Unification of European non-financial disclosure obligations: what consequences for your non financial statement?

Europe is working towards a capital markets union with three main objectives:

1. Overcoming the fragmentation of national markets for financial services,
2. Making the continent more attractive to investors,
3. Promote access to finance for small businesses.

Climate change poses a systemic risk to the global and European economies and requires massive investments. It poses a threat to the achievement of European objectives.

In order to respond to these economic and financial challenges, the European Commission launched its action plan for “Financing Sustainable Growth” in 2018.

One of its first measures was to improve the disclosure of sustainability information by companies. Why? To inform investor decision-making and redirect financial flows towards more sustainability. The Non-Financial Reporting Directive (NFRD) adopted in 2014 introduced mandatory non-financial reporting for around 11,700 European companies.

Investors have a growing need for ESG information. This data is not sufficiently reliable, relevant and comparable, mainly due to a legal framework that is considered insufficient.

Indeed, the mismatch between the sustainability-related information published by companies and the needs of the users for whom it is intended is due to a lack of precision in the current reporting requirements. With so many standards and private frameworks in place, companies are still unaware of exactly what information they need to report.

The European Union wishes to reduce the margin of interpretation for companies, “at a lower cost”, by defining precise and standardised indicators at both European and global level. To this end, EFRAG, the European Commission’s Financial Reporting Advisory Group, has been tasked with establishing standardised ESG standards based on the work of various working groups such as the International Sustainability Standards Board (ISSB), which is part of the IFRS Foundation, and recognised initiatives such as the Global Reporting Initiative (GRI), CDP*, CDSB* and IIRC*.

The future CSRD will be a clarification of companies’ ESG disclosure obligations, in particular in line with the information that financial market participants need to meet their own disclosure obligations.

On 21 April 2021, the European Commission published a proposal for a Corporate Sustainability Reporting Directive (CSRD) to strengthen the European Union’s sustainability objectives. It will replace the NFRD. Together with the Green Taxonomy and the Sustainable Finance Disclosure Regulation (SFDR), this revision constitutes one of the pillars of the European green growth strategy and the Green Deal, which sets the European Union’s carbon neutrality target for 2050. Indeed, transparency on the environmental and social consequences of economic activities is a prerequisite to initiate their transformation.

The CSRD is a directive for companies, a deepening of the integration of ESG criteria into their management. It expands the requirements of the NFRD by applying them to all large and listed companies, while improving the quality of information on the sustainability risks they face and their own impact on people and the environment.

Its legislative process, currently underway, is expected to come into effect from 2024 (for the financial year 2023), and the first standards are expected to be issued by EFRAG by the end of 2022.

The future CSRD quadruples the scope of the current NFRD and will apply to approximately 50,000 companies instead of the current 11,700.

Evolution of the scope of sustainability reporting obligations

The CSRD will clarify what is expected of companies: more analysis of the issues, a higher level of verification, a prescriptive list of information to be published, and prospective and quantitative data are expected.

Firstly, the analysis of dual materiality, which is the cornerstone of the future CSRD, is a prerequisite for ESG reporting, which will be based on an unambiguous definition.

In addition, the reliability of the statements will be enhanced by an independent third party audit that will provide a higher level of assurance than the current verification (limited assurance) of published sustainability information. The European Commission has the possibility to adopt reasonable assurance standards, which would increase the requirements and validation tests to be performed.

To enable investors to better understand the growing gap between the book value of many companies and their market value, disclosure of information on intangible assets such as intellectual, human and reputational capital, as well as information on research and development, will be required.

Through the work of EFRAG, whose initial work was open for consultation until 8 August 2022, general and sectoral sustainability standards will be determined with quantified targets for the short, medium and long term. SMEs will be provided with standards commensurate with their capabilities and resources.

• For environmental factors, companies will need to specify their strategy for dealing with climate change and provide data aligned with the Taxonomy.
• On the subject of social factors, companies will have to publish information on the promotion of equal opportunities or the respect of human and fundamental rights.
• Finally, in the area of governance, the role of management in combating corruption, integrating sustainability issues into decision-making, and engaging with external stakeholders will be clarified.

The desire to standardise and make sustainability reporting more accessible is reflected firstly by the obligation for companies to publish all financial and non-financial information in a single management report. The aim is to maximise the overall performance of companies by means of steering that takes better account of the cause and effect relationships between financial and non-financial information.

In addition, the CSRD plans to digitise corporate sustainability information in the same way as financial information through a Europe-wide digital access platform. Digital tagging of key data will be required so that it can be compared and analysed by stakeholders.

With the CSRD project, the exposure to reputational risk (greenwashing, lack of transparency) and loss of social license is multiplied and becomes European or even international.

The European Commission’s CSRD proposal dated 21 April 2021 has not yet entered into force.

The draft implementation schedule is as follows:

• October 2022: Adoption of a first set of standards from EFRAG’s work
• 2022 end: Finalisation and adoption of the CSRD by the European Union
• October 2023: Adoption of a second set of industry-specific standards resulting from EFRAG’s work
• 2024 (for the financial year 2023): Implementation of the CSRD by relevant companies (excluding listed SMEs), possibility for SMEs to publish this information on a proportionate to impact and voluntary basis
• 2027 (for FYE 2026): Implementation of CSRD by listed SMEs

It should be noted that a European directive must be transcribed into the national law of each Member State.

However, this timetable is not fixed yet. The Council of the European Union in February 2022 and the European Parliament’s Committee on Legal Affairs in March 2022 have stated their position and wish to delay the implementation timetable by one year.

Whatever the final timetable for the implementation of the CSRD, the legislative work in progress obliges companies to prepare for its implementation from now on. Indeed, the creation of a sustainability analysis that meets the transparency standards and serves the company’s project can be anticipated nine to twelve months before the publication date. Assuming that the scope of information to be produced covers between 50 and 100 reporting points, it is then a matter of the company organising and launching a fully-fledged project and securing it step by step.

Notes:

EFRAG: European Financial Reporting Advisory Group

ISSB: International Sustainability Standards Board, part of the IFRS Foundation

GRI: Global Reporting Initiative

CDSB: Climate Disclosure Standards Board (CDSB), is a consortium of companies and NGOs, recently consolidated into the IFRS Foundation

IIRC: International Integrated Reporting Council.

*A micro-enterprise in the European sense is an enterprise which, at the fiscal closing date, does not exceed the numerical limits of at least two of the following three criteria: (a) balance sheet total: EUR 350,000; (b) net turnover: EUR 700,000; (c) average number of employees during the financial year :10.