in the key milestones charting the path for the sustainability journey of organisations. In fact, Stone Soup is part of EsImpact (the Spanish professional association of social impact measurement and management) and its working group on standards, and have produced a report on the subject. This publication on sustainability and impact standards both from a reporting and impact measurement perspective, will be launched next 24th November in an event in Madrid hosted by the Comillas Chair of Social Impact.
We welcome the EU’s efforts to make business more accountable for their effects on people and planet. As a consultancy with a social heart, Stone Soup and its community of consultants will continue to implement projects that deliver positive impact and contribute to solutions to society’s challenges.