Of all the momentum with global corporate sustainability reporting, the European Union (EU) and companies in the EU have been on the leading edge of promoting transparency on sustainability. In fact, many of the more widely accepted environmental, social, and governance (ESG) reporting frameworks have spun out of Europe. Furthermore, the EU has issued several regulations in recent years, aimed at enhancing reporting on ESG issued by companies. The latest of these regulations is the EU’s Corporate Sustainability Reporting Directive (CSRD).
One might assume this new EU regulation will only impact companies operating in EU countries; however, it will also be imposed on certain companies operating outside the EU, including those in the United States. And while most of us in the U.S. are closely anticipating whatever final rule the Securities and Exchange Commission (SEC) issues, especially after releasing its proposed rule on climate-related disclosures in March 2022, it will be important to understand the potential impact on U.S. companies with ties to EU companies from this CSRD.
Who is Required to Report Under the CSRD Regulation?
The EU’s CSRD will also have implications for U.S. subsidiaries of EU parent companies and U.S. parent companies with subsidiaries located in EU countries. The CSRD is expected to require four times the number of entities to provide mandatory sustainability disclosures than under current EU non-financial reporting requirements. This initiative is designed to bring sustainability reporting on par with the importance and structure of financial reporting over time.
Whatever teams, technology, and processes (including internal controls) are currently in place over your financial reporting, it’s likely your company would need to build similar reporting programs around this sustainability reporting (if you are in scope). Below, we summarize the relevant rules for who is required to report under the CSRD:
- Large or listed EU companies: A company is defined as a “large” company if you exceed two of three criteria. These criteria include a balance sheet (assets) of €20 million or more, a net turnover (revenue) of €40 million or more, and an average of 250 or more employees during any year. In contrast, “listed” companies include any company with stock listed on a regulated EU stock market, certain financial services companies, and public interest entities as identified by local countries of incorporation. Under this provision, if an EU company operates a U.S. subsidiary, that U.S. subsidiary may be required to report in the EU parent’s annual sustainability reporting.
- Global companies with a significant presence in the EU: Companies with their ultimate parent outside the EU may be required to report under the CSRD if the net turnover (revenue) from those EU subsidiaries exceeds €150 million for two consecutive years. Additionally, at least one of the EU subsidiaries is a “large” or “listed” company or individually exceeded 40 million in net turnover.
What is the Timeline and Scope of Reporting Requirements?
As developed by the European Financial Reporting Advisory Group (EFRAG), the European Sustainability Reporting Standards (ESRS) set rules on what companies will be required to report under the CSRD. The standards require environmental reporting on issues such as climate change, pollution, water, marine resources, biodiversity and ecosystems, resource use, and the circular economy. Additionally, social topics such as workforce, workers in a company’s value chain, and affected communities. Lastly, consumers and end-users and governance practices, such as corporate culture and business conduct.
The CSRD not only requires a company to report on ESG activities for its own companies, but also for companies within its value chain. Vendors, service providers, customers, and other companies within direct and indirect business relationships, whether upstream or downstream, could be subject in a company’s sustainability reporting. The CSRD also requires reporting on those companies’ material impacts, risks, and opportunities on sustainability.
The timeline for implementation and first reporting will vary based on which scope and category your company falls under. Reporting under these EU sustainability reporting rules could begin as early as the next calendar year 2024 (reporting to be issued in 2025). However, there is a complex phase-in of the requirement over four years. For instance, large EU subsidiaries of U.S. parent companies and U.S. companies listed on regulated stock markets in the EU would begin reporting for the calendar year 2025. Furthermore, U.S. companies with greater than €150 million of net turnover in aggregate from EU subsidiaries and at least one large subsidiary will begin reporting for the calendar year 2028.
There will also be audit requirements on this sustainability information. Companies will be required to hire an independent third-party firm to provide limited assurance on the published sustainability information. The requirement for limited assurance reporting is expected to be expanded to reasonable assurance at some point in the future.
While there’s a lot to take away from the new CSRD rules, here are three key takeaways we’ve identified:
- Competitive advantage: U.S. companies that embrace sustainability reporting and integrate ESG considerations into their strategies can gain a competitive advantage in the global marketplace. By adhering to the EU’s standards, they can access European markets more easily and build trust with international customers. U.S. companies that fall behind in adopting sustainability practices may face reputational and financial risks when dealing with international markets.
- Influence on U.S. regulations: The EU’s leadership in sustainability reporting has not gone unnoticed in the United States. As awareness of ESG issues continue to grow and investor pressure maintains, there is an increasing call for standardized ESG reporting requirements at the national and international levels. Certain U.S. states have introduced legislation mandating ESG disclosures, and regulatory bodies such as the Securities and Exchange Commission (SEC) are actively exploring the implementation of similar rules. The EU’s regulations serve as a reference point for these discussions, providing insights into best practices and potential frameworks.
- Compliance challenges and costs: Adhering to the CSRD requirements may pose challenges for U.S. companies with foreign subsidiaries in EU countries. Compliance costs such as data collection, verification, and reporting processes are likely to increase. Companies will need to invest in systems, tools, and resources to meet the reporting obligations. If your company has operations in any EU jurisdiction, whether a parent in an EU country or you operate a subsidiary in an EU country, now is the time to identify the extent your company will be subject to the CSRD rules. It will take time to build the people, technologies, processes, and internal controls to appropriately meet these reporting rules. If you find customers, suppliers, vendors, and service providers will be subject to inclusion in your CSRD reporting, it may take even more time to gather data points from those parties.
The EU’s corporate sustainability reporting regulations are expected to have a significant impact on U.S. companies. As the global focus on sustainability intensifies, it will be essential for U.S. companies to recognize the importance of ESG reporting and proactively adopt transparent and comprehensive reporting practices to remain competitive and address stakeholder expectations in an evolving international business landscape.
The CSRD will require certain U.S. companies to align their reporting practices with the directive’s requirements and potentially lead to significant compliance challenges and costs. Therefore, U.S. companies should closely monitor the implementation and implications of the CSRD to ensure compliance and seize opportunities for sustainable growth in the European market. If you have any questions about complying with ESG reporting, Wolf’s ESG team is here to help.