The Corporate Sustainability Reporting Directive (CSRD) - New Changes and Responsibilities Coming for Companies
Am 8. Juli 2022 hat Jake Drucker (Student an der Unversity of Pennsylvania Law School) einen Vortrag zu den Neuerungen betreffend Nachhaltigkeitsberichterstattung von Unternehmen in unserer Kanzlei gehalten. Das Thema Corporate Sustainability Reporting ist aufgrund des derzeit vorliegenden Richtlinienentwurfs auf europäischer Ebene für zahlreiche Unternehmen sehr praxisrelevant. Der nachfolgende Beitrag gibt einen Überblick über den aktuellen Stand der Richtliniengebung und gibt auch einen Ausblick auf das US-amerikanische Reporting System.
On 21 April 2021 the European Commission set forth a Sustainable Financial Package, lauded by the commission itself as an "ambitious and comprehensive" initiative that would aid in strategically directing financial resources toward matters of sustainability within the European Union (European Commission, pp. 1). Included in the proposal is the Corporate Sustainability Reporting Directive (CSRD) that has the potential to place new and immensely notable reporting responsibilities on EU-based companies within the realm of sustainability. While in its current state the CSRD is still in the mere proposal stage, by the end of June 2022 the European Financial Reporting Advisory Group will submit to the commission its drafted standards of company reporting, which will be prospectively followed in October 2022 by an official commission adoption of such related standards (Bernoville, pp. 16). By the end of 2022, the EU member states would be obligated to uniquely implement the CSRD into their respective national legal systems, and by 2024 qualifying companies would be required to compile reports regarding their personal sustainability data in compliance with the prospective CSRD commission directive, in relation to fiscal year 2023 (Bernoville, pp. 16). Likewise, if the directive does in fact successfully come to fruition, by fiscal year 2027 the scope of the CSRD will potentially expand even more dramatically to a far wider range of applicable companies (Bernoville, pp. 16). From a foundational perspective of law, this proposed new directive makes explicit that its ‘‘legal basis rests on Articles 50 and 114 of the Treaty on the Functioning of the European Union (TFEU), as Article 50 of the TFEU is the legal basis for adopting EU measures aimed at attaining the right of establishment in the single market in company law…. Article 114 of the TFEU is a general legal act with the objective of establishing or ensuring the functioning of the single market – in this case, the free movement of capital’’ (CSRD, p. 20).
Major Expansion to Regulatory Scope
It is of considerable note that the changes in requirements brought by the CSRD do not relieve obligations owed from earlier regulations such as the Non-Financial Reporting Directive (NFRD), but rather the new directive serves to add to, expand and supplement the previously applicable regulatory framework(s) (European Commision, pp. 7). Whereas the NFRD is generally applied to large entities that deal in the public interest that maintain more than 500 employees, the CSRD's criteria for compulsory compliance is far more inclusive. Accordingly, under this new amending directive companies meeting just 2 of the following 3 factors would be subject to such regulation: (1) more than 250 employees; (2) €40 million in (balance sheet) turnover; and (3) €20 million in overall assets (Bernoville, pp. 7 ). Additionally, as the proposal currently stands any EU-regulated index listed companies would likewise be subject to automatic compliance within the CSRD, regardless if they are EU-based, or not (CSRD, p. 10). However, the amending directive creates an exemption carveout for "micro enterprises," defined as companies with either less than 10 employees or maintaining less than €20 million in annual turnover, even if said firms are EU index-listed (Bernoville, pp. 7 ). The increase in companies that would fall under the new reporting requirements of the CSRD is rather immense. Whereas the NFRD framework subjected about 11,600 EU-based companies to its respective regulations (European Commision, pp. 6), the CSRD would dramatically raise this number to approximately 49,000 companies with about 15% of said firms being located within Germany, which is naturally of particular note to Austrian-based firms, companies and overall interests (Bernoville, pp. 7).
New Requirements at a Glance
Currently, the NFRD maintains a reporting framework that covers five key areas: (1) Environmental Protection; (2) Overall Employee Conditions; (3) Human Rights, (4) Firm Diversity; and (5) Initiatives to Combat Corrupt Behaviors and Actions (CSRD, p. 23). Moreover, for each of these areas companies must explain their respective (a) outcomes; (b) policies; (c) possible liabilities and risks; and (d) key performance indicators (CSRD, p. 23). Supplementally, the CSRD would expand these basic facets to include more forward-looking and future-oriented targets to be pegged and ultimately met, and standardizes the reporting format to be symmetrically aligned with both the European Union Taxonomy Regulation, as well as the Sustainable Finance Disclosure Regulation (SFDR) regimes, respectively (CSRD, p. 4, 5). According straightforwardly to the amending directive:‘‘The objective of this proposal is therefore to improve sustainability reporting at the least possible cost, in order to better harness the potential of the European single market to contribute to the transition towards a fully sustainable and inclusive economic and financial system in accordance with the European Green Deal and the UN Sustainable Development Goals’’ (CSRD, p. 3). As a hallmark, new requirements of the directive would force companies to publish data on what has been coined the ‘‘Double Materiality Concept,’’ presenting not only environmental factors affecting the company, but also inversely the company’s effect on the environment and on social issues more generally (CSRD, p. 1, 8, 13, 28, 30, 31).
Another majorly important prospective change with the CSRD is regarding the third party audit of all reported company information and data in compliance with the regulation. Currently, under the NFRD there is virtually zero requirement to have any reported data scrutinized or even partly reviewed for accuracy by an impartial auditor. However, this would be of paradigmatic change under the CSRD framework. In accordance with the new directive, a third party audit report would become absolutely compulsory in order to ensure and guarantee genuine and reliable company compliance (CSRD, p. 4). With regard to formatting, the CSRD would also change the NFRD requirement of PDF formatting into an online digital machine XHTML format within the same strictures of the general ESEF regulations (CSRD, p. 35). This, again is in the full spirit of enhanced and streamlined uniformity among EU reporting regulations.
CSRD Compared to United States Reporting Frameworks on Sustainability
To fully understand why certain things look the way that they do in the United States, it is vital to grasp the U.S. constitutional system of "Dual Sovereignty" Federalism. Under this system, the national (federal) government is in a power-sharing relationship with the 50 several state governments. The lawmaking branch of the U.S. national government can only pass regulations for the country as a whole through a very limited set of avenues, and regularly faces legal pushback from the state governments even when they modestly venture to do so (U.S. Government, pp. 1). Additionally, the political environment within the United States is currently at a polarized high creating a gridlocked paralyzing effect on the national government's ability to attempt even semi-sweeping regulatory legislation. Finally, and as also attributable to this political polarization, the national electorate tends to elect a President from the opposite political party every 1 to 2 election cycles which has presented a situation wherein a newly elected administration can unilaterally decide to undo and reverse course on many of their predecessor's executive regulations. Because of this uniquely American style of governance, examining individual state sustainability regulatory frameworks in addition to the centralized national regulations of the U.S. federal government becomes absolutely necessary (U.S. Government, pp. 2).
However, EU-based companies subject to the regulatory requirements of the impending CSRD, and especially those of which have business dealings, investments or partner subsidiaries within the United States would be best advised to understand the dynamic of sustainability reporting in the country. At present, sustainability reporting for American corporations largely takes the shape of a market oriented response to the demands of shareholders and stakeholders, which is a very typical laissez-faire feature of the country (Alqaseer, et al., pp. 1). In fact, according to a study conducted by the Harvard Law School Forum on Corporate Governance, it was found that in 76% of these voluntary sustainability reports companies fashioned their briefings as a press release with pictures and quotes from the company CEO (Alqaseer, et al., pp. 23), and in a notable 96% of cases the CEO went as far as to write an entire letter to current and prospective shareholders regarding the report (Alqaseer, et al., pp. 28). Moreover, the study also noted that more than 75% of these reports plotted their sustainability data on easily digestible and almost oversimplified graphics and tables, done so very purposefully so that layman investors can absorb the information with relative ease and convenience (Alqaseer, et al., pp. 27). Prominently, it has become a common practice in the U.S. for companies to utilize, what the study calls, the "Materiality Matrix" that highlights specifically which areas of sustainability are most important and prioritized by the firm and their investors - which again - is driven foremostly by the interests of the latter (Alqaseer, et al., pp. 33). In 93% of cases, the study found that American companies will publicly disclose the diversity data as reported to the Equal Employment Opportunity federal agency, which is extremely valuable data for an EU-based company subject to the new directive that also maintains American business ties (Alqaseer, et al., pp. 35). Moving forward, this Harvard study predicts that the utilization of third party auditing of sustainability reported data will play an ever increasing role (Alqaseer, et al., pp. 43). Most recently, in 2021 it was found that 53% of American company reports used "at least some degree of external assurance," but similar to sustainability reporting in the United States as a general whole, there is a major lack of uniformity in how the framework of third party data information reviews are conducted by external private agencies (Alqaseer, et al., pp. 43). Since in many cases the company itself is funding the external reviewing agent for their service, reasonable concerns can certainly arise regarding legitimacy and undue influential pressure with respect to true and unbiased accuracy.
As a company subject to the new prospective CSRD directive with U.S. investments or business connections, it is evident that the lack of required sustainability reporting from American firms can make streamlined efficiency and uniformity of required compliance rather difficult. However, and as aforementioned, since the United States is a power-sharing system of government the several 50 American states have a relatively wide range of independence in how they govern their jurisdictions, and as such EU-based firms can extrapolate useful information based on which state a particular U.S. firm or subsidiary operates within. For example, the west coast American state of California has the strictest environmental regulations in the entire country, with air pollution standards for automobile emissions even harsher and more restrictive than the United States federal government (Hubbard, pp. 2). The state of California represents 20% of the entire U.S. economy, which is about equivalent to the economic size of Germany, and so the sustainability regulations that California imposes can, and do in fact have indirect but massive impacts on the nation as a whole. According to the U.S. News World Report publication, following California, ranking in respective order as the most heavily regulated states in America are: (2) New York, (3) Ohio, (4) Illinois, (5) Texas, (6) Oregon, (7) Washington, (8) Florida, (9) Massachusetts, and (10) Louisiana. (Alaska, Arkansas, Connecticut, Hawaii, New Jersey and Vermont were excluded from said report based on insufficient public data.) (Hubbard, pp. 11).
By the end of 2022, when the CSRD is prospectively set to become a finalized and binding directive imposed upon the EU member states and their applicable companies, it is very possible that it will ultimately present with very limited changes to its current proposed form. On the other hand, it is also a realistic possibility that after going through the bureaucratic review and adoption process, it will eventually look quite different - only time will tell. In the short term, factors stemming from the Russia/Ukraine conflict will undoubtedly play an influential role in the directive’s end product, and from more than one of the NFRD’s core reporting frameworks. How an EU-based company, subsidiary or index listee interacts either directly or indirectly with the Russian state or Russian business interests may very conceivably make its way into the final directive as the review and adoption timeline develops. Areas such as; Environmental Protection, Human Rights, and Initiatives to Combat Corrupt Behaviors and Actions could easily be incorporated into the directive through the lens of Russian dealings, and so this is a serious aspect that companies should concern themselves with as long as the conflict persists.
Likewise, companies who would presently meet the qualifying standards of subjection to the prospective CSRD in 2024 to issue a report on their 2023 data would be best advised to anticipatorily assume that the directive will go into binding effect upon them ‘as is,’ and in its sharpest form. As such, these companies should take the appropriate steps now to begin collecting sustainability data in the forthcoming year(s) to come. Starting now to think about what company sustainability targets are realistic for the unique aspects of one’s firm in the future would be a prudent, practical and necessary step forward, as well. The specific consequences for noncompliance with the CSRD have not yet been definitively articulated by EU and Commission officials, but it is safe to assume that such penalties would be harsh and burdensome. As we move forward from the acute phase of the pandemic, the European Union continues to make forward-thinking preparation efforts a top priority in many different aspects. The CSRD is a manifestation of just one of these priorities, but as presented above, it possesses the potential to cast major implications on a vast range of companies throughout the EU. As is the case in everything, it is best advised to be over prepared and fully ready to organize the necessary components of one’s business accordingly in order to ensure lawful compliance moving forward.
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