The EU’s move comes at the same time as growing global attention to sustainability reporting in the run-up to COP26. 

Since 2018, EU rules have required large entities to include a non-financial statement as part of their annual reporting obligations. Responding to growing demands for enhanced non-financial information from multiple quarters – and following a large stakeholder consultation – the Commission has now adopted far-reaching legislative proposals to review its existing Non-Financial Reporting Directive (NFRD) and improve the flow, comparability and reliability of sustainability information.

The proposed Corporate Sustainability Reporting Directive (CSRD) seeks to mandate sustainability reporting and assurance by amending several EU laws, including the Accounting Directive, Transparency Directive, and Audit Directive. As the Commission makes clear, the ultimate aim is over time to “bring sustainability reporting on a par with financial reporting.”

Extended scope

The proposals significantly enhance the scope of the existing NFRD rules to cover all large undertakings as well as all those listed on EU regulated markets, with the exception of micro-entities. This includes EU subsidiaries of non-EU undertakings and any non-EU entity with transferable securities listed on a regulated market in the EU. An exemption is foreseen for those companies within groups where the parent complies with the legislation. Listed SMEs would also be granted an additional three-year phasing-in period to comply with the new requirements.

The Commission estimates that this would increase the number of entities required to make sustainability disclosures from around 11,600 to approximately 49,000, at an estimated price tag of €1.2bn in one-off costs and €3.6bn in annual recurring costs – although the increased standardisation may deliver €1.2bn to €2bn savings per year by eliminated other information demands on preparers.

New disclosure requirements

Compared to the NFRD, the CRSD sets out in far greater detail the information that entities should report, covering their whole value chain. Specifically, the Commission proposes that the mandatory disclosures should provide descriptions of:

• Business model and strategy, including plans and implementation
• Sustainability targets, and progress towards achieving them
• Role of the boards
• Policies in relation to sustainability factors
• Due diligence processes for own operations and supply chain
• Principal risks and dependencies
• Indicators relevant for measuring the above
• Intangibles, including intellectual, human, social and relationship capital
• Process carried out to identify the information disclosed.

Such disclosures should be qualitative as well as quantitative, providing both forward-looking and retrospective information according to short, medium and long-term horizons, as appropriate. 

While retaining the existing ‘double-materiality’ approach, the proposals seek to remove any ambiguities about the fact that entities should report information necessary to understand how sustainability factors impact them – as well as the information needed to understand their impact on society and the environment.

The legislative proposals provide for sustainability information to be published as part of the management report in a digital, machine-readable format. This will require eventual sustainability standards to be accompanied by a digital taxonomy to enable information to be tagged.

Towards European sustainability reporting standards

As widely anticipated, the proposals introduce mandated EU sustainability standards, to be prepared by the European Financial Reporting Advisory Group (EFRAG) and adopted via secondary legislation. The standards should be based on the recommendations recently made by the EFRAG Task Force on Non-Financial Reporting Standards, with a first set of standards due for adoption by 31 October 2022, followed by a second set a year later. A three-year review process is suggested.

Information required by the standards must be understandable, relevant, a faithful representation, verifiable and comparable. Three key subject matters are proposed: 

• Environmental factors, including climate change mitigation, climate change adaptation, water and marine resources, resource use and circular economy, pollution, biodiversity and ecosystems.
• Social factors, including equal opportunities and access to the labour market, working conditions and human rights.
• Governance factors, including the role of management and board, business ethics and corporate culture, political engagements, relationships with business partners, internal control and risk management systems.

The development of such standards should take account of existing sustainability reporting and accounting standards and frameworks, as well as internationally recognised principles on responsible business conduct, CSR and sustainable development. Insofar as possible, the development of standards should be based on constructive, two-way cooperation with leading international initiatives. 

The international dimension

Acknowledging the number of international initiatives currently seeking to foster convergence of sustainability reporting standards, the Commission reiterates EU support for such ambitions, which would benefit EU companies and investors operating globally. Under this prism, a more coherent European approach to sustainability reporting will ensure a stronger European voice in global developments to advance the interests of European entities and stakeholders.

A voluntary approach towards SMEs

While SMEs not listed on EU regulated markets are exempt from the requirements of the draft legal rules, the Commission proposes the development by October 2023 of proportionate standards for SMEs to use on a voluntary basis. It is thought that such standards, which could also be used by listed SMEs within the scope of the proposals, would enable SMEs to respond in a cost-efficient way to the requests for information received from other entities including those in their supply chain as well as banks and insurers. In a kind of ‘one-stop-shop’, this would also set a reference for other entities on the information that they could reasonably expect to ask of SMEs.

Mandatory sustainability assurance

A key pillar of the proposals is a new limited assurance requirement, to evolve towards reasonable assurance once capacity has been built up. Assurance engagements would be based on standards adopted by the Commission by delegated acts, although EU countries could apply national assurance standards if no equivalent standard has been adopted by the Commission. 

The assurance should cover the period of the report, the sustainability reporting framework and standards used, the scope of assurance and the sustainability assurance standards applied. The opinion should be published together with the annual financial statements and management report. 

While EU countries are given the option to accredit independent assurance service providers, there is an acknowledgement that the service is most likely to be provided by the audit profession. To enable this to happen, changes to EU audit rules are proposed to ensure that statutory auditors have the necessary level of relevant theoretical knowledge both via the examination of professional competence and ongoing professional development. 

Additional changes address rules relating to the organisation of the auditors’ work, fees, independence requirements, quality assurance, investigations, oversight, appointment of the auditor, role of the audit committee and registration of third-country auditors.

The draft legal text also sets out to update existing provisions relating to the collective responsibility of the administrative, management and supervisory bodies to ensure alignment with the new sustainability reporting requirements.

What happens next?

The legislative proposals will now be scrutinised and amended by both the European Parliament and the Council before a final legal text is adopted. While the negotiation process will take months, there is strong political momentum to reach an agreement rapidly. 

If a final legislative text is adopted in the first half of 2022, and a first set of standards adopted by the end of 2022, the new requirements would start to apply in part for reports published in 2024, covering the financial year 2023. Full disclosures would be required from January 2026.

Further coverage of the EU’s proposals will appear on ICAEW Insights and in the ICAEW Daily email. You can sign up for the email by clicking the ‘Daily’ option in your preference centre.

Further resources:

• Read the full proposals
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• ICAEW’s Improving Corporate Reporting hub