ESG – Regulatory Overview

The increased importance of Environmental, Social and Governance (ESG) matters is by no means a novelty, fuelled partially by society’s call for change as well as by the EU’s advancements on a legislative perspective. This article sets out the legislative point of departure and highlights the key developments that have taken place within the ESG sphere since then.

The Non-Financial Reporting Directive (NFRD)

The outgoing Non-Financial Reporting Directive (Directive 2014/95/EU) was adopted back in 2014 and came into force in the financial year ending in 2017. This Directive applies to large public interest entities (PIEs) that employ in excess of 500 employees, targeting approximately 11,700 large companies and groups across the EU.

The NFRD together with its follow -up non-binding reporting guidelines have been criticised for not catering for the quality of information which is nowadays demanded by users. The lack of guidance and assurance hinders the level of comparability and reliability of sustainability information which is reported.

Following the adoption of the 2015 Paris Agreement(1) on climate change and the United Nations Agenda for Sustainable Development (the ‘2030 Agenda’) which emphasises the Sustainable Development Goals, the European Commission has sought out a strategy which further connected finance with sustainability through its action plan “Financing Sustainable Growth”(2).

This article summarises the key legislative changes since the introduction of the NFRD.

The Corporate Sustainability Reporting Directive (CSRD)

The CSRD was issued in April 2021 and supersedes the NFRD.  This is a major tool in the achievement of the European Green deal’s objectives which seek to transform the EU into a resource-efficient economy with zero net emissions of greenhouse gasses by 2050.

This proposed revision seeks to improve companies’ accountability and transparency when reporting their own impact on the environment and people through providing reliable, comparable, relevant and understandable information. The adjustments which take place through the CSRD aim to improve clarity in the disclosure requirements which apply in specific circumstances.

The principal changes which are expected to be brought about by the CSRD are:

• Reporting requirements have been extended to additional companies, including all large companies and EU listed companies except listed micro-companies.
• All companies within its scope are required to seek limited assurance for reported information. The CSRD also includes an option to require reasonable assurance at a later stage.
• The information requirements for companies within its scope is specified in greater detail through making reference to mandatory EU sustainability reporting standards, such as those currently being developed by the International Sustainability Standards Board (ISSB) and European Financial Reporting Advisory Group (EFRAG).
• Requires all information to be published within companies’ management reports and disclosed in machine readable format.

A company is considered to be ‘large’(3) when two of the following three criteria are met:

• It employs more than 250 employees on average during the financial year;
• Its balance sheet total exceeds 25 million euros;
• It generates a net turnover in excess of 50 million euros.

The introduction of the CSRD is expected to make it mandatory for approximately 49,000 companies within the EU to report and disclose critical non-financial ESG related information, representing a significant increase from the 11,700 companies previously targeted by the NFRD.  The increase in targeted companies required to report should substantially increase ESG disclosures within the EU and is expected to bring about a greater emphasis on people and the environment.

The introduction of value chain reporting requirements is expected to require all entities, that transact significantly with entities that fall within the scope of the CSRD, to report ESG data in line with the directive. Reporting requirements include a double materiality perspective, meaning that disclosures should provide the necessary information to understand the entity’s impact on sustainability matters, as well as the impact that sustainability matters are creating on the achievement of the entity’s goals. This shall include both a retrospective and a forward-looking application through qualitative and quantitative information, including information which considers an entity’s value chain.

The proposed changes are expected to be implemented in a stepped approach, primarily applying to entities which are already within the scope of the NFRD from the 1st of January 2025 reporting for the 2024 financial year. Then applying to large companies not presently subject to the NFRD from the 1st of January 2026 reporting for the 2025 financial year, followed by listed Small and Medium-sized Entities (SMEs) on the 1st of January 2027 reporting for the 2026 financial year.