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Corporate Sustainability Reporting Directive: the rush to get ready

Brian Tomlinson

Managing Director, Environmental, Social and Governance, Ernst & Young LLP

Contributors

8 minute read 22 Nov 2023

For US-based companies doing business in the EU, getting readiness efforts underway is critical.

In brief
  • US companies are looking to complete scoping exercises in the near-term and assess the range of reporting options.
  • The double materiality process by the European Sustainability Reporting Standards (ESRS) remains “new” for US companies; existing approaches might be adapted.

The Corporate Sustainability Reporting Directive (CSRD) is a complex regulation for companies to prepare for. This is particularly so for groups headquartered in the United States that do business in the European Union (EU).

US groups that have more than a de minimis footprint or revenues in the EU are likely to be scoped in to CSRD reporting to some extent. With compliance horizons fast approaching, it is critical for companies to get readiness efforts underway. 

We talked to over 200 companies about their CSRD readiness efforts. They reinforced that CSRD was complex, that there was a broad range of issues to consider beyond just compliance, and that all of this was being considered under significant time pressure. Companies from every sector are wrestling with readiness, including the best governance structures to put in place to enable progress toward compliance.

There were, however, three issues that were front of mind at this stage:

  • Scoping
  • Reporting options
  • Double materiality

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CSRD scoping – assessing the “size of the problem”

 

Fifty-four percent of companies surveyed had conducted a CSRD scoping exercise. For many these exercises often produced unanticipated results, with the CSRD criteria scoping in a much larger proportion of their business than they expected. We’ve also seen a number of companies conduct initial assessments of their CSRD exposure, incorrectly concluding that they would not be scoped in, or underestimating the full scale of the CSRD scoping. Given these issues, many companies are focusing on scoping and looking to complete comprehensive assessments in the near-term.

 

A few key issues on scoping were raised by the companies we spoke to:

  • Data availability issues: The scoping under CSRD is on an entity basis. This can present challenges for companies that may not quite have the right data where they need it. For example, some have employee data on a country-by-country basis, which does not directly map to entities, necessitating workarounds as part of calculating the relevant size thresholds. Equivalent technical issues arise in relation to the calculation of balance sheet and turnover totals.
  • Interactions with group structure: A group’s structure can significantly impact the extent of the scoping. Features that can have impacts include the elevation of EU holdcos and the extent of the business that sits under EU holdcos. 
  • Debt issues: Having securities listed on an EU regulated market is an element of the scoping under CSRD. Given this, companies are looking carefully at where their securities are listed, on which exchanges, and the jurisdiction of the issuer. This can have an impact on the extent and timing of the scoping.
  • Cross-functional collaboration (across internal groups and advisors): To complete a comprehensive scoping exercise, companies are having to collaborate across functions including Finance, Sustainability, Treasury and Group Legal, and doing so across relevant jurisdictions with scoped-in entities. The issues presented by scoping may also require engagement of outside counsel, such as securities counsel, to review the complexities presented by the scoping in relation to listed securities.

The EU is also pushing through an amendment to the size thresholds for scoping (uprating them in line with 10 years of inflation) as part of the EU’s 25% reporting burden reduction initiative; this accommodation may cause some entities (right at the lower bound of the size thresholds) to fall out of their current scoping category. 

 

Reporting options on CSRD – at which level and when

 

Third-country groups (those not headquartered in the EU) with entities scoped in to CSRD face a complex set of considerations for deciding on how to report on CSRD.

 

The majority of companies we speak to have not made final determinations in relation to the reporting option. However, many are expressing an initial preference. This preference is a basis on which to commence readiness work. Clients are broadly aware of the range of options available to them. Each comes with its own set of challenges.

 

The reporting option chosen is informed by a broad set of considerations that goes beyond compliance. As such, the process for reaching a decision is iterative and a bit like “playing a particularly complex game of three-dimensional chess.”

 

We highlight a few considerations:

  • Extent of scoping: For some US group companies that either have a significant portion of their revenues or entity footprint in Europe, or that have elevated EU holdcos in their group structure, much of their business is likely to be scoped in to reporting under CSRD. This may drive a different set of conversations around the reporting option when compared to a US group that only has less than 5% of its business scoped in to CSRD.
  • Scale of disclosure: The ESRS (and Taxonomy) which entities scoped in to CSRD will report on are an extremely extensive and novel set of disclosures. As such, companies are considering whether they can get comfortable with the extent of disclosures required at the reporting option chosen (and on the applicable time horizon).
  • Control of process: Given the extensiveness of the disclosures and the attendant strategic considerations attached to CSRD, many companies want to perform the preparedness for CSRD at the enterprise level. Additionally, many companies have prepared and housed their sustainability data at the enterprise level. This may influence the reporting option being considered and the way readiness is overseen.
  • Leader or laggard: Many companies that have been leaders on ESG and sustainability disclosure want to maintain that leadership position. That may influence how they choose to report on CSRD, in addition to the capital markets implications of the disclosure choice made.
  • Interaction with other reporting requirements (current and anticipated): Companies are also aware of the range of sustainability reporting initiatives underway, in both the regulatory and voluntary space. Many are considering how their preferred reporting option under CSRD will impact their readiness efforts in relation to other requirements and if efficiencies can be gained.

Double materiality

Only 8% of surveyed companies felt ready for the requirements of a full-fledged double materiality assessment.

Many of the surveyed companies had approaches in place to conduct a “materiality” assessment or a “priority issue assessment” for the purposes of voluntary sustainability reporting. These were often constructed by reference to an existing voluntary ESG reporting disclosure framework, such as Global Reporting Initiative (GRI) or Sustainability Accounting Standards Board (SASB) (now folded in to International Sustainability Standards Board (ISSB)). However, it was understood that the double materiality process prescribed by the ESRS was “new” and that existing approaches would need to be adapted. This was particularly so given that the double materiality assessment was the primary driver of the reporting under the ESRS; those topics that the assessment identifies as material are those that will be reported on (in addition to the mandatory elements set out in ESRS2).

The structure of the double materiality assessment means that something is “material” if it is material under either the impact or financial materiality perspective — it does not have to be both. A further challenge is presented by assurance, as the process for conducting the double materiality assessment (regardless of its novelty) will be subject to assurance alongside the disclosures themselves.

Given that, there was a significant burden of education to explain how the ESRS double materiality assessment was different and build capacity around conducting assessments, with support from their advisors. 

A few further challenges were identified:

  • Guidance: A novel standard presents a range of interpretational issues. Companies seek authoritative guidance to supplement the direction provided by the ESRS. Such guidance is under development by the European Financial Reporting Advisory Group (EFRAG), but many clients indicated that it cannot come soon enough.
  • Interaction with existing materiality approaches: For companies considering reporting at the global level, there were considerations around the interaction of the ESRS double materiality assessment and ESRS disclosures with existing materiality assessments and disclosures made for the purposes of SEC reporting. 
  • Extent of stakeholder engagement: The ESRS prescribes a laundry list of potential stakeholders to be consulted for the purposes of an assessment (including stakeholders who cannot be directly consulted, such as nature, noted as a “silent stakeholder”). Companies are considering how best to manage this consultation burden and the type of tech solutions that can be leveraged to make the process as streamlined as possible.

Beyond the beginning

The scoping, reporting option and double materiality assessment topics are complex and require iterative consideration. Nonetheless, clients are also turning their attention to the phases of CSRD readiness that will inevitably follow. This is necessary as the compliance time horizons under CSRD are close at hand and the build to get ready for CSRD disclosures is very extensive. This multi-year readiness effort will likely include:

  • Readiness roadmap: Clients are conducting gap assessments, mapping their existing reporting to the requirements of the standards they will have to report on (both mandatory and materiality driven elements). Such gaps are expected to be extensive and require significant cross-functional collaboration to fill.
  • EU Taxonomy: That readiness roadmap will likely include novel and complex elements such as the EU Taxonomy, which will be reported on at the same time as CSRD and in the same reporting format. Taxonomy requires a range of KPIs in relation to turnover, capex and opex, based on how “green” a company’s business activities are.1
  • Updating ESG reporting approach: As part of CSRD readiness, many companies are thinking about their existing ESG reporting and whether it should be revisited in light of the extensiveness of required and regulated disclosures.
  • Revisioning ESG strategy: The CSRD readiness roadmap may also cause companies to re-consider their ESG strategies. For example, companies may (as a result of their double materiality assessment) have to report on a range of sustainability topics they have never reported on before (e.g., circularity). As such, to avoid having to disclose the absence of a strategy on that theme, a company may want to rapidly develop and subsequently augment such strategies in these new areas.

Getting ready for CSRD is a complex, multi-year undertaking. It is imperative that companies assess the extent to which they are scoped in to CSRD and begin their readiness efforts. 


Summary 

CSRD is a complex regulation particularly for groups headquartered in the US that do business in the EU. With compliance horizons fast approaching, it is critical for companies to get readiness efforts underway.

About this article

Brian Tomlinson

Managing Director, Environmental, Social and Governance, Ernst & Young LLP

Executive, thought leader and speaker focused on ESG, sustainability and long-term value. Former attorney with 20 years of experience in law, financial services, public policy and sustainability.

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